Animal Spirits Podcast - Talk Your Book: Looking for the Next NVDA

Starting point is 00:00:00 Today's Animal Spirits, Talk Your Book, is brought to you by Vanek. Go to Vanek.com to learn more about their semiconductor ETF, SMH and SMHX. That's Vanek.com to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Redholz wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Britholt's wealth management may maintain positions in the securities discussed in this podcast.

Starting point is 00:00:43 Welcome to Animal Spirits with Michael and Ben. Well, here it is. The whole kit and caboodle, so to speak, does the fate of the stock market rest on the shoulder of invidia and the AI enthusiasm? It feels like it. But I don't know. I'm sure something else would come up, I think. How about this? Yes.

Starting point is 00:01:03 That's the answer, Ben. The answer is yes. So I don't know. I've been having lots of conversations in the past couple weeks. I don't personally... With yourself or... Yes, I was talking on my own head. I've had a few conversations with people in the tech space talking about AI and like the potential

Starting point is 00:01:19 here for it. And I, to be honest, you mentioned on this podcast when we're recording, you don't use a lot of these things a lot yet. Like I dabble in chat GPT and perplexity and clawed. a little bit. These are the ones I've heard of. But I hear people all the time talk about how they're using them all the time. And I'm not there yet. But listening to people talk about what is potentially coming, I know eventually I'm going to get there. So this is, it's, I don't know, the honeymoon phase, I guess, is a good way to explain it. Like, it's all theoretical, most for normal

Starting point is 00:01:47 people. Not for the tech, for the tech people, I think it's already, they can see it. And they're using it. Yes. But I think for me, this is the interesting part of the whole thing, because I'm thinking about what it's going to do for our business and making my life easier and more efficient and that sort of thing. So it's a very, yes, it's hard to, you ask the question. Like, is it all just being pulled forward or is it going to be great forever? Who knows? Well, I listened to this weekend. I was listening to Bill Gurley and Brad Garstner for a podcast and they had Satya Nodella on the CEO of Microsoft. Did you listen to that, Ben? No, I did not. I'm too busy listening to sports podcasts like an idiot instead of listening to CEOs like you. Yeah. And, and, and,

Starting point is 00:02:27 And I got to be honest, fascinating. Obviously, it should be a successful guy doesn't forget to scratch your service. But I understood very little of what they were talking about, right? They're talking about like. That's how I felt. I was listening to Patrick O'Shaughnessy's a couple weeks ago. Okay. So with modest proposal and the guy from Sequoia.

Starting point is 00:02:46 Yes. And I felt like. Oh, no. Is he from benchmark? I apologize. But either way. Same thing. It was all over my head.

Starting point is 00:02:51 All over, clearly on my head. Yeah. I'm listening and I'm absorbing very little of it. But I'm trying. So, Ben, to your point. point, like, there is so much ahead of us. And so this is like the hard part. I asked the guys, like, is it too cute to think that we're in the early innings?

Starting point is 00:03:08 And yet the stock valuations are fully reflective of the future. And of course, we don't know. So, but what we do know is, what do we know, Ben? Very little. Well, we know that there's people out there that are smarter than us to talk about this. So that's why we brought in Angus Schillington, who's an equity research analyst with Vennick and Nick Frosty, who's an associate product manager, talk about. about their semiconductor ETF, SMH, which it's been out since the year 2000.

Starting point is 00:03:31 Do you think they knew that SMH would be shaking my head when they made this ticker? Probably not, right? You know, you say semi, I say semi, and who's right? Semi? Okay. I don't know. I don't have a strong opinion. Grandma, I have attached on that one.

Starting point is 00:03:42 Very interesting conversation. We get into all things, Envidia and Broadcom and technology stocks. And this is Talk Your Book. Michael tried to get into Talk His Book at the end. But anyway, here's our conversation with Nick and Angus. Guys, welcome to the show. Thanks for having us. Thank you.

Starting point is 00:04:01 Thanks for having us own. So there has been a lot of enthusiasm from investors over the past couple of years for access to data centers, GPUs, semiconductors. That has been the driver of the most recent iteration of the bull market. Invidia is up 160% year-to-date, something like that. And I saw a chart this morning from Torson Slack that shows there are more data centers in the U.S. than in all other major countries combined. So we've got 5,381 data centers.

Starting point is 00:04:30 I'm not even quite sure what that means. If I'm being honest, you could explain. The second place is Germany at 521. Why does the United States have such a massive, massive lead over the rest of the world? I mean, I think comically I would go at that and just simply say, look, the rest of the world doesn't, is difficult to count, right? It's Europe. We've really not played technology as well as they possibly could have done. just getting fired up, Latin America not really there.

Starting point is 00:05:01 China's huge. I have no idea what that number is, but it's to all intents a purpose is U.S. versus China. But China has, without doubt, been scaling at incredible speed with their own technology. U.S. is the home of technology. It has Silicon Valley. It has the most incredible venture capital industry. And really, I think it really talks to just the global leadership.

Starting point is 00:05:27 in tech hardware, software, and applications. I assume in this space, you have to be feeling pretty good right now, but this fund that you have, the Vanek Semic semiconductor ETF, SMH, has been around since 2000. So you guys have seen some things in this fund. After the dot-com bubble blew up, you know, tech stocks got shellacked. And I think a lot of people who weren't around then don't realize how bad it was. I don't know, like an 80% crash in the NASDAQ or the NASDAQ 100, something like that.

Starting point is 00:05:54 I'm sure semiconductor stocks were taking part of that as well. The current environment obviously feels a lot better than that. But I'd love to hear your take on the cyclicality of this industry and maybe how things have evolved this century in this space. Sure. God, that's a big question. So I would think about cyclicality as product or as modality. Okay, so there's a really interesting narrative or analog when you look at, you know,

Starting point is 00:06:24 pre-2000 in the US, like we had the Cisco craziness, we had, you know, Amazon fired up, did really well. And then at Y2K, the whole thing just dumped, right? And you asked the question, what happens, right? And it's not dissimilar to what we're seeing right now, difficult to monetize all of this capix, right? And it wasn't until 2008, 2009, that we really got fired up and we haven't looked back. And I would put that straight at the feet of the iPhone. semiconductors, they created this sort of monetization piece that really helped this thing take off. I don't think it's dissimilar to where we are in AI right now. But I think if you think about this fund, like how it's done over time, and Nick will probably

Starting point is 00:07:13 get to it at the end, it really followed that route, right? But the way you want to be in the semiconductor space is in the leader. So the leaders have done exceptionally well over very long periods of time. And that's sort of how I think about it. So I don't think about it as cyclical. I think about it as at the leadership layer, very structural. So the leader is invidia. Obviously, it's 21% of this fund of the SMH.

Starting point is 00:07:44 It is the only $3 trillion company in the category. Again, I mentioned it's up. It was up 160% on the year or something like that. But interestingly, if you look at Nvidia relative to either the broader market or relative to like if you just divide Nvidia by SMH, that looked like a blow off top a couple weeks back. And it has since retrenched said differently. It's competitors, at least in the short term, seem to be catching up.

Starting point is 00:08:13 what is the story within Vidia and the competition surrounding it? I mean, let me say we don't typically have these conversations around single stocks, but this is a very, very unique situation where Nvidia can be or could be considered to be the sector up until

Starting point is 00:08:29 now. So if you don't understand Nvidia and how it fits in, it's difficult to have a conversation. So we're massive believers in mental models, right? This was a Charlie Munger thing. I can't imagine approaching an investment opportunity without a mental model, right?

Starting point is 00:08:47 So basic thesis architecture of like financial components, competitive dynamics, here's the issue or the answer to your question, which is for investors, and this is an extremely well-known stock, Nvidia has been AI, right? And that is, by and large, true 90% market share, massive gross margins. Nick and I went on the record about six months ago saying it's time to diversify out of out of concentrated invidia positions we love invidia awesome company will continue to be an awesome company tough stock really tough stock because we think or we believe that this space is atomizing right and we can sort of drill down into that but phase one heavy heavy heavy invidia we're in

Starting point is 00:09:35 phase two now we saw that from the broadcom results late last week we think that the share price is telling a pretty accurate story. So when we were on the record back in July saying we're probably at a level that you can really start to diversify, that's turned out to be pretty much right. We're at about the same level now, whereas some of the names that will be beneficiaries from Phase 2 are really in liftoff mode. So I guess one of the liftoff ones would be Broadcom, which is up, I don't know, 30%. We're recording this in mid-December. It's up 35% in the last week or so. It's now in the, what are we calling it, the Quadro Comas Club, for a trillion dollar company. Now we've got a handful of those. I feel like this has got to be one of the

Starting point is 00:10:20 companies that not a lot of people understand or know. And I know you said you don't spend a lot of time in individual companies. But this is a stock that seemed to be on people's radars now that it hits this mythical level. Is this one of the companies that is coming up to challenge in video? Right. I mean, I do spend a lot of time on stocks, right? Maybe I got that. I didn't get that quite right. You must know every single company in this space in order to make to make money, I think. That's sort of where we're coming from. We've designed funds to play diversified. So again, we'll come back to that later. Look, Invidia was their first. They were there first with a general purpose solution that was literally awesome. It solved every single

Starting point is 00:11:06 problem. They, you know, Jensen had been preempting this for 10 years. They have a software top piece which, you know, allows total interoperability. You can build massive clusters. You can plug them in and it works super fast, right? So that's great. But, you know, the clients, the CSPs, some of the other big players, their input driven. businesses, right? They don't like being tied to one solution or one software platform. And when you look at something like Amazon, how they built out in AWS or how they built out in logistics, they're about crushing costs and they crush cost with their own input. So it makes sense that they will move on and find other solutions. So Broadcom

Starting point is 00:11:54 little in terms of like compared to Nvidia, not as well understood, but Hock-Ton, one of the greatest CEOs of all time, Bolton acquisitions, tuck-in acquisitions. These guys are champions in networking. They're champions in A-6. And this is where we think the market is starting to fragment. So, but why six months ago? Is this a valuation thing?

Starting point is 00:12:20 Is this a competition thing? Because, of course, these things are very difficult to tie it. But like, why now or why six months ago? Just straight mental models. So we were getting data points. We were sort of analyzing transcripts and numbers coming out of TSM, where it's really our sort of lead point where we were seeing a couple of things. One, unit sales were not dramatically higher.

Starting point is 00:12:43 So most of this Nvidia run has been margins. It's been pricing power. It's been ASPs and this crushing gross margin above 70%. It hasn't been radically growing, and I mean radically not to the same degree, growing the number of units they're selling. So we were sort of like starting to think, right, what is coming down the pike? We can see now, or we could see back then inside of Amazon where they've ramped their silicon teams. They've got a piece of silicon called Traneum, which you'll hear a lot about next year, which can do a lot of the stuff that Nvidia chips can do.

Starting point is 00:13:18 Businesses like Tesla, you saw them evolve over time where they now, you know, inside of Dojo, which is their autonomous driving piece, they build their own chips, right? called the D2, built by TSM. So running down the same kind of process, we know the customers, right? We know the architecture, and it's felt to us like this, as this fragmented, right? And, you know, stock prices move for a million different reasons. But one of them is better options turn up, right? So we saw better options turn up. We designed the fund that Nick will talk about at the end around this idea.

Starting point is 00:13:56 And it got it was a crazy conversation to be having. having, you know, second and third quarter last year. Actually, first and second quarter last year, all right, what if Nvidia no longer has a trajectory? Where would we want to offer clients a solution next, right? And so we've been thinking about it for a while. You've got to be ahead of these things. And, you know, typically momentum, and especially in Nvidia's case, momentum was driven. If you look at the upgrade cycle by blowout earnings. So you've got blowout earnings, numbers went up. You've got more blurred earnings

Starting point is 00:14:29 or related numbers went up. So the step up, step up, step up, we just felt that that could just wasn't sustainable. So let's say that, let's say that in video, and I would imagine, I'd like to hear your opinion,

Starting point is 00:14:41 I would imagine that this ends. I'm using air quotes because I'm not, nobody's expecting Nvidia to go away or anything like that. But, you know, the, the crazy run-up and when I say it ends,

Starting point is 00:14:51 you know, a gap down of 15% or whatever, something like that. I would imagine that it's going to come after earnings. where either the margins aren't expanding or there's something in it. So let's assume that happens. We don't know when, but it could be this year or in three years. But eventually, let's assume that it will disappoint.

Starting point is 00:15:08 Is it possible for the rest of the space to do well if Nvidia suffers? Like I guess said differently, will Nvidia's like burn out or whatever bring the entire space down with it? Or will money just move to other growth areas? I mean, that's a great question. And I don't, I'm trying to sort of think of a sort of simple way to think about, I don't, we don't think that Nvidia crashes, right? Let's separate the company from the share price, right? Let's think the company, we think it's on a long term, very sweet growth trajectory.

Starting point is 00:15:41 We've probably seen the easy money, grows at a slightly different clip, and the laws of economics, you know, my, my profit is your margin will kick in, right? So you maybe see gross margins come down as well. that demands a lower multiple, right? So as we were sort of building this thesis, one of the things that I was really interested in was to look at the dispersion of analyst earnings, right? I think of that as a really interesting way to consider risk, right? What's the highest to lowest analysts, right? Because if they're tight, everyone's got a good idea, what's gone?

Starting point is 00:16:15 If they blow out, no one's got a clue. And we took, you know, the lowest analyst, sensible analyst in the market. somebody who was a tech specialist, we took their earnings two years out. They happened to be the lowest sensible analyst in the market. And then we put a multiple based on what that growth implied, prorated to where we were now. And that was a share price that was radically lower, right? So I think it was 50% lower at the time. That is probably the kind of thing that will happen. So the Nvidia business will continue to grow really nice. And this is going to be a great year. They've got a great new product coming down the pike. But the question,

Starting point is 00:16:52 is what's the multiple and are earnings projections too high? I'm curious how you take these thoughts on a company like this and translate it into portfolio management in terms of positioning sizes in your fund here. I assume there's some sort of semiconductor index that you're following as a baseline. How do you change the weights of your holdings like this? How does that work in terms of tracking an index or having a...

Starting point is 00:17:17 Nick, you want to take that? Yeah, I can take that. And to take a step back, maybe one from that, right? to the initial question, like, Angus has said this really good, and we've talked about this on previous conversations that him and I have had. If you look at the space as a whole, maybe from an SMH, which is more of a broad-based semiconductor exposures, you know, if Nvidia starts to, let's say normalize, right, because that's what it is. It's normalization. It's hypergrowth. They were unbelievable, but they're still a good company. They're just not going to grow

Starting point is 00:17:42 at the clip that they were at some point, right? We don't know what that. It doesn't mean they're a bad company. There will be a net winner that moves up, right, and starts to take the place. in the portfolio for that. So then to kind of shift to your question, it's like, these are passive products, right? These are passively managed. We follow a set of indexes for that from market vector for SMH. That's looking for the 25 largest most liquid names in the industry, right? So you're really getting kind of the gold standard in broad semiconductor exposure, and it's a team of winners. Because if you look at the portfolio and look at the top holdings, Nvidia drives TSMC. TSM is driving ASML, right? And it just kind of moves down the curve. And just naturally, that's,

Starting point is 00:18:24 you know, how the passive product works. So to maybe answer your question, you know, we're not making calls. 20% is the max weight that we allow in SMH. And it gets rebalanced on a quarterly basis. So we're going back, it'll, in video, obviously, over the last couple years, has gone over 20%. Other than that, besides that 20% threshold, is it basically just market cap weighted? Yes, correct. Okay. Yeah. We have, you know, liquidity, things like that, that have to, they have to qualify for just to make sure that the experience for the client is right. But yeah, 20%. And then it's market weighted pro rata down from there.

Starting point is 00:18:55 There's rig diversification rules, things like that where you can't have so much in the top five stocks, et cetera. So it goes pro rata down from those. I guess you've been in this industry, not to date you, but you saw the last cycle. So how does how does this environment compare and contrast to the last one? I guess looking at the dot-on bubble. The players have changed. I think that's the first and biggest point, but also silicon now, in terms of what it touches,

Starting point is 00:19:25 radically more broad, right? So, you know, you had it in PCs and desktops back there. You now have it in literally everything, fridges, cars. So I think just the application of silicon has changed. Now, everything silicon touches can now be optimized by AI. So if you think about the sort of the dot-com piece, you were sort of retrofitting for the internet, right? And you very sort of early adoption, things were super slow.

Starting point is 00:19:53 Now you've got like optimized hardware, optimized silicon, that now will need to be upgraded over time. So if you think about the last big sort of tech move, which was moved to the cloud, so companies, you know, enterprise is taking servers on premises, off president premise. So sort of rip and replace into the cloud, we're now moving into another period.

Starting point is 00:20:16 kind of not dissimilar where your sort of cloud will move to more general purpose and specialize. So as this moves on, right, so here's the interesting point. Well, this is actually so this is about data. This is about data ownership. This is about processing unstructured pool of data. So what's different this time around is you're going to get a big build-out in infrastructure networking, that kind of stuff. That's probably not going to be done at the enterprise level, that's going to be done at the CSP slash Colossus level. Then, you know, you'll plug into that, draw out the foundation models, and then run your data through it, for inference. So data is much more important than it

Starting point is 00:21:01 was last time around, and the bench that needs to be retrofitted and the opportunity driven out of that is just that. So when we talk about it in video as potentially, you know, flattening out, that's, in a nutshell, what we think the problem is with investment positioning right now, which is, it feels like in portfolios and video is set up to continue to do what it's doing, right? And if you watch or read any transcript from an Nvidia call, Jensen will tell you he believes AI is going to be fast, right? And I'm sure it is.

Starting point is 00:21:38 The question is, what percentages of the Nvidia play in that and what percentage do the other name play in that? And I think that's when we come to portfolio construction around an ETF, which is like diverse flight exposure, that's what we're thinking about. I invest actively. The risk reward dynamics are a little bit different. One of the different things about this time versus last time is the end user or the end customer. And it seems like right now the hypers have an unlimited runway.

Starting point is 00:22:05 The market is giving them the benefit of the doubt. And so long as the investing class is going to reward them and give them the benefit of the doubt to keep spending, It seems like there's no slow it out in sight. The big question that people are keeping asking is like, all right, well, what about the return on these investments? Do you think that that's a 20, 25 story? And do you think that the bar is set too high? The second one, I don't, it's difficult to say.

Starting point is 00:22:28 The first one, you know, these guys have unlimited capital, right? So they're running super high cash flow models, right? So whether it's Amazon or Microsoft, raising too much cash inside your balance sheet makes your return structure less optimal, right? you want to draw that cash down. But the environment we've been in and the sort of tax structure of acquisitions and the size of acquisition have to make for those is just not practical. This is kind of a dream for them, which is like we can deploy this capital. We can depreciate it over time, right? It doesn't impact our shareholder return. So I think they continue

Starting point is 00:23:01 to spend like drunken sailors. There's no question around that. The question is what are they spending on? And what we're seeing now, what we have pretty high conviction in is it is more customized specific solutions rather than the general purpose solution that that is in it in video so there's a diversifying it pretty broadly and you can see that in google you can see it in amazon and i don't think it just doesn't feel like that's that's priced in last point is this is the most overheld stock i overhaul wrong let me just say it is it is the most health stock in both it appears in products you don't even expect it period. The problem there is, especially if it's overvalued, it goes from being the most liquid

Starting point is 00:23:48 stock one day to the most illiquid stock the next day if you get a negative surprise. A trapdoor just opens and there are no buyers. So I think that's sort of where we really want to help our investors. And I think this conversation is super helpful and thank you for having us on to understand that there are other options and you can diversify. If you look at the top 10 holdings in the NASDAQ 100, if you go back to like pre-pandemic, so end of 2019, Nvidia wasn't even the top 10 of the NASDAQ 100. How surprised are you by this run that they've been on? Is this, is this completely shocking or is this just something that you thought, like,

Starting point is 00:24:25 of course, this was going to be one of the biggest companies in the world someday. Once we saw the first blowout numbers, it was pretty clear because we had this sort of, you had the optic of chat GPT, what that was capable of. It was mind-blowing. It became very clear, very quickly. So it came from nowhere, no question. But it was pretty clear, pretty quickly, the scale of this opportunity set. So I don't think it's a, you know, it is a stock with a very high revenue with a very high

Starting point is 00:24:56 gross margin and with a very high multiple. You can put it on a different multiple with slightly lower earnings and the market cap is not what it is today. This is part of what makes investing so fun and also so difficult is that you can have this dynamic where these companies are creating the next industrial revolution and perhaps what we're experiencing now is going to be larger than the internet. And all that can come to pass. But you don't know really where you are in terms of like the stock market cycle. So it does feel earlyish. In fact, it feels like the top of the first inning in terms of like

Starting point is 00:25:34 where AI is in my life. I'm not using it very often. And there's no doubt that all of that is coming but then you have the companies that are nearing $4 trillion of market cap, how much of this are we pulling forward? And of course, that's, you know, you don't know, I don't know, nobody knows, but billions and trillions of dollars are being placed on that bet. So is it, I guess, instead of rambling, I'll ask you a question, is it too cute to say that we're early in the cycle in terms of AI, but the stock market reflects all of, is discounting all of it. Is that too cute? I think it's sort of, it goes back. I mean, that, no,

Starting point is 00:26:14 no, it's not as the answer, because I think it draws out the debate that is too much market cap in Nvidia, right? And I think that's, that's kind of what we're talking about, right? You know, when we think, I mean, go back to the sort of the mental model, the Charlie Munger framework, which, which, you know, worked pretty well for him. You never want to be trying to get off the train right at the last station, that's a disaster. You get stampeded and then you want to be getting off the train before you get there. This AI thematic opportunity looks limitless. Now, I don't want to put a number on it, but it looks limitless right now. Just the applications and diversity. I think you've just got to be really careful how you access it, right? And, you know,

Starting point is 00:27:05 when I think about investing, right, a very simple philosophy, we sort of which are somewhat of Bannick, because look, you get a group of companies you think are going to succeed around a theme or a country or whatever, right? Put them over there, right? You make sure you don't have any of the losers. And everyone starts to lose, get rid of them, right?

Starting point is 00:27:22 Because it's the drag factor at the bottom of the portfolio that really starts to hurt you. So if we put the sort of AI opportunities through that framework, it felt to us like InVidia would become a drag and to some extent it already has started. Nick, I'm curious from your end, if advisors are using this fund as a piece of their portfolio, how are they looking at a thematic fund like this that's going to be more high octane?

Starting point is 00:27:49 I'm guessing to the upside and the downside, how do they look at this as a carve-out in a portfolio management process? Ben, can I just set that up for Nick? And then I'll set it to you. So we've had SMH forever. It's $25 billion. It's this sort of, as Nick said, it's the winners on the winners on the winners. We launched an adjacency called SMHX, which I've got to say. was not my idea, right? I had a different idea. It was Nick and his team's idea and

Starting point is 00:28:11 origination. The idea was that you would go for fabulous semiconductors, which is effectively what Nvidia is. And that is the one I think we feel like is really most interesting now. Sorry for Nick. Is this, is SMHX? Is that effectively SMHX invidia? No, the opposite. So it's X. So a fabulous semiconductor company is going to be the ones like Nvidia, right? The ones that are designing and selling the chips, but they're not manufacturing anything. Right. So, Nvidia outsources, all their manufacturing to TSMC, we're looking for essentially the next invidia inside of SMHX, right, while still including Nvidia, right? Because it's the same thing where it's a passive product.

Starting point is 00:28:49 We're looking for the 22 largest, most liquid fabulous companies defined by the indexing company, which are going to be companies that are outsourcing all manufacturing, right? So when we look at the space as a whole, in back to, you know, the initial point of, you know, why did we see Nvidia coming? I don't think anybody saw Nvidia coming. but I think the business model of Nvidia, that fabulous business model, allowed for it to happen because they have such higher margins, lower capital expenditure, it allows them to be more innovative, it allows them to invest more in R&D.

Starting point is 00:29:20 They were a gaming GPU company for the longest time, right? Like nobody even thought of them outside of that, AMD, the same thing. So now you've got this company that was able to pivot on a dime, I will say on a dime, right, for the layman, right? and see the opportunity ahead and scale this business to be one of the largest businesses in history, all because of their business model. And that's kind of, that was the underlying thesis of fabulous semiconductors. SMH is great. You know, largely, again, the gold standard in semiconductor companies, all of the winners in the broad space, if you want to look at the AI revolution

Starting point is 00:29:56 and you want to say, hey, listen, Nvidia owned 100% of market share for this first inning, right, If you're looking at it on a, you know, a nine-inning basis, who knows where we're really at, but they've won 100% of the market share, that they have to lose some, even if they're still a great company, other competitors are going to come in and take some of that market share or just be the next iteration of it, like Broadcom, right, and their A6 chips, the fact that, you know, GPUs are the foundation, now these hyperscalers and then down the line when you have other enterprise companies that are building these, they need the broadcoms of the world. They need the ARMs of the world. They need these other fabulous manufacturers to keep pushing the AI narrative forward. And that's really what our thesis is, is looking at it that way. The way we think about it and joke about it internally is that SMH is the heavy, balanchy stuff, the SMCs, the A lot of equipment stuff. And the innovators in these super flexible business models, the guys in the garage are SMHX kind of thing.

Starting point is 00:30:57 But when you can walk into one of these businesses, it's crazy. If you're only designing software, right? And then NVIDIA is a great at it. Everybody gets very rich, very quickly, right? If you have heavy balance sheet pieces on that, you're stuck with depreciation and horrible CAPEX where the profits are not there for distribution. So you tend to find in the fabulous business models,

Starting point is 00:31:21 the best engineers will gravitate there because the optionality is considerable. What if the next NVIDIA isn't publicly traded? We haven't even spoken about Open AI. or CoreWeave or XAI or any of these other companies, is that, do we have enough publicly traded companies to make money? Well, I mean, SMHX, we had, we did that to lower to 22. We worked with the index, sort of to make sure that the, the environment was big enough

Starting point is 00:31:44 from a liquidity. Lower to 22, what? 22, what? 22. 22, yes, 22 constituents. So SMH is 25, SMHX is 22. I think if all things considered, if we stayed the same as we are now, you might run into that. But I think we don't even know what's going to.

Starting point is 00:32:03 You've got GROC, right? Not AI GROC, or not X's GROC, but the chip grok that is going to be specific to AI solutions, right? That's just one example. There's going to be, I think, a lot of newcomers to the space. At what point do they go public? I don't know. I'm not an expert on IPOs. Obviously, we haven't had as many of them lately.

Starting point is 00:32:20 That could be an issue. But I think if the market is right and there is, you know, the AI evolution continues, I don't don't foresee that being an issue. But when we work with the indexer, we really try to make sure that we pick a number of constituents to make, you know, to make it feasible for the long term, right? Because we're launching long term products here. We're not trying to catch fads. So we want to make sure that there's enough, enough constituents out there, that the market share is big enough, that the liquidity is there, et cetera, et cetera. But can there be another, like, doesn't it cost so much money to run these companies? Like, aren't these very capital intensive,

Starting point is 00:32:57 of just like financial capital? So when you think about TSMC, right, what did TSMC do? I mean, bananas. They achieved global domination in making other people's chips, right? And how did they do that? They did it with exceptional customer service. They did it with insane execution. They had some tax help.

Starting point is 00:33:15 They're in Taiwan. There's an ecosystem. And they've beaten everyone, right? They've literally beaten everybody. Okay. But they still have to continue to invest. So heavy, heavy balance sheets. But they have a right because they have leadership.

Starting point is 00:33:27 and you just can't compete with them, they have a right to a 50% gross margin, right? So sort of slightly talks to Michael your question just now, which is like, are there enough companies? Now, if the company has a moat and a leadership, especially at tech leadership, they can catch inflections, difficult to see how they're going to get X'd out, right?

Starting point is 00:33:47 There's a question I have in my mind about ASML, Intel's a hellscape. But as sort of Nick said, you want to be in a sort of portfolio of the winners, right? And the ones that have win, you understand why they won, you understand how to value them. So that when, and this is sort of the SMHX, the SMH piece, which is if, for some reason, for example,

Starting point is 00:34:12 ASML no longer has this sort of tech leadership, one of the other large companies in that portfolio probably will, right? So it's sort of six or one or a half a dozen, the other. They trade off against each other. So if you put that to one side and then think, about the sort of the other piece which is this this innovative like fabulous piece you don't need any capital i mean you very very little capital you can be VC funded right the piece that gets difficult is how you fund working capital to go into mass production that's where you need you

Starting point is 00:34:43 probably need to be public so there is no end to what can be done at the sort of more granular level and that's sort of what we're starting to see now and that was as i said what the broad corn numbers kind of told us. I suppose Intel is a good example of why you eventually try to look for those other winners, right? Because not saying Nvidia is going to become Intel, but how many people would have thought Intel was going to end up with his fate 15, 20 years ago? It's been pretty obvious for a while.

Starting point is 00:35:10 Intel is a disaster area, right? So there was an inflection point. So Pat Gelson-Go was one of the early guys. They had that sort of dis-sist conversation. So it was only the paranoid survive? Was that like the end of him, basically? They had all these great sayings and books and all this stuff, like, look at what we did. Right.

Starting point is 00:35:29 But they missed. Their culture allowed them, gave them permission to miss mobile. I mean, I swear to God, they had, you know, their X-86 no longer has a moat. X-86 is the, basically, the arm. It's a sort of operating piece on top of of CPUs, right? And they thought that would go on forever, and it didn't, right? So then they sort of tried to play optimization, so profits went up. the business just declined and degraded.

Starting point is 00:35:56 Then they get Pat back in and he sells the board on this idea. And the only guy, and he had an idea. I swear to God, Nick and I were on the record on a video like a month ago saying there is a narrow path forward for Intel, right? They got to do what we think they're going to do. They got to burn the ships and then they fired the only guy who could do it. But what comes next is, it's potentially crazy. Do you think there's any value in Intel if you're,

Starting point is 00:36:23 so courageous and bold, or is it just an absolute void? Yeah, in the stock. You probably don't want to be searching for value in these names, but no, okay. All right. I mean, if you put it in the sort of unicorn space, I mean, here's what I think's going to happen to Intel.

Starting point is 00:36:36 All right. So the board fire pat, right, which is a, whatever, he's a technology guy and, you know, he's got his faults, but he's the only guy he could execute, right? And the executing means build the foundry business. And they have some really cool technology.

Starting point is 00:36:52 And they potentially have some technology inflection, specifically that could knock out ASML, right? And that's sort of one of the issues that's going with ASML right now. They've got two lines. They've got backside power. They got, you know, all around gates. These are great technologies that Pat elevated, right? So they got a shot, but without him, you can't do it. So what happens next?

Starting point is 00:37:13 So the board then go, Pat, you're done. They also say products, 886 is our focus. X86 has got nothing, right? literally it's got nothing, right? So the board just struck out twice. Is it impossible for them to be acquired? The enterprise value is $120 billion. That's where I'm going. So, hold on. So, right, who, right, who is this important to, right? Because this was existential for Pat. It was existential for Intel. But you remember, it was existential for the United States of America, right? If you think about risk management,

Starting point is 00:37:47 but one-on-one risk management, right? Right now you've got everything in Taiwan. TSM. You've got the Taiwanese government saying to TSM, you're not moving, right, the leading edge stuff to Arizona. You can make like, you know, speaking parts for like electric dogs, but you're not making the cutting edge stuff, right? We want, we want this here, right? So, they're proactively keeping it on shore. So if you're Apple or Nvidia, you're there, right? You would love a second source, right? And put this in the context. So in 2021, right, according to the Department of Commerce, I think, the chip shortage post-pandemic cost the United States negative 1% of GDP, huge number.

Starting point is 00:38:33 But that stuff was like very low end, right? That was like fridges and cars and all that kind of stuff. Think about it. Like that's like a 10-foot swell. Think about the tsunami if you lose Taiwan, right? Now, I'm not saying it's going to happen. I think it's very, very unlikely. But if you're on the board of Apple or you're on the board.

Starting point is 00:38:51 of the United States of America, and your military ships are all being made out of that. You don't want that to happen under any circumstances, and you don't want to react after it has happened. You've got to fire up that Intel foundry. So I am a huge believer in the sort of Manhattan Project outcome for Intel, which that thing gets taken in-house. And if you think about how that fits into the incoming

Starting point is 00:39:16 administration's sort of philosophy, right? Wait, the Treasury, the Treasury is going to buy Intel? I don't know where it would end up and I can't you listen to me I'm Irish I can't vote right

Starting point is 00:39:28 I haven't spent any time studying it but I do know that this fits very neatly into MAGA it fits very neatly into

Starting point is 00:39:36 national security it fits very neatly into innovation AI everything you know if you took the foundry inside

Starting point is 00:39:46 right and you didn't give it to like an elected representative you give it to Elon or or David Sachs and say, build this into a Manhattan project. I think you've got something super interesting.

Starting point is 00:39:55 Now, I don't think minorities ever get to participate in that. So what's the takeout value? I don't know. But that is a real, this is existential for the US. They cannot not have a leading edge manufacturer of semiconductors. So I think about Intel as a pair, a risk pair with TSM, which we have a pretty sizable position in. all right yeah um and that to me is always the risk to tsmc that i'm sort of thinking about in that

Starting point is 00:40:26 mind map um the needs to be a second producer and right now there isn't i guess last question for me before i let you get out of here um i'm asking this selfishly because i own the stock google is uh on fire over the last five trading days there's been news coming out of there what's the story is this getting re rated higher as a potential serious player in ai uh i i'm a tech hard guys so got it okay one guy i'm a semi's guy so i gotta dodge that one but um i think it's being unbundled and that's unlocked it looks pretty interesting well they did raise their youtube tv price by ten dollars a month so maybe that's it um they've got crazy modes and again this is sort of what we're talking about it's like if you get a portfolio of like semiconductor hardware

Starting point is 00:41:11 companies and you build moats around them and that you can't compete with them and you're just compounding these huge margins of return capital employed and you also own the sort of of the innovators, you've kind of got it buttoned up to the extent you probably don't need to take the invidio risk. That's sort of where we're coming from. Okay, bold. I like it. Gentlemen, really appreciate the time. Thank you for coming on. Yeah, no problem. Thanks for having us. Okay, thank you to Nick and Angus. Remember, check out Vanek.com. To learn more about SMH and SMHX. Email us, Animal Spirits, at the compound news.com. See you next time. Thank you.

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Animal Spirits Podcast - Talk Your Book: Looking for the Next NVDA

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