VALUE: After Hours (S08 E37): The Best Business You've Never Heard Of?

[Tobias]

We're live. This is Value After Hours. I'm Tobias Carlisle, joined as always by my co-host Jake Taylor, our special guest today.

Todd Wenning, he's a repeat guest. How are you, Todd? Good to have you back.

[Todd]

It's great to be here. Thanks, Toby.

[Jake]

Repeat offender.

[Tobias]

You sent through a new report that you've put together recently. Take us through the report. So I just read it.

[Todd]

I just wrote this big report on a company that's based in the UK called Howden Joinery. UK investors probably know it very well. It's HWDN in London.

So if you want to buy the shares, it's primarily through the London market. There are some OTC shares, but you've got to be really careful with those because they're not very liquid. And so if you're going to venture that way, make sure you look at the limit orders on those.

So this is a big UK company. It's a FTSE 100 company with a market cap still in the single digits. So you think about comparing to the US market, it would be a small cap, but in the UK, it's a member of the FTSE 100.

So a very well known company in the UK. And so a couple of years ago, I posted on X and I said, I guess it was Twitter back then and said, what are some companies in Europe that are high quality that Americans probably don't know anything about? And Howden's came up to me multiple times from people saying, hey, you got to look into this company, which was a good hint that maybe I should take a closer look.

They have one of the best annual report histories I've ever seen. They are great communicators. They've got great artwork.

It's very kind of irreverent. It's got like a fun sort of illustrations that kind of help you understand how the business works. They're very clear with how the business runs.

And I started reading it and I was probably about six pages in. I said, yeah, I've got something here that I really want to dig into. And so a lot of pattern recognition kind of fell into place and I started digging in there.

Howden Joinery (HWDN): The Hidden UK Stock With a Competitive Advantage

So I've been a shareholder and my firm K&A Capital has been a shareholder since inception as well. So what Howden's does is they are a kitchen manufacturer. And in the UK, they primarily sell kitchens and joinery.

So joinery being carpentry, things like, you know, for the doors and things like that for the floors and things. And what's unique about their business model is they are business to business and they only deal with the trade customer. So that's the pro customer to us in the US.

They do not work with customers like regular homeowner consumers. So you can't just walk into the store and say, hey, I want a kitchen. So what's really great about their business is they've got a couple of different things going for them.

They do really well in high density areas. So UK being a fairly densely populated area, they have these very small, about 10,000 square foot stores or depots as they call them around the UK. And they've got some stores, maybe we'll talk about this later, in France and in Ireland and in Belgium, I think they might have a few left in Belgium as well.

But they deal primarily with the trade. And so someone will come in, the builder works independently with the homeowner. They say, hey, I want a kitchen remodel.

The builder works with the customer and with Howden's to come up with the plan for the customer. And they build a great kitchen. You can put it in very quickly.

And this is what Howden's major advantage is relative to what I think is the US model, which is way too decentralised. I mean, if you guys have ever looked into getting your kitchen remodelled, there might be six or seven different suppliers supplying the kitchen remodelling. And say, hey, this part broke, so we got to wait for that to come in.

And that just doesn't happen with Howden's because they control the entire kitchen. And so someone, if something breaks, they can just go back to the store five miles away, get a new one, come back, finish the job. So it's very appealing, the business model to the pro builder, because they can turn over jobs a lot faster and move on to the next one.

And so that's one aspect of their business. The other aspect of business that I really like is that they have an ownership culture at the depot level. So from the beginning, the depot managers get a share of the store profits.

And then it's a monthly bonus related to the profitability of the depot that they manage. And then everyone else in the store who works at the store, the staff members also get a cut of the monthly profits. And so it self-manages, right?

Kind of a left Schwab model. Right, right. So if you want to hire someone else, you have to convince the rest of the staff that, hey, they're worth sacrificing a little bit of your monthly bonus to bring this person on and make us more efficient.

So it's a very self-regulating system and it's a very profitable business with a consistent 60% gross profit margins. EBIT margins are about 15% because they have a lot of operating expenses, but it's a very strong business model. ROIC is probably about 20 in a normalised market.

So very strong business. And so the point of my article was that kind of going long, long loop here, but getting to my article, what I posted was they should come back to the U.S. And they haven't been in the U.S. in over 20 years. So my understanding early on was that Houdin's had a small programme in the U.S., maybe one or two depots back 20 something years ago. But it turns out they had a pilot programme when they were operating under a previous parent company called MFI Group. And MFI Group had their hands in a lot of pots. They had a retail operation on the home improvement side.

They had some other things around the world and they ran into some financial trouble in about 2005, 2006. And so they had to pull the pilot programme in the U.S. and elsewhere. And so the model was working really, really well.

It was starting to really hit scale because there's a bit of a J-curve in the adoption. So they launched in the Atlanta, Georgia region around 2001 and then started ramping up. They were starting to get a lot of home flippers around that time, going into the housing crisis, a lot of home flippers found their model very appealing.

And so one of their depots actually in the U.S. was on par with their mature stores in the U.K. and in a market that I don't think was actually an ideal market for them to be in. So long story short, you have this great business model that I think would fit really well in the U.S. and could eventually have a similar depot structure in the U.S. as they have in the U.K. They've got about 800 something, 870 depots in the U.K. They could have at least the same number in the U.S. over the next 10, 15, 20 years. So it looked like a huge option value that's just currently not even being considered for Howden's.

And if the kitchens are so great, why is the food so bad in the U.K.? I actually like the food in the U.K. I got used to it when I lived there, but yeah, I understand.

[Tobias]

So where do you see the valuation? Where do you see the next five years?

[Todd]

For Howden's, I think so. Howden's has had trouble scaling outside of its home region. It's been in France for about 20 years, and it has about 60 or so depots in France.

It just has never gotten to the scale that it was potentially hoping for. I think there is a number of reasons for this, but I think the model could be replicated in the U.S., right? And so I think the net present value, based on my rough estimates, being an outsider, not knowing all the details of how much everything would cost, I was trying to be as conservative as possible, but I think it would be a net present value positive for them to move into the U.S. and really give it a try because they really could scale their business quite substantially in the U.S. and deliver a lot of value for a long time. So I think a lot of the valuation you're seeing right now in the stock, I think the PE is about 16, depending on the day.

It's been up the past couple of days, but it's been about 15 or 16. And I think there's been some concerns about future growth because they're reaching full penetration in the U.K. market. They've got about four or five years left of depot growth there before they've hit what they term to be the full amount, about 1,000 stores.

So they have to find a new growth market. One of the things that they've done over the past year is they acquired a company in the U.K. called DIY Kitchens, which is a direct-to-consumer DIY DIY kitchen. So it's not in the trade.

So they're holding it completely separately from the trade-only Halodins, but it indicates to me that management needs growth. They want to find new opportunities to grow for the longer term. And for me, I look at how much they spent on the DIY acquisition, which is about £370 million.

They could have done that investment in the U.S., kept focused on the trade, and it could be just as big as the home market is in a 10-, 15-, 20-year period.

[Jake]

Seems like with 10,000-square-foot footprints, you could find a lot of those in the U.S. for probably not insane rents.

[Todd]

Right. And that's the key to their success. So they had a competitor in the U.K. called Wren Kitchens move into the New York City area about six or seven years ago, and they recently went bankrupt. So you might think, that's a terrible precedent. Maybe that's a sign that they shouldn't come in, but they had a very different model. So Wren's is more of a traditional showroom where they work directly with the homeowner.

And so they had to get real estate in these glitzy, high-traffic areas, whereas Howden's, what they'd like to do is find these sort of industrial parks around the population centre and build networks around there so that they have the inventory always in stock, but they're in locations with very low fixed overhead costs. So by having that, it's an initial cost advantage that Wren's Kitchens did not have. So I think that would be, it's understandable if management says, well, I'm concerned about going in because Wren's just got kicked out.

I think it's a completely different business model than what Wren's was offering.

[Tobias]

So assuming they get to saturation, which seems likely in the U.K. in the not too distant future, what do you see that sort of no growth valuation versus where it's trading right now?

[Todd]

So the market's currently pricing it with a very low growth forecasted, but I do think that they can continue to add services to what they're currently doing in the U.K. So similar to what Home Depot did in the U.S., where they ran out of store locations and what they did was monetise those locations even better by adding more services. So one of the things that Howden's has done in the past couple of years is they've added bedrooms in addition to kitchens. So if you want to redo your bedroom, they've got bedrooms that you can just kind of plug in and upgrade and they look great.

So you can see how they could go to other locations in the house. They could go to bathrooms maybe next. These are additional markets that they could move into within the home and expand their current footprint.

[Tobias]

So the stock's on 16 times earnings. And what sort of expected return are you at that level? And then where do you see the valuation?

[Todd]

Strong to quite strong. Strong to quite strong. I mean, I think there's a great opportunity.

I think the U.K. housing market has been in a real rut over the past, since really since Brexit. It's been under a lot of pressure. Interest rates have been high.

Housing turnover has been pretty stagnant. Their other big market, France, has not been much better. And so if you have a return of more normalised interest rates, more normalised housing environment, I think the stock could very well be growing at the current or the earnings could grow at the P.E. ratio right now. So you're looking at a peg potentially of one, right, where it's growing 15, 16 percent for a couple of years at a P.E. of 15. So I think it's a very, very attractively priced right now. It's mid single digits, mid to high single digits, free cash flow yield.

I think there's some growth left and mid-teens is, I think, quite reasonable for this stock going into if it recovers back to at least the mid cycle.

[Jake]

Aside from the reports that you like, how do you feel about management? Because you're sort of betting that they're going to figure it out, right?

[Todd]

Yeah. So I think very highly of management. And this was not this was not meant to be any sort of knock on on management's capital allocation.

I just don't think anyone has been really thinking about it. And so I really wanted to bring it really to their attention that, hey, there's there's this huge market. I mean, it's been it's been 20 years and there's been a new management team since then.

I think it's I think it's very easy to dismiss the U.S. markets, because you can easily talk yourself out of it because we don't operate on the metric system. Right. So you can't make.

And so Howden's tried this when they were in the U.S. originally. They were shipping cabinets from the U.K. to the U.S. in metric terms and trying to teach the U.S. home remodeler how to use the metric system.

[Jake]

Yeah.

[Todd]

And that's just a really big uphill battle. Right. So so part of my thesis and my argument is that, hey, come into the U.S., build your own facility, because that's what they were actually trying to do before they got the rug pulled out. So they were very close to building their own U.S. facility. And that way they could design products for the U.S. customer, right, directly for the U.S. customer in inches and feet and in the imperial system and start delivering what the builders are looking for, making the builders jobs easier, because that's who they're trying to serve. They're trying to serve the builders, not the homeowners necessarily.

But the homeowners are the builders customers. But they're trying to enrich the trades persons. The trades person comes back to them over and over again.

So that's the key, I think, to the argument is build a mini mill. All right. Start producing things at a small level.

And if they start going well, start building more and more and more. It's a it's a very you can scale it very quickly once you have the blueprint in place and word starts getting around between builders in different regions like, hey, have you tried these guys before? They're really good.

And I think that's right where they were. They were just about there and they got pulled pulled out. So it's a it's a it's one of those what ifs, right?

Like what what could have happened? And I'm always drawn to those types of stories. But so anyway, get back to your question about about management.

I think that the DIY acquisition was something that's still I'm still working through because they when they when they kicked out the MFI retail business, right, the focus was to focus on the trade. And then they brought retail back into the mix. And so it was kind of like, are they going to be focused on this this brilliant business model that they have?

Right. This trade business model. The company also issued shares to acquire DIY kitchens at a what I believe is a pretty attractive valuation.

Yeah. But on the other hand, the sellers of DIY kitchens took the stock and held it. Right.

They wanted the stock. They wanted to participate in what they saw as the value for Houghton's. They think very highly of each other, both both parties.

And they've been you know, they they know each other quite well. And so I think it could it could work out. And maybe there's something to the effect of, hey, maybe we can move into new markets with leading with this retail concept with DIY kitchens, getting a better feel for, hey, what do the customers want in those regions, and then following it up with the with the trade business, which is a much better business, in my opinion.

And I think that could be something they could do to integrate the businesses, because there's really no synergies other than other than that. So I think so I think there's been a lot of big capital allocation decisions that management has to make. And I think the US is as good as option of any of those probably better, in my opinion.

[Jake]

Is that 15% EBIT margin? Is that before or after the profit sharing? Do you know?

[Todd]

That's after.

[Jake]

Yeah. Okay.

[Tobias]

Is that representative of the sort of stocks that you look for? Todd, what else do you like or sort of hold or can you talk about?

[Todd]

Yeah, I probably have more industrial than I than I typically would. I've just been drawn to a number of those recently. I think a lot of them have been attractively priced.

Ferguson, I own that's it's one of my top holdings in the K&A core equity strategy. And then I just added Watsco last month. Watsco is a company that I've known for a long time, looked at him for a couple of years ago, always felt like they're a little too expensive.

And we had I had some concerns about where the housing cycle was, because HVAC, those are a big replacement cycle. And then, you know, it was tax credits past couple years. All of a sudden, things are starting to shake out.

So the stock's been beaten up. But it's a great management team. The family has a major ownership position.

So that's very indicative. How do you like their vesting schedule that they do? Oh, I think it's so unique.

It's so, you know, you can have qualms with it. And I certainly don't think it's perfect by any stretch of the imagination. It can lead to some behaviours that you may not want.

Right. But I do think that in general, it's a very appealing compensation plan because it is relentlessly long term. And that's unique.

I mean, most companies I look, I look at a couple of dozen companies a year, at least. And most of the compensation plans are just, you know, like Munger's famous compensation committees, right? You know, just do your best and hey, you win and tails you win, heads, shareholders lose, right?

But I think this plan is at least thoughtful. And I do think that it does align interests quite well for the long term. And so when there are concerns about short.

[Tobias]

How do they do that? What's the mechanism?

Watsco (WSO): Why HVAC Distribution Could Be a Long-Term Investment

[Todd]

So they have a vesting schedule where they, I think it's, they don't even know how much stock that they have until they reach retirement age. So if they leave, so if you're like a senior executive and you're like, hey, 15 year, great run, I'm going to jump to a CEO role somewhere else. They give up all that vesting.

So you have to retire with the company above, I think it's 65, that you have to, you have to be at least 65 and retire with the company before you can use that vesting schedule. So there's just this feeling like, hey, you know, if the better I do now, the more my, my equity comp builds into retirement. And so it does, it is, it is interesting.

They have a big dividend as well. And that is, I believe, to help appeal to potential companies they want to acquire, right? So if they acquire an HVAC distributor that, you know, gets the ones that get bought out, but they can get a dividend, right?

They can get, take shares and they can, they can get a dividend to help supplement their income. So I think that is one of the things that they use as a, as a, as a carrot, so to say for the acquired companies that they're looking for.

[Tobias]

And this is Watsco. What's the business? What's the, what's it about?

[Todd]

HVAC distribution. So, you know, they're primarily in the sunbelt of the U.S. Air conditioning, you know, unfortunately due to climate change, this is going to become increasingly inelastic. You know, the HVAC breaks in your house, you have to get a fix, especially if you live in the sunbelt, there's, there's no two ways about it.

And that's increasingly true.

[Jake]

Or you get divorced. Those are your two options. Right, right.

[Todd]

Yeah. There's no chance you're not fixing the HVAC. And so to me, that's, that is a no brainer in terms of something that's not going to change.

So we were talking before we jumped on about all the change, you know, that we're seeing in the economy from AI. And to me, that's one area of the market that is just not going to change. There might be the tech stack that the HVAC is using to process the logistics and things might change.

But in terms of the end product demand, HVAC is not going anywhere for a very long time, unless there's some innovation that comes along that renders it obsolete, which I don't think is anywhere close to happening.

[Jake]

We might have to go backwards on some of this stuff when it did a bunch of refrigerator units that were online connected and all over Europe right now have gotten packed and shut down.

[Todd]

That's right. Yeah. Yeah.

The more our, our houses are connected by Wi-Fi, the, I guess, the more concern there is for that sort of thing happening to the average human average, average resident.

[Jake]

Do you really need your oven connected to the internet? No, there's no, there's no reason for that whatsoever.

[Tobias]

My kettle's connected to the internet. Is it really? Get out of here.

In case you want to check the temperature of the tea. You couldn't get one that wasn't connected to the internet. How do you see the housing cycle?

US Housing Market: Why High Mortgage Rates Are Freezing Home Sales

[Todd]

In the US? Yeah, in the US, I think we're just at a, at a freezing point right now. There's just things aren't moving.

Just thinking about the interest rates, I don't even know how people are affording houses over a certain level with 7% mortgages at the current asking prices. And so that's getting, that's getting, we're coming to a head, I think there. And I think we might've already, already hit it.

And you see the new home builds just froze up. I think for a while there, the new home builds were an option for people because they were buying down the mortgage rates. But that, but that requires people to want to live further afield because the home builders can't find any available land near cities.

And that was at a time when work from home was still a valid option for most people. And so you could live, you know, 20 miles from the city centre, 30 miles from the city centre, drive into town two days a week, and it might've, might've worked. But now if the company's saying, Hey, you got to be here every day, that shifts the equation to, Hey, you got to live closer to the city.

And that means newer home builds are just not as good of an option as they were before. And so that means higher prices. And so it's, I think it's just been just a tonne of pressure on the potential homeowners.

You know, we, we bought our house, what was that? 11 years ago now. The game has changed, you know, in terms of the affordability it's, I do feel bad for people looking for, for homestay.

I'm not sure how they make it work without support from a family member or some other means.

[Tobias]

I've been watching Nick Gurley, who has some housing commentary and he, he has the, he tracks the two rates, mortgage rates and house prices. And a lot of the housing industry folk realtors and so on think that the problem is higher rates. And that if you cut rates, you get a flood of people back into the market.

But I just don't think the math maths when you, when you look at it, because just to go back to those long run rates, doesn't really improve profitability enough. And we've got the result of it is, as you point out, there's that freezing where there's fewer transactions going through than the credit crisis at the very bottom, which is kind of amazing. And you've got to go back 30 years in the data to find comparable transaction volumes when the population was much, much smaller.

So it really is. I don't know what the solution is. It takes a long time to kind of unfreeze, but it seems like it's a hangover from like the post pandemic stimulus and all of the sort of stuff that went on around then.

And we're six years into that.

[Jake]

So it's yeah, I'm freezing anytime soon. Unfreeze is one, one boomer dying at a time. Is that kind of how it's going to work?

I don't know, maybe.

[Todd]

Yeah, it may. It may be the case. I've seen studies that show that we have all the supply that we potentially need, but that's, I think it's tricky.

I think because national home numbers does not tell you everything because it's where people want to live. That's where it matters. So you could have homes in areas that nobody wants to live in.

Technically, someone could live in them, but it's not going to solve the problem. It has to be near where people want to live. But I think in terms of how this might turn into, it might impact house remodelling is it probably forces people to stay in their current location a lot longer, right?

If you, then they might otherwise would, right? Instead of upgrading to a larger house, maybe say, hey, how can we, how can we refit the current house that we have? Because, you know, we have a 3% mortgage, let's say on this house and jumping out and getting a 7% mortgage just jumps my payment every month, like doubles, triples potentially.

But I could stay here and make this house work. You could see some tailwinds from that if rates come down a little bit because you can justify maybe making that investment in your existing home versus trying to jump out and go somewhere else.

[Tobias]

Um, how about, uh, what about the impact of private equity? You see a lot of private equity. It's, it's like a, it's like a meme almost on Twitter that the, uh, the private equity guy, you know, when I say private equity, I mean like the search fund type first time private equity guys are often looking for HVAC type businesses.

Are they competitors in there or what, what do you think that has any influence at all?

[Todd]

For, for Watsco? Yeah. So I think they're buying from Watsco, right?

Yeah. So there, there's been a big push, um, certainly in the, in the post COVID era, like 21, 22, there were a lot of HVAC plumbing roll-ups trying to combine the HVAC and plumbing businesses. And so Ferguson, which is a company we also own, um, remodelled a lot of its, remodelled a lot of its, uh, its, its distribution centres to serve both HVAC and plumbing instead of just doing one or the other, because increasingly they were finding that these, these roll-ups now offer both.

Uh, so they want to keep it, you know, dedicated to those, to those customers. Um, but you think about the, the exit window for a lot of those investments, um, right about now. And so they're, they're starting to, maybe they're trimming back.

Um, I know, um, we used to own ChemEd, which owns, uh, Roto-Rooter and they were talking about how they were facing a lot of, of private equity competition on, on Google clicks because they were paying whatever they could to get placement above Roto-Rooter on Google searches, because they were using, um, plumbing as a loss leader for their HVAC business. But that you're starting, you're starting, you're starting to see these things roll off because they've got the private equity firms have to exit. And so maybe they're going to pull back to look a little bit more profitable going into a sale.

Um, so I think the dynamics there might be, might be changing a bit. Um, but there's still, the industry is still very fragmented, the HVAC distribution business. So there's plenty of opportunity.

Um, you know, Watsco has no financial debt, so they, they can withstand higher rates and keep doing what they're doing where competitors, smaller finance focused competitors may not be able to do that.

[Tobias]

Tell us a little bit about Ferguson's.

Ferguson (FERG): Why Industrial Distribution Is an Attractive Investment

[Todd]

So Ferguson is the phrase that I just have always used is balanced. They have, they're the second largest HVAC distributor in the U.S. after Watsco, and that's only 10% of their business. So they are extremely, extremely diversified.

Um, they, they focus primarily on the plumbing market. So not just home remodelling, but commercial, they've done quite well with a lot of the data centre build outs. Um, they've had, um, plumbing, the waterworks.

So, you know, new, new areas being developed. They need waterworks. They need, um, sewer lines and things like that.

Ferguson is, uh, one of the largest players there along with Coren, Maine as another one. Um, but interestingly, a good tie into the original Howden's piece is, um, there's, there's a, there's sort of a graveyard of UK companies that came to the U.S. trying to appeal to the U.S. consumer. Uh, Tesco being a great example.

Marks and Spencer, I think bought Brooks Brothers at one point. So there's a lot of this, a lot of, there's a long history of companies in the UK trying to come to the U.S. And vice versa, uh, and failing with the U.S. consumer. But there's a much better track record with UK companies coming into the U.S. on an industrial distribution basis, um, and employing a business to business model. So Ferguson was acquired by a UK company back in, I think, 1982. I could be off by a couple of years there, but, uh, it was acquired, um, by Wolseley in the UK. And so basically Wolseley financed a lot of the growth in Ferguson to take it to about 1500 locations around the U.S. And it eventually got so big that it relisted in the U.S. and rebased in the U.S. And so the, the Howden's parallel is, is interesting there because it's a very similar model in the sense that, hey, it's a business to business, industrial focused, uh, business plan, right? And so the track record there is not anywhere near as bad as it is for UK companies trying to come to the U.S. and sell to the U.S. consumer. Um, so, so Ferguson has about 1500 distribution centres, uh, around the U.S. and serve a variety of customers. They're about 50, 50 commercial and residential.

So again, balanced, right? Very diverse distributor, uh, in the U.S. focussing on water.

[Tobias]

Awesome. Uh, let me do a quick shout out and we'll do some veggies, JT. Everybody missed your veggies last week.

Gonna need a double serving. Paris, France. What's up?

Welcome. Snohomish, Valparaiso, Jupiter. Good on you, Sam.

You've already won. Tallahassee, Boise, Los Altos, Lawrence, Yakandanda, Australia. I don't know if that's real or not, but it could be.

Lausanne, Switzerland, Petit Tikva, Israel. Remember I'll read anything that's put into the screen of UWA. Bangalore, India, Göteborgs, Fergie.

Uh, is that local? Uh, Sweden or something like that. I'm not sure.

Antwerp, Belgium, Vancouver. Thanks team. We appreciate it.

JT, hit us.

Jake's Veggies — NVIDIA, CoreWeave and the Risks of AI Circular Financing

[Jake]

All right. I'm giving you some fresh veggies from St. Louis. I'm going to be here all week hanging out with, uh, Bloomstrand and Bobberbody and Bill Brewster.

Actually went on a nice walk with Bill this morning. So it was good. Uh, so today we've got a Disneyland story for you that also turns out to be a physics problem that might also turn out to help with our, uh, NVIDIA problem.

So bear with me as we kind of wander all over the, uh, the intellectual landscape. So as you know, everything decays, your coffee cools, your car rusts, your body wears out, uh, not yours, Toby, but other people. And the physics word for this wearing out is entropy.

And the rule is pretty simple. You know, a sealed box will run down. Uh, and however, however busy it looks on the inside of the box, doesn't really matter.

If nothing is coming in, eventually it's going to stop. And the only thing that beats it, uh, are things that eat energy and information to keep the disrepair at bay. Uh, so plants eat sunlight, some animals eat plants, other animals eat other animals.

Uh, and that's kind of the only real path that you can get to fighting entropy. Uh, I'll just give you a quick little kind of personal fun story about entropy. Um, I had a, uh, a massive bee infestation in my chimney and I was like, I don't know what to do.

Like I tried going up there and spraying them. I tried, like, we tried to get somebody to come move the queen to get them to go somewhere else. These guys would not leave.

And I'm like two stories up fighting them and getting stung all over the place. Finally, I realised, wait a second, I'm going to put a little, I'm going to shut down them getting outside energy. I'm going to put entropy on this thing.

So I got this like a big mosquito net and I threw it over the top of the chimney and then, and then tied it off so that all the bees were trapped. The ones who were inside were trapped on the inside. And the ones who were stuck outside came back and they couldn't get in.

And, uh, eventually it was a, it was a bee massacre. Uh, and I felt bad about it, but they had to go. And I used some physics, but, uh, anyway.

Uh, you know, a business money kind of works in the same way as this, where a business stays alive. Only if strangers keep feeding it money that they've earned elsewhere, uh, money that only circulates, circulates inside of the box. Isn't really food.

It would be more like heat. Um, so, all right, on the Disney it's 1955. Walt is building a theme park in an orange Grove in Anaheim.

Like it's the middle of nowhere at that point. Uh, and he's, he's short of cash and he needs a famous host for the opening. Broadcast.

So he calls his friend art link letter and art speciality was getting, uh, he was a TV, you know, character at that time. Uh, his speciality was getting ordinary people to talk and, and make their answers entertaining and live television, unpredictable guests, uh, things usually going wrong. And then being able to like work with it.

Uh, all very useful qualifications for a live broadcast of the opening of Disneyland. So link letter agrees to work for Disney for this broadcast, but, uh, Walt can't really pay him enough money. So they make a deal.

Uh, and so link letter asks for his, like the union scale, which is like way below his normal fee. Uh, but link letter being a savvy businessman says, I just want one thing in return, a 10 year concession to sell cameras and film inside the park. Uh, so even, you know, he pays Disney the normal, uh, you know, concession fees that they get.

And years later, he said it was worth a couple million dollars this, but it was probably downplaying that number. And that was back when a few million dollars was actually real money. Uh, so he's, he did quite well on this.

Uh, but let's think about what link letter actually bought. He didn't own the park. He didn't own any of the rides.

He owned a claim on basically families who came into the gate and needed photography services, film and development. Uh, and, but if nobody showed up, his shop would have died. And, and if they did show up, uh, he did very well.

So he had that outside energy coming in. Now there was a second deal. Walt also needed construction money for the park.

And he got, uh, he got it actually from a television network. So he went to NBC and CBS first, but they were doing well and didn't really need to take a gamble on, on a theme park. ABC was struggling at that time.

It was kind of an early fledgling and they needed something to break through. So they put up $500,000 for a third of the park and they gave Walt a line of credit and backstopped a bunch of loans in exchange. Disney gave ABC a weekly show leading up to the park.

And this also, the show also happened to be called Disneyland, just generically, uh, and it detailed like what was going to be in the park. So you picture this loop, like ABC's money helps build the park. The show about the park airs on ABC.

The show sells families on the idea of going to the park, uh, and the park makes ABC's investment eventually like money good. Uh, so capital kind of came in one door and promotion comes out the other. And if you describe that in 2026, you might call it circular financing.

Like we're hearing that term a lot right now, right? Uh, five years later, Disney actually bought out ABC for seven and a half million dollars. So it worked out well for all parties there.

Um, but it's, you know, obviously the AI build out has, uh, is, is full of these kind of loops, right? And everyone is arguing about whether circular financings are good or bad. And, uh, and that's, maybe that's kind of the wrong question.

The question probably should be like, where's the gate? Like, you know, the front gate of Disneyland. Let's take NVIDIA and Corweave.

I'm going to try to give you the mechanics in like one sentence. NVIDIA sells the chips to Corweave. NVIDIA puts $2 billion in for Corweave stock.

And NVIDIA has promised to buy whatever computing capacity Corweave can't sell to anyone else out to 2032. So it's basically like ABC and Disney with, with one extra clause, which is if the park is empty, the financier has to buy all the unused ride tickets at that point. Uh, and there's a one big difference.

This box decays much faster than Disneyland ever did. Like Walt's castle is still standing there 70 years later. Like we can go look at it.

Uh, but the GPUs are kind of more like snowman, you know, like they're gone. They melt in a few years. So this box needs to be, have a bigger gate and it needs to pay off sooner.

Um, so, and here's a little bit more of the physics side, like inside a sealed box, the money is still moving around. NVIDIA books, a sale Corweave books, an asset, a lender books alone. Everybody's kind of getting warmer in this whole thing.

It's just heat though. It looks like life from the outside, but it's not actually, uh, that heat is already inside of it, inside the box shuffling around. So we can do a little bit of a, a rough separation of Corweave's numbers.

If we look, they had 3.7 billion of net operating cashflow in the last six months. And we might call that food. Like that's actually like coming from the outside.

And then there's $14 billion of cashflow from financing in the same six months. And that's probably really more like sort of internal to the AI heat. So another number that we might watch is NVIDIA's $36 billion of capacity commitments.

If those shrink when outsiders are taking the capacity, uh, that's kind of okay. Uh, but when that's almost like a nourishing meal, but when NVIDIA is the one who has to take it on, then that's like basically kind of the equivalent of NVIDIA, like breathing on their own hands to stay warm. Uh, so eventually we're going to need to know who is going to buy all this compute.

What are they willing to pay? Whether those payments justify the cost of the machines, uh, including power financing, water, all the other things that go into this stuff. It's not like it's like necessarily low CapEx and low OpEx.

And eventually we also have to replace all this CapEx when the chips are, are fully burned up in a couple of years, let's say five to seven, whatever. Uh, so all this stuff is still very unknown, uh, what we're going to get out of this. Uh, so this brings us back to, to Art Linkletter to close this up.

He had a very clever contract. Uh, but what, what made that contract valuable was a family at Disneyland wanting a picture bad enough to go buy a roll of film there. And all those arrangements between Disney and ABC and the banks ultimately depended on millions of ordinary people coming in, uh, to make decisions to come in.

Uh, and so it's going to be the same thing for AI there is will customers get enough value from the computing to pay prices that make this investment work? Uh, cause you know, you can finance the camera shop, but, but somebody still has to buy film at some point.

[Tobias]

Good one, JT. That's a good question. Where do you, where do you fall on that answer?

AI Investing: Can Real Customer Demand Justify the Massive Spending?

[Jake]

I would defer to you intelligent gentlemen, uh, hear what you say first.

[Tobias]

Well, like I love AI. I think, I think it's an incredible, incredibly powerful tool. And I use mine all the time.

I have it just running in the background all the time now. And so I can see that there's just like, it's so much more powerful.

[Jake]

Playing itself at Solitaire or what? What's this thing actually doing?

[Tobias]

It runs the website. It runs, uh, acquires multiple website, which I redesigned. Everybody go check that out.

I spent a week or two with my AI building it out, building some AI features into it. It was a really fun process to go through because it's so intuitive. Now, like you can ask it in natural language to go and do something and it will go and do it.

And if you don't like it, you can just change it immediately. Whereas it would drive a human being insane. The level of like fiddling that I was doing with it, but it's ability to go and do stuff and then look in the backend and optimise for various different things is sort of incredible.

And I just, I can see that as solo business owners, small business owners, entrepreneurs, it's just an absolute game changer for them because it gives them a super smart assistant MBA level, like executes pretty well. Um, and so I can sit there like, I just think that that I, the, the use cases is real demand, much, much harder to estimate. And I think whether the demand can grow fast enough to justify the spend up front, like that's a much more difficult question.

I think that's where you see that. You can see on a stock market, like a boom and bust, and then a boom again, like in a, in a.com 1.0 style scenario where we get a little bit ahead of ourselves. Like the first guys have got to go and build the, the pioneers have got to go and build the, the cables and die on the trail.

So the rest of us can drive across country or fly across country in comfort. And it might be that the initial guys are going to not make it to the other side, even though ultimately it's an incredible tool. I'm a big believer.

I've been saying this a little bit recently. I know I'm kind of becoming a little bit obsessed about it, but I'm kind of working on a little book about this too. But this, I think the singularity is real and we're probably in it right now.

Um, which is kind of extraordinary because this is a thing that it was science fiction in 1965. It was science fiction in 1993, maybe not science fiction in 1993. Maybe it was like, it was conceivable.

And then Ray Kurzweil has talked about it more recently, but I feel like it's here. And the rate of change in the power of the AI systems from last year to this year is extraordinary. If it keeps on doing this for five or 10 years, I have no, I don't know what we'll be doing because it'll be very, very powerful.

So I think that the customers are going to have fun on the rides, like whether you can get the customers to use the rides or not. I guess that's another question and what they'll pay for it. I don't know.

Those are hard answers to hard questions to answer.

[Jake]

Well, let's just say right now, Toby, what would you pay? You just have one subscription and it does kind of all the things that you want to work on and you call it kind of a relatively unlimited token budget. What would you pay per month for it?

[Tobias]

I mean, it's like, uh, it depends on what sort of revenue you can generate on the other side, right? Like if you're, if you're, you think about it like an advertising budget, like if you're the ROI on an advertising budget, the way that it works, you put some money out in some sort of cycle.

[Jake]

And you waste half of it, but you don't know what half you wasted, right?

[Tobias]

But you get like, if your ROI is two, you put $1,000, you get 2,000 back. You put in five, you get 10 back. You put in 50, you get a hundred back.

Like my spend is unlimited provided that the other side is generating income. Sure. I don't know.

It's a hard question to answer. What do you think, Todd?

[Todd]

I think it'll be interesting to see how the average consumer adopts it. I think for us, right, finance guys, we do a lot of data crunching and small business owners, we need that help to reduce our time burden. But I don't know how like the average person is going to use it.

My wife hasn't, has barely touched it. And I think that's kind of where the meta is, what meta is trying to do, right, is make it more user-friendly and solve day-to-day. And I think we're right at the stage right now where we're still kind of in that 1996.com era where it was like, you're going to put your credit card online, right, that sort of thing. And I feel that way too, just very sceptical about sharing personal information, private information.

[Jake]

When has Facebook ever done anything with your private information?

[Todd]

Yeah, I mean, if the product's free, you got to wonder who the product is, if the product's you. And so I think that's my biggest concern with the next phase, is how do you get over that hump and make people less afraid of it? It's kind of like Waymo as well.

So there's a lot of apprehension about getting into Waymo for a lot of people for the first time going, I can't trust this machine to drive me, let alone my kids and my family around. And then once you get...

[Tobias]

I'm going to get a random Uber driver off the internet to come and do it.

[Todd]

So then once you do it, once you ride in it, you're like, oh, this is just as safe as maybe more than the average driver. And so I don't know how we're going to get to that point where it's like, hey, your data is secure. I mean, we're getting the AI, early phases of AI have just been a boon time for scammers.

I mean, the scam, the spam I get, it gets better and better every single day, it seems. And so they're benefiting, which makes me a little more apprehensive about sharing anything, because then it's like I give them more fuel, right? Adding to the entropy, right?

I'm adding to the system if I give them anything. I'm not even here right now, but this is my AI bot. Right, exactly.

So I mean, I think there's one of my thesis points and a lot of my investments is that as the world becomes more AI, and there's just so much more content being put out there, authenticity is going to matter more. So we own Disney, we own Games Workshop, and I think we own Nintendo. And I think that there'll be plenty of content competing with all those things.

But I think at the end of the day, people will increasingly value things they know that are real and authentic and developed by people. Because ultimately, I think that's what people want, is to have that human connection. And I think AI taken to a certain extreme is devoid of that connection.

[Tobias]

I think that the blitzkrieg of spam and marketing email that it's been able to generate can only be combated by an equivalent blitzkrieg on the other side, which is why I think... One of the things that I used, I saw a Muse skill come through, which said contact all the do not call type registers and have your details removed from all these lists. And so I just copied it across into my Grok bot and I said, hey, go and do this for me.

And it worked for about an hour and a half. And it sent me back to saying, yeah, you've been removed from three of these lists, and one won't respond. And I'm going to keep on tracking.

And I was like, this is incredible. I think I've been thinking about it since. And the only reason I don't use it more is I don't know what it can do.

I think that it should just be... They should programme into its ability to tell you what it can do and ask you if you want to go and do that for you. Because I think that that's the only way to combat the growth in all of that spam and marketing, is to have it fighting for you on the other side, like taking the calls in the first instance.

I won't be sad to see the back of this election because of the amount of election text messages I've gotten.

[Jake]

Brutal.

[Tobias]

Yeah, Ohio's been bad.

[Jake]

We're not even in a swing state.

[Tobias]

I get Ohio ads here.

[Todd]

Ohio's been terrible.

[Jake]

Yeah.

[Todd]

It's been bad here.

[Jake]

Condolences to everybody who lives in a swing state in the US. What a nightmare. Yeah.

[Tobias]

It's only every two years. And it only lasts for like a month. But it's a lot.

I'm not used to it coming from Australia. What AI are you using at the moment? What do you guys prefer?

[Todd]

I tend to use a mix. I work primarily on Clawed for financial things. But I find that like ChatGPT and Gemini have different things that they're good at.

So I'll often consult the various ones just to see if they have different perspectives on things. I do not outsource my writing. That's one thing I'm pretty insistent on.

It's not to say that I don't let AI edit a review. And maybe there's a sentence that I think is written really well. It's like, hey, I can't write any better than that.

So I'm going to keep it in. But 99% of the stuff that comes on my page is written by me exclusively. And I think it's really, really important to make sure that you're doing that.

[Tobias]

Artisanal.

[Todd]

And not outsourcing that. Artisanal writing. Handmade writing.

And you can click the AI thing on my Flavorstocks tab to make sure that that's true. And it should be. But yeah, I use different ones to get different pieces of feedback.

So I think Claude's very good at complex financial tasks and helping me organise things. Whereas Gemini's really good at images. Generating, like on my Howden's report, the cover, that was done by Gemini.

I tried doing that in Claude and it was a disaster. So it's weird how I think we're going to have these multiple platforms that specialise in different things. I'm not sure that they're all going to be going to one point.

They might diverge. I think Google, given its business model, is focused more on the usability. It's sort of like the Lowe's of the home improvement world.

Being more customer friendly than, say, Claude might be for a newcomer. Someone new to the AI world.

[Tobias]

I do think it's funny how many of them have different strengths. Like I use OpenAI for images. And Claude, I think, is better for...

I've just got better at using Claude for building the website, that kind of back-end analysis type stuff. I find Gemini... I switched over to Gemini when there was a report.

It seems so funny. Every few weeks, one leapfrogs the others and it says, this is now the most powerful AI that is out there. And when that happened, early on, when I didn't kind of appreciate that was going to happen every three weeks, I switched over to Gemini and that was a big mistake.

Gemini, at that point, was not good enough. But I find Grok can take an audio and turn it into a transcript pretty easily, which some of the other ones can't do. I find they all have their limitations and they all have their strengths.

And you definitely need a suite of them to do different things. I think it's funny. Like, are we just replacing...

Like is ChatGPT now Adobe? Is Claude WordPress? I mean, I don't know.

Or is Claude... Yeah, WordPress. That's the...

I use Claude for WordPress. I just think it's funny. Like, they're clearly more usable than that, but they are replacing software functions rather than replacing everything at once.

[Todd]

It reminds me of that meme image from social media years ago, where it would show kind of your workspace as an office in the 1980s. And then everything condenses into the laptop and now everything's condensing within the laptop, right? So I think that it could just be how the technology matures.

Just it keeps absorbing different things.

[Tobias]

Lotto Allocators says, along the same lines that you were talking about, people are going to create their own better versions of... Yeah, I think Star Wars is an easy one to do. Better at...

You guys heard that Mace Windu fell out of a window? Hilarious. My kids love it.

Play it over and over again.

[Jake]

Is that right? I've seen the Anakin goes much deeper, dark path with Padme as kind of a... I haven't seen that.

Also negative character. It's pretty good. And a little Mark Hamill as a young kid.

[Todd]

It's interesting. I mean, there's been fan fiction forever, right? And it's just...

[Tobias]

Fan fiction is better than the real thing.

[Todd]

Yeah, a lot of times, right? And so it's like fan fiction on steroids. And then so I think what that will do, right?

Is if you're Disney parks, right? It drives more people to Disney because they want to actually see it in the physical world. They spend all this time working with it in the digital world and then want to experience it in real time.

So I don't see it as a complete negative for the core IP when there's people trying to build things off of it.

[Tobias]

I was at Disney about a month ago with the kids because I'm in California. Got to take the kids to Disney. And I was struck by that Disney adult meme really is real.

There were way, way more couples there than there were people with kids, which I thought was a little bit strange. More? Wow.

I would say like 10 to 1, like something like that.

[Jake]

Really?

[Tobias]

We went on a Tuesday because we had a day off school. And so we took the kids on a Tuesday, which might've been a weird day to do it. Our school was closed that day.

But the other thing that I noticed is that everybody's in Disney merch. Like they're already dressed in it when they arrive. We were buying stuff there, but they had clearly like they were repeat customers that were coming back.

They were wearing the merch and they were like, this is really, this is a big cult. Which is good from Disney's perspective.

[Todd]

Yeah, there's a really good, Acquired does great stuff, the podcast. And they just did one on Disney I think in August. I just listened to it and it was fantastic.

One of the things they talked about was how Disney kind of had this resurgence in the 80s and 90s. And we all remember the Disney Channel on cable and things. And that those people, right, who are roughly our age are now have discretionary income, right?

And so all of a sudden you want to go relive your childhood and what a great way to do that. But yeah, I think the prices have been, have put a lot, push a lot of families away from being able to afford it. I think that's a recurring issue because like as the Veggie's point is, you have to keep replenishing that entry, right?

You have to keep getting kids in the Disney IP and so that they grow up and they share those relationships with their kids. That's the nostalgia effect. That's one thing I really believe in is that there are very few assets that grandparents can talk about with the grandchildren, right?

Sports being one of them. And then Disney is another one, right? And increasingly Nintendo because as people our age get older, we'll continue to play and we'll be able to do that with our grandchildren one day, hopefully.

So Disney has to manage that quite carefully, making sure that it's still affordable and accessible for everybody.

[Jake]

I had my own digital version of that over the weekend with, it was like, it was like Field of Dreams, like dad, you know, do you want to have a catch? Except it was dad, do you want to play some MLB the show with me? And I was like, yeah, I better do it.

[Todd]

Yeah, I mean, this is something that we, that our grandparents never, never, never did before, right?

[Tobias]

When we, when we took the kids, my wife said her favourite, and my wife's a Californian, so she grew up here when she was a kid. And she said her favourite rides before we arrived, she was like, my favourite rides are the Matterhorn and Space Mountain. So we have to make sure we do the Matterhorn and Space Mountain.

We did them first. And then at the end of the day, I said to the kids, what were your favourite rides? And they said the Matterhorn and Space Mountain.

So I was like, that's interesting. Cause there's a lot like the, the Star Wars rides are not kind of rollercoaster things. They're more individual experiences, but the line is huge to get in there.

It's just very, very long. Cause I can't serve very many people at once. And then the rides aren't, I didn't think they were that much fun.

I think the Matterhorn and Space Mountain, that's the way to go.

[Todd]

We took our kids to Disney World in Florida two years ago. My wife and I had never been, we never went as kids. So it wasn't like something we had to do, but we went for just one full day.

And I was probably about as much of a sceptic as you could possibly be. And I was like, this is, this is amazing.

[Jake]

This is awesome.

[Todd]

It is a, it is a, it is a amazing experience because you do kind of let your guard down, right? Like you can, you can be not a responsible adult anymore, right? You can be, you can be like, Oh, look at there, there's Cinderella.

And like, no one's batting, right? It's just like normal by people. You can get to be a kid again.

You can have that wonder and that awe. And it's a really, really remarkable place. And this is coming from somebody who was like, I have no interest in going to Disney World, but my wife's like, well, let's take them to Disney World.

And we had, we had a great, great time.

[Jake]

See, you were hitting the bed on, before you were even on the flight home.

[Todd]

No, that was, that was a couple, a couple months or a year later, stock got, got more attractively priced.

[Tobias]

Oh, there you go. Incredible business, right? They've got that.

They've just got to create the IP up front. And then the mouse doesn't have an agent. Well, the mouse is no longer under copyright either.

So they've got to come up with a new, Oh, okay. It's like 70 something years after Walt's death. Yeah.

Copyrights over. That's why there's a horror Mickey mouse movie out there.

[Jake]

Really? Okay. I didn't know about that.

[Tobias]

So they really do need to replenish it. Like as Buffett said, it's like an oil, it never needs to be replenished. It does need to be replenished occasionally, but I think they've struggled a little bit with a new IP.

I don't know what they've got, but I certainly sort of missed my kids a little bit. Well, Frozen seemed like a monster. That's, that's 10 years old now.

[Jake]

Damn it, Toby, we're getting old.

[Tobias]

That's at least 10 years old.

[Jake]

That didn't come out like six months ago.

[Tobias]

I might be lying. Let me, let me see. I know, I know.

[Todd]

It might have been like 2016, something like that.

[Tobias]

2013, fellas, 2013. My oldest. What year is it now?

No one knows. On that, fellas, we made it. Thanks, Todd.

If folks want to get in contact with you or catch up with what you're doing, how do they do that?

[Todd]

Best way is either to my blog, flyoverstocks, flyoverstocks.com, or go to my RIA's website, kna-capital.com. And there's contact information there.

[Tobias]

Good one, JT.

VALUE: After Hours (S08 E37): The Best Business You've Never Heard Of? | Todd Wenning

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