Chit Chat Stocks - Investing Power Hour #45: $MSFT Coming for Google; Affirm Layoffs; $UBER Earnings

Episode Date: February 12, 2023

The CCM Investing Power Hour is a live-streamed show every Thursday at 9:15 AM PST. On the show, Ryan, Brett, and a rotating list of guests have an unscripted discussion on a variety of investing topics. You can watch the show on our YouTube channel here: https://www.youtube.com/c/ChitChatMoney Follow the show on Twitter: https://twitter.com/chitchatmoney Subscribe to our newsletter: https://chitchatmoney.substack.com/ ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson. This is the Investing Power Hour number 45. These live streams go out every 1230 p.m. Eastern time

on Thursdays on YouTube. You can also catch the replays on YouTube. And for the majority of you, You can catch the replays on Sunday mornings on your favorite podcast player of choice. We do not care how you tune in as long as you tune in and enjoy these episodes. Ryan, it's an exciting week. We're talking. There's a lot. It's been busy in the investing world this week. So we had plenty of stuff to talk about.

We're going to hit, of course, the Microsoft. Yeah, maybe. Maybe. A lot of hoopla and nonsense. All right. Well, let's save the takes. but we got Microsoft Chat, GTP, Affirm Layoffs. I'm going to talk Nintendo earnings in kind of the context of long-term thesis versus short-term worries. And I also have loaded up the Uber

report, which earnings report, I should say, which is always fun. Before we get into it, today's episode is presented by Stratosphere.io, our investing home screen for fundamental research I can tell you that, as Ryan loads up the share screen right now, this is the first thing I look at every morning when I'm going to update my, or not update, check in on my investing portfolio. And it's great because it has its full dashboard. It has charting tools. It has everything.

It has a nifty newsfeed, SEC file aggregation, which is vital. When we're researching companies, everyone knows how unorganized some of the investor relations pages can be, how unorganized Edgar can be. And it also has a fundamental charting tool to help you easily compare companies. So you don't have to aggregate the data yourself. You can take this data that Stratosphere has already compiled for you, make your visualizations, track what your key KPIs over time. And there's plenty of more that Stratosphere has to offer. They just launched this and they're getting better every, every day. And you can try it for free by going to stratosphere.io.

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We're going to be using Stratosphere throughout this episode. And yeah, tell them that we sent you over there. All right, Ryan, let's get into it. Before we do though, Make sure if you're listening, you enjoy these episodes. Give us a review on Spotify or Apple. And to keep updated with the show, the best way to do that is to subscribe to the newsletter.

Okay, Ryan, let's try to get into things as quickly as possible. Why don't you talk about what the thing that it seems like no one, everyone cannot stop talking about and it's Microsoft versus Google. And I will tweet out the link to the show. Yeah. And as we're speaking, I just shared that stratosphere dashboard. Google is down another 6% today, I think. So it's not just a bunch of hubbub. The market's kind of reacting to it as well. I want to... Let's see. They're down well off 10% since this news dropped. Basically, Microsoft put out this press release saying that they have reinvented Bing.

Coincidentally, this is kind of interesting because we just did our Google episode. If you want to learn more about it, we're actually Google shareholders. So I'll just disclose that right now. I might sound biased. But basically, they mentioned that they're reinventing bing um and they're combining it with open ai or i think the parent company of chat gpt which they have like a 50 ownership in um and basically it's going to have sort of chat gpt functionality alongside the bing search experience um it says we have brought together search browsing and chat into one unified experience you can invoke from anywhere on the web delivering like more comprehensive answers alongside the actual search results.

So there's a bunch of examples that you can go see if you go look it up, like type in, you know, sports games or whatever, it'll give you something. It'll give it like a chat GPT answer on the side. And then a bunch of like typical search results. But to be honest, it's, this is what Google already does. yeah hey let's not uh let's not lead yourself into the question let's try to play a little devil's advocate why microsoft can win does does this uh look we're no ai experts but do these things provide more value to a search engine i think that's the core question people should ask

and then the next one is if it does it add to the search queries so okay so does it like add new search queries that people will make? Or is it going to steal market share from the existing search queries, which would potentially impact Google's bottom line as they might serve ads on less of them? There's also other questions that you go down many different scenarios about, will they actually start serving ads within these queries again? But Ryan, what do you think? Does this enhance the value of search? I say yes. I think it's pretty clear it does. Although I don't know if it's as revolutionary as people say yeah i don't know if i want to go as like i don't want to omit like risks like i don't want to say like oh this is you know who cares just keep buying

google uh it just to me kind of feels like this is partly integrated in the existing search experience for google i think it does enhance the value to have like the option to have like a full blown, more comprehensive answer to something that feels like you're speaking to a person. I don't know if that's, but now I'm not saying that that's going to drive everyone to Bing. Bing has been growing share on PC for a while, for at least in the recent years. However, what I would be more concerned about, I want to, gosh, I can't find it, but basically there was Oh, here we go. There was a quote from Satya Nadella that essentially said they don't care if they lose a bunch of money doing this. They're going to go after the search market, but I'm trying to find it. No, no, that's exactly – yeah, it was thrown around on Twitter and the news sites a lot.

Yeah. I mean, that's exactly what he said, right? He says, from now on, the gross margin of search is going to drop forever. There is margin in search, which for us is incremental. For Google, it's not. They have to defend it all. Um, my concern really beyond, like, I think they will probably gain some share over time in PC because they have the infrastructure, they have, they own the, they own the hardware. They own the operating system of a lot of basically a bunch of new PCs that are sold with their Windows OS. So it's easy for them to kind of play as, you know, the default. Which is funny. They got in trouble with that in the past with Netscape. So I wonder, is it anti-competitive?

But what's funny is, I'll let you keep going, but all the companies within the sphere, Apple, Alphabet, Microsoft, could all threaten each other with anti-competitive stuff. But then I think that would bring up the anti-competitive stuff that they're doing. So everyone's being anti-competitive, but so they don't want to accuse anyone of anything. But continue. Yeah, my concern is that Microsoft bids a ridiculous amount to power the Apple Safari search because Google really does own the mobile search. They have more than 90% share there, basically because they – predominantly because they have Android, so they're the default search on Android, which has most of the mobile smartphones in the world. But they also power Safari on the iPhone. Or they're the default.

I mean, people can go search Bing. It's not blocked, but they're the default search engine. But they pay – I think it's, what, $15 billion for that? it's estimated could be could be 20 yeah I think

the renegotiation whenever that is we don't have the info it probably will be 20 billion dollars now because Apple grows their devices steadily each year

yeah my concern is that they start to just hemorrhage money for that the thing is I still don't think

that's the end of the world for Google yes obviously pressure and search and market share losses would hurt them but for one

I don't necessarily see it happening I think Google already has a lot of this functionality I think it also gets blown up in the finance universe like Bing's going after this the typical consumer does not know the typical consumer doesn't care they don't follow Satya Nadella on Twitter they don't like

check Microsoft's press releases every day they just go in and they log into google chrome yeah was it yeah and back in the i don't think microsoft bing was around for the entirety of the early 2000s but back within you know before google kind of had their um their own platform advantage with android and to some extent chrome i guess you could argue with it in that they won through execution and adding on these free services around everything i think i would be concerned yeah if bing got the i mean it'd be something to watch for for sure if bing got the the license from apple but what would really concern me is if somehow and this is just a total hypothetical apple's own services

which they've been copying google to some extent with maps some of the other stuff icloud whatever and they copy and they were somehow combined with bing because i think what gives google a bit of a And again, we don't need to talk about this forever on this show because we just discussed that on our not-so-deep dive from earlier this week. It's not just the search. It's the search plus Maps plus YouTube plus Gmail plus Google Workspace plus Google Pay plus whatever. So it's almost like they have the best of Microsoft with Android plus Chrome plus the search engine. So they have kind of the operating system. than also they have the Apple stuff as well.

So I'd be worried if somehow those were combined, but without Microsoft having a lot of those other services, except for, of course, Office 365, but you have to pay for it. So the market share is much, much lower. There's billions of users on Google Workspace plus Gmail versus Office 365. We just looked at them.

What is it, like 100 million subscribers, something like that? So yeah, sizable base, but still it's not going to affect kind of the way you operate the search market where you add on these products around it that are free but either way it'll be interesting to

follow I think I think yeah it's not it's not as I mean it's not something to just stick your nose at and say like oh this is dumb because it's obviously not dumb it's cool technology but I see

no reason why this doesn't become a commodity sort of like voice tech where you have enough resources, you have enough skilled AI developers, you can build this chat bot, that's plenty good. And just because Google has the distribution, I think they're going to win once they launch this thing. Yeah, the demonstration had a slightly wrong answer,

but ChatGPT, if anyone's aware, has wrong answers constantly. So I don't think that means that Google's worse at this. No, we have a comment here. uh says a wonderful business with a strong moat does not need to invest excessively in other bets that burn capital i feel google just isn't a wonderful business even though price maybe is fair yeah i disagree with that because they're separate they're separate other bets are not tied to the business at all in fact that's why they changed it to alphabet i mean way more has no association with uh whatchamacallit you know that the the deep mind i guess connects with it

a bit, but you also have that biosciences startup that is in no way connected with Google. That's why they're under the Alphabet umbrella. Yeah. Just to be clear, I appreciate the comment and yes, they do burn money in there, but I would disagree that they have to burn money in other bets. I think they choose to burn money. I think any business, if you look at this, I'm showing a chart here. Free cashflow per share over the last 20 years has compounded at 20% a year. Along with other bets, hemorrhaging money. Yeah. An increasing amount of money being hemorrhaged. So I think, no, I disagree. I think Google search is an absolutely wonderful business. I think YouTube's

a wonderful business. And I think their ecosystems now complement each other extremely well. um android is maybe not that wonderful in selling the hardware but it's a great addition to the ecosystem because it leads so many people to google so um i think the other bets don't get me wrong other bets irks me i think google spends a ridiculous amount of money on stuff they don't need to um like life science and stuff their last layoff round their last layoff round laid off what 27 masseuses so i think yeah there's probably some excess costs and they hire more than they need but no i think the core business is probably one of the best digital businesses of all time oh yeah there's things there's things to be worried about with google

and slash alphabet however you want to call them but on the top of my list i don't think and look whatever i could cold this could be a cold take three years from now on the top of my list is not chat gpt higher on my list is apple tiktok instagram seating uh taking share along with operating expenses plain and simple yeah so i don't know i mean i don't know this i know it seems so easy to just scoff at like oh whatever like if this isn't gonna hurt google but i think the voice technology taking over search was probably

sounded just as compelling oh remember that yeah I mean both of us got caught everyone got caught in that hype remember that

like you're gonna get an Alexa it's gonna power your house and you're not gonna search with a button anymore you're gonna do it through voice now these tech

this tech might be better than the voice tech that Amazon had at Alexa but I still think it's similar

last thing I have on this when Nadella slash Microsoft says that basically they said, basically copied Bezos and said, your margin is my opportunity. I wouldn't have that been their same mentality in 2009 when they launched Bing.

I think it would have, and yet they still lost with, at the time, the operating system advantage. So look, maybe Alphabet slash Google was a better, more agile business back then, but I still think, look, they've been investing since in DeepMind for a decade. I think they'll be okay. Let's see what we got to comment here.

Yeah. A couple of comments around Google's excess costs. Yeah. Sandeep also says, if Google has to replace around 20% of its existing search with open AI type of thing, doesn't that eat away at their own market share revenue while simultaneously increasing operating expenses i would be very surprised if 20 of their search moves to ai it would be well i just say within the next couple of years like on a longer time horizon maybe but yeah sorry continue yeah i mean i think yeah maybe over time over like 10 years yeah that's possible but i think they could also improve monetization on that over time as well to replace their existing monetization on traditional search, it is more expensive compute-wise, which is a potential

headwind, but I think compute costs have gone down over time and I think they will continue to go down. Plus both of these companies have their cloud division. So in the long run, I think they benefit. And when you talk, the comment here says it's going to increase their operating expenses, and that's a concern, right? I think, yes, that's true. Yes, in a vacuum, that's worse for margins. But if they need to spend on this, if they need to have this AI engine going, the company with the most capital, the company with the cloud division that can make it the most efficient is going to have the widest moat. It will make it impossible for anyone but Microsoft to compete here or maybe another big tech

company, at least in my opinion, if this stuff is as legit as people are saying. Yeah, it's also worth noting, I mean, I know someone told us this recently, but when you think about Microsoft Edge, Microsoft Edge is Microsoft's browser

competes with Chrome. It's powered by Chromium. They got rid of their own infrastructure behind Microsoft Edge and chose Chromium, which is Chrome open-source architecture. It looks exactly, I mean, look,

they basically copied that, the layout. I checked it out yesterday. It looks exactly like it, which might be the way to go. It looks exactly like Chrome. It might be the way to go. Yeah, I agree. But I don't think you're going to get,

I think the risk here is that you get maybe a higher share of new Windows operating system users that choose Bing, but you don't get, I don't think you steal share from existing Chrome users. Yeah, that's a fair point. Okay, let's wrap things up on this and go to the next topic.

But prediction, Microsoft market share in overall search is 3% today. In five years, is it above or below 6%? Five years? Yeah. Below, assuming Google still powers Safari. Okay, caveat, that's fair. I will go below as well although I think given the

desktop share that Microsoft has been winning over the past decade I think I would go with higher but not at 6% we'll see though alright next topic Ryan Affirm announces layoffs for 19% of its staff

they reported earnings what were you looking at there yeah they did report Affirm is one of the buy now pay later providers well known for being one of the primary providers for Peloton purchases. They had a tough quarter. Allowance for credit losses doubled year over year.

So more people are not paying back their, I guess, micro loans, which is basically what this is. And they had a letter that announced layoffs. So it was, and whatever, like, I mean, And it's the right thing to do potentially. However, I take issue with the letter because I opened this press release and here's how it starts. Affirmers, this is the hardest email I have had to write to our company since founding it almost 11 years ago. I think that's like the worst way to start a letter.

To me, don't lead with a term of endearment if you're going to give them bad news. And if your theoretical term of endearment is affirmers, I don't know, that just pisses me off. It's like when, what's his name, did Twilions. So I don't think you should do that. I think you should just say team or, I don't know, dear employees. It's not time to just be as nice as you can and then give them terrible news. Second part, I hate it when CEOs do this. This is the hardest email I have had to write to our company since founding almost 11 years ago. All your employees, they don't sympathize with you. They don't feel bad for you. Obviously, you're extremely wealthy. You've done well. You're the CEO. Don't make it about you. I feel like someone should tell them that. and it seems like so many tech CEOs have done this. Yeah. You got to flip it around and say, this is probably the hardest email you're going to receive. Yeah.

Yeah. So my dad, I mean, here's what we're going to, here's what we're trying to do for you. Here's the next steps. Not, this is such a sad day for me.

Yeah. And it's like the Shrek thing when Lord, what's his name was like, many of you will die, but it's a risk I'm willing to take. I know. I know. It's always like that.

The, but there's a reason they're doing these layoffs. I mean, we look at this visualization here from Stratosphere. The report was yesterday, so they haven't updated the operating income yet, but trailing 12-month revenues were kind of flatlining

on the buy-now-pay-later providers and earnings are moving in the wrong direction. So I think that combination, and yeah, over the last 12 months, it looks like revenue has almost compounded 100% a year, but

Man. Low quality revenue. It is low quality. Yeah, that is exactly right. Low quality revenue. Over the last year, stock is down 83%. And it is still trading. Well, we got no earnings here, but it's still trading at a sales ratio.

Price to sales of 3.3 with gross margins of only, let's say, let's look at the table here, about 60%. yeah I mean well yeah those are not even that important of figures but the like yeah well the big issue here is that they're just like hemorrhaging money and yeah they have no earnings so you gotta

you gotta use something and well you can't use Evie to tame the Royal Canadian Legion is celebrating its 100th anniversary and now our change has a $2 coin to mark this milestone Honor the Legion's mission to carry forward stories of service and sacrifice to new generations and their dedication to supporting veterans and their families from coast to coast to coast.

Celebrate this enduring legacy. Find the 100th anniversary of the Royal Canadian Legion $2 coin today. The thing that I find interesting is these companies, the companies that are losing a lot of money right now are going through difficult periods with their stock, yet stock-based compensation continues to jump. And at Affirm specifically, stock-based compensation has really started to jump. It surprises me that employees are like, and maybe they don't have a choice, but willing to accept more stock comp given what's happened to the stock. I guess the option is like, all right, well, if you're not willing to take more stock-based compensation, you can join the other 19% that left or that had to leave. Yeah, that's an interesting way to put it. Maybe that is the case.

I think maybe they force it on them. One thing that concerns me, and we like to focus on free cash flow here, as a lot of investors do, and we kind of really harp on finding companies that convert their earnings into free cash flow. But one thing that can trip people up, and I think trips us up sometimes, is when a company is targeting free cash flow, say the management team is incentivized on free cash flow, they might be overly incentivized to use non-cash stock-based compensation, and they could hit their free cashflow targets, but they may have doubled SBC or stock-based comp as a percentage

of revenue. And that can really not be value accretive. So yeah, I want to, let's... I think the other important thing with Affirm's earnings that I saw, active merchants declined sequentially. So less merchants on the platform this quarter. Keep in mind, a firm sells to basically two sides. They sell to merchants and they sell to customers because they want more customers adopting buy now, pay later with them. And then they want more merchants offering it. Merchants declined. I believe a firm tried to institute price increases this quarter.

Really? Really? Didn't work out then. yeah i mean active merchants only declined by like i think it was it wasn't that much so given that they raised prices and they only saw that decline that's not the biggest deal but it kind of gets to a problem which is like if you're a buy now pay later provider do you have like i don't think you have pricing power merchants will just adopt clarna or afterpay or buy in for whatever apples is i'm sure amazon prime has one now too yeah i think there's some key differences to the industry

that make it just not the same as the card networks and i remember a couple years ago when there were some certain people out there saying that these were going to kill the card networks within a few years i think the progress on that might be stalled uh visa and mastercard both doing trillions and gpv right now payment volume through their networks on an annual basis so i think you know we'll pause that disruption for the time being but yeah what yeah it seems it seems like the buy now pay later providers didn't get to a high enough scale quickly it didn't turn into a duopoly like the card networks did and the product is has just the ability to be copied which is not great i did see a report that apple is finally going to release

apple pay later and apple pay i don't have the numbers on that but just i think generally what they gotta have probably a few hundred million users would that sound right ryan it's the fastest It's by far the fastest growing player in fintech. Yeah, and I think at least probably like 30, 40% of Apple users are using it, and it's probably going to grow. So they launched that. I think it's not game over for some of these buy-now-pay-later providers, but I just think it's going to be a tough spot. Why? When you're in financials, I don't understand going after this segment, which hasn't proven their unit economics, hasn't proven that the market share is stable.

and there's plenty of people coming for them in competition. I mean, we're about to record today a fintech company with one competitor, a huge and growing market, and there's not three startups trying to compete with you every day and then all the big tech companies launching a competing product to go after it. I just don't see the moat here. Yeah, consumer finance is tough.

Like, it's not the stickiest thing in the world. Unless you're a bank, it's very easy, I think, to hop between if you're a consumer, especially for buy now, pay later providers. I imagine a whole bunch of Affirms customers are also customers elsewhere, and they will just take whichever microloan provider or credit provider, which is just what these BNPL providers are, that's offered to them on the merchant site. I mean, sign up's quick. Yeah, I agree. Okay, before we move on to the next topic, I am going to ask you the hot take question for the breakout video. So in three years, no, let's extend it a little longer. In five years, is the buy now, pay later industry larger or smaller?

Smaller in terms of companies, competitors. There's going to be less players in the space, I'd imagine, due to bankruptcies. I think there might be more consumers, but I think a lot of those consumers might just all be on Apple Pay. especially in the U S I can get with that take. Yeah. Yeah. I think I agree. I think the market basically that the shareholder value created or the enterprise value, however you want to define it, I think is going to be smaller than it is today because these are nice

products. Some people want them, but they may not be there. They may, they might not be the next card networks as people were predicting. All right. Next topic, Ryan, what do we got here? Or you have anything else to add something else to add? A fun question that I was thinking about yesterday. I don't know why this kind of came to my mind, but with all the interest rate stuff that's gone on over the last two years, there's a lot of – I think about how would I have changed my portfolio if I knew what was going to happen? so i'm going to invert it if if you knew that rates were going to drop to zero tomorrow i don't know why that would ever happen but say the fed federal reserve took rates to zero tomorrow how would you change your portfolio i don't think i would it's too okay you can play the game where

you say, I know what everyone else is going to do when they drop rates, and they're going to go for growth stocks again, because that's the narrative. And that's what I should do, because then everyone will follow in. However, that's such a hard game to play. You don't know when that narrative is going to change. I think the best way to do it is to say, oh, what are you going to do with your portfolio about inflation? What are you going to do with your portfolio about interest rates? I say, make a portfolio, invert it like you just mentioned, and make your portfolio. I don't want to say immune, but focus on finding stocks that are what you think are inflation protected and what you think are rate protected. So it doesn't matter what rates are. It doesn't

matter what inflation is. These businesses slash stocks can perform well for you. Do you agree or disagree? I think it might just be better to get long speculative crap. In the short term, yes. I think that would be, if you knew rates were going to go to zero, we all know the mentality of the market right now, you'd probably make some money yeah i kind of thought that too it was like all all my all the stocks i currently own would benefit i'm sure or there's there i mean maybe not long term but they would yeah they would shoot up the next day i'm sure yeah like i think like 70 of our holdings all equities would yeah it's yeah but we that's kind of what really it's

a true part of our investing philosophy as we build it out. It evolves over time as everyone's does. And I think one of the important things we're trying to hone in on is finding stuff that is inflation protected and also finding stuff where it doesn't matter if rates go from 0%, 5% to maybe even 10%. They have the balance sheet. They have the business model where things will be okay, regardless of where the Fed has rates. I will say though, I thought a lot more of my businesses were inflation protected than it turned out to be uh well at least what's an example of the short term it's hard to like you know i think you think like oh this provides a really valuable service i'm sure like even if inflation was prominent people would still pay for it they

could raise prices yada yada yada it it has some effects on the margins the only i think true inflation resilient businesses at least that can like that are like resilient in one to two years within one to two years of inflation jumping there's very few either you have to have inflation

linked contracts like I think the airports in Mexico have I think card that works not directly but through just volume you know yeah or you got to be using MasterCard

Yeah. And there's some other ones that are like that. The one we're about to study today, market access, I think would be inflation protected a bit. Yeah. So we tend to go for some subscription type businesses. I think a lot of our portfolio is within that subscription software, either consumer or enterprise. And I think if you have a high quality subscription business, it can be inflation protected. However, they have to raise the subscription price. So it might put them in a tough spot if inflation is kind of hot for one year. Okay, do we raise the price while the consumer is being harmed? When in contrast to that, if you are Hershey, Pepsi, Coca-Cola, a CPG company, you can raise

your prices as a distributor to the grocery store or whoever you're selling to by 10%. And the consumer is not really going to bat an eye. But if you raise the price of your consumer subscription from $12 to $14, yeah, you probably can if you're providing a lot of value, but it's a little bit harder. All right. Let's talk about your items, your news. Okay. Yeah. So last week we talked about Peloton, right?

And I didn't prep any of the numbers, so I kind of read through a bunch of stuff. So I tried to prep what I wanted to look at. So for any listeners, we're kind of going through the key numbers and then the analysis. So apologies last time for being just throwing out a lot of numbers. Don't want to do that because that's really hard to listen to on a podcast. But Nintendo reported earnings last week. Let me share the screen because there's one slide that I think is important for anyone watching. And there's just a few key numbers here.

First off, if we're looking at this slide, they have their guidance that they had previously and then their modified forecast for their new report. And this is for kind of the three months of their fiscal year. So theirs ends in March. The big concern I saw, and I think is why the stock fell, and this kind of leads into an overall question I want to talk to kind of through the lens of Nintendo here. So they guided their hardware, which is kind of their console hardware for the Switch,

down to $18 million for the full fiscal year from $19 million before. And their software, which is sales of games and then also subscriptions for their Nintendo Switch Online from $210 million down to $205 million. So a slight decrease. I think the bigger concern was probably the hardware, given that they talked about before how the supply chain for semiconductors were hurting them. But then the supply chain eased or the supply worries eased. They got a bunch of supply and the holiday demand was a bit lower than the previous two years. It was at the same levels as pre-COVID, but still a bit lower than they expected.

And if I look at their games lineup, it looks fine that they're building the subscription business and everything looks great there. But I think you'd agree with me here, Ryan. And let me stop sharing the screen. 2023 is not going to be their banner year from a profitability standpoint. However, so I kind of think like, look, 2023 might not be a great time to own the stock. I think short term kind of you can see it if you follow the company closely

the earnings might not be as strong as it is they might have hardware the hardware might be down this year just because they're not launching a new console

at least we don't think right now and as they get to the end of that life cycle they're going to sell less the games line up is not going to be as great

however I think maybe in 2024 when they release the new Switch or whatever they call it and they release the new Mario Kart game I think things look strong for the long-term, especially as they have the Nintendo Switch Online providers.

They have the downloadable add-on content for their strong titles like Splatoon and Mario Kart. And then we finally get the movie and visual team, visual stuff going along with the theme parks. But it's kind of that contrasting thing. Like, how do you manage when you have short-term worries about a company, but long-term, you think the thesis is still intact?

I'm curious. We can talk about it either specifically with Nintendo or kind of in a broader lens, whatever you want. Well, so you're talking about fiscal year 23 as in like... Oh, sorry, calendar year 23. I mean, yeah. So what the... Yeah, just the next 12 months or just the next quarter?

I'm thinking the next 12, like calendar year 2023. So the next 12 months. I know they have the confusing fiscal years, but I guess it depends. They could have some really big games kind of in their lineup, but right now they just did their big release for the first half of this year,

and they only have one big game, that new Zelda one. But curious your thoughts. Yeah, with Nintendo specifically, I'm not sure 2023 is going to be that bad of a year. Unfortunately, right now, I'd say they're still in the early stages of potentially building out an iterative console,

maybe early days to even Xbox is a bad analogy. But they're still tied to hardware sales for the time being, until their installed base is probably a little bit bigger. I would say the installed base is still buying games actively. Active users is still growing. That's a positive for me, but given that they're still tied to the hardware cycle, you're basically waiting, I think, for a new switch to launch for any sort of big revenue increase. However, I think they've made the right investments with the Mario movie. I think it sounds like they're going to launch a new downloadable version of Mario Kart, like new courses, right as they release the movie, which I really like. I think they're probably going to see a lot of – if the Mario movie is successful, it's going to really benefit the rest of the ecosystem. system. However, I think in general, when you're looking at a company where you can tell there's going to be some difficult periods in the next year or so, or just in the short term- And what we mean is we can envision the stock being down like 30%.

Yeah. I think if you would have asked me like two years ago, I would have said like, well, I don't care about the short term. I'm worried about owning this for the next 10 years. I think now it would adjust. It would impact my position sizing. Yeah. Maybe trim a little bit. I mean, just at the margins. I don't think... Wait for confirmation that what you believe about the business is going to come true in the long term. Wait for positive operational developments that you're looking for, not just the price to improve. I don't see that much difficulty or that much issue with downsizing a position if you think there's going to be some difficulty in the short term. Yeah, I agree with that. It can be a little

dangerous because it's not 100% predictable. And I think maybe inverting it can be even more helpful where I get hesitant on trimming a position too much unless the stock totally blows out and goes up like 50% in a month. And you think it kind of got a little overvalued quickly, where you can say, okay, I'm worried about things in the short term. If that materializes, and like Ryan said, the long-term thesis is still intact. Okay, that could present a buying opportunity. I can be ready for that buying opportunity. When the volatility hits, I won't be nervous about it. I won't be psychologically scared because the stock's down 30%. And I will be able to add to my position at what could be a very, very attractive price. Again, this is no

prediction on nintendo stock specifically uh we don't do that and it's who knows the stock could be up uh six months from now but i think in general it can be good to go through those scenarios because then one you won't be surprised and two you can take advantage of them yeah i agree all right uber uber yeah this one will be more fun speaking of stock-based compensation yeah so let's see we had earnings for the quarter let me show a few charts I'm going to load it up and then share it here

just some contrasting things one second there earnings slides are very buggy it's not really a great sign when an internet company has buggy slides overall thoughts on the quarter overall thoughts I thought it was fine It was fine. So here's some positives that I saw. Because Uber we've looked at and basically outside of the operating expenses, or the expenses, which we'll get to here, we've kind of liked the business out the mobility business. And we see here, here's some highlights that they talked about in the quarter. membership for their uber one subscription which i think would enhance their moat especially versus

their competitors doubled in 2022 to 12 million i think that's great sign their active writers slash you know people that are using the platform were 131 million monthly actives i think that's great and their advertising revenue now exceeds 500 million however and all right the zooms the Zoom shares. We know how this goes. It's very annoying. Okay. It just blocks.

The Zoom share thing blocks out your tabs. Please fix that, Zoom. But if we look at the earnings here, Ryan, year-end 2022, loss from operations $1.8 billion. And on what was the revenue? On $31 billion in revenue. And then if we scroll down to the cash flow statement, free cash flow was positive for the year. We had $642 million in operating cash flow, and then CapEx is $250 million. So slight operating cash flow, positive.

However, let's look at the stock-based compensation. I think this is a prime example of the concern we had earlier of a company is targeting free cash flow, And then they just pump up that SBC. Stock-based compensation went from $1.2 billion in 2021 to $1.8 billion last year. Yeah, what do you think? Thoughts, Ryan, before I kind of move to some of these stratosphere charts and see what you think? well i think there there was also the one-time payment to the uk based on whatever that litigation was that kind of hurt cash flow if you exclude that i think cash flow looked okay if i'm if i'm not mistaken it was like five percent free cash flow margins on the revenue but yeah just for some numbers it would have been 1.1 billion i think which i guess is getting close to break even on that sbc number but still below that sbc yeah i don't know for uber uber is

kind of an anomaly for me because an enigma i should say because i think i could see a world where they actually are truly profitable but it's just still has the tech focus like the tech mindset and the Silicon Valley mindset of rewarding your employees before you reward your shareholders. That's kind of why I like, and we're going to talk about this here in a second when we record the market access show, companies that are maybe headquartered in New York or are tied in some ways to- Nebraska, Chicago, even. Yeah, that too. Are tied to the financial system in some way. So a lot of the software companies that are like financial ancillary,

so like interactive brokers or market access or Schwab or, you know, these are still tech businesses, but they're also finance oriented. They tend to grow profitably. Yeah, have a better balance. And they think about shareholders. Yeah.

I mean, it's not like they're not thinking about employees, but they have a better balance where in Silicon Valley and Seattle and maybe Miami too, some of the other areas, It just seems so imbalanced. I mean, here's what interests me about Uber specifically, getting back on them. If we look at this chart here from Stratosphere, gross profit, and I believe they would calculate this by taking out the operations and support too, but whatever it is, gross profit has grown from $1.6 billion to about $12 billion in a little under, what would you call that? A little over five years. compound annual growth rate of 41%.

And part of that was when they had a dip during the pandemic. I mean, the unit economics here, even when we were doubting delivery, they're showing to be surprisingly strong, at least to me. The question I think is, and yeah, let's look at the market cap. We're at 73 billion.

We're probably, if you talk about all that SBC, we're probably, you should probably market in like $100 billion market cap over the next five years if that's kind of your time horizon. Favre says negative 23 billion of retained earnings. Yes, exactly. Yeah. Exactly.

Yes. Yes. They burned a lot of money. They also have long-term debts. We're talking about EV. It's actually higher. So I'd say EV, like if you're talking about their enterprise value, I'd honestly maybe to be conservative pricing like, okay, the business is $100 billion in enterprise value

because of that SBC and because of that debt. Even so, if they fired half their employees and- And they have a ridiculous amount of employees. Yes, exactly. Because if they fired half their employees, pulled a little Twitter, not in the abrupt way where they do it in a single day with no plan. I think they did announce layoffs, if I'm not mistaken. Yeah, I think they did as well, but it's not going to be 50%. It's not going to be enough.

They don't have a Google. They don't have an alphabet-like business where they can be this. No Uber layoffs on the cards. Yeah, maybe I should have looked that up beforehand. But either way, look at this gross profit. Okay. And then let's add in operating income. I mean, just look at that dichotomy. We just got a huge negative here. And I honestly think, and I'm going to ask you this too, I honestly think the stock would be pretty darn attractive if you had a way leaner cost structure, because I think

they are turning into a bit of a monopoly here. Not in food delivery, but in mobility. We talked about this on our Not So Deep Dad with them. Wanted to do that within the last year. Yeah. The other thing I think about like a lot is people probably think we're grumps for going like, like, like applauding companies that reduce their workforce. And to be clear, like, it's not like, obviously, like getting fired is like a horrible experience. But if they reduced their workforce today, I think it would bode well for expanding their workforce long-term. Exactly. Growing profitably helps you hire in the future. I don't know. Oh, yeah.

It just seems I don't I've never been a fan of And I think Buffett said this at one point Was like, we've never encouraged Companies to have more employees Than they need

Yeah, because it's just, you know, one Employees lose purpose, two You're always at the risk of getting fired when you don't have the sustainable business Yeah, a company like Alphabet or one of the Tech giants can do it because they're so damn Profitable, but yeah, it's just not Doesn't make any sense, and from an investing perspective look we wouldn't

share any layoffs as personally but from an investing perspective you're trying to analyze these businesses and how much cash they can generate

for shareholders so yeah and it gives new places for them to work where they can provide more value yeah here's though I guess I skipped over

your maybe opinion on this what are your thoughts on their development with Uber One the advertising stuff it seems like good progress I don't know

yeah I had a hard time kind of understanding their advertising strategy like some of the ads looked a little some of the advertisement areas that they were going after seemed weird to me like it didn't seem that useful um but i think with like especially an uber delivery uh or uber eats there's definitely room for advertising more ad dollars as restaurants are probably willing to pay for that premium spot on the platform on the app so

So I would say advertising, as long as delivery continues to grow, advertising is kind of like Amazon search ads in a way. It can be very margin accretive. Yeah, I agree. And it could separate, I think, and one here, DoorDash is just such a tough competitor because they seem to want to lose even more money than Uber. But I think you can separate yourself from the pack. All right, that's the big four topics are done. if anyone watching has any questions throw them in but Ryan it looks like you have some extras here

if you want to we got 10 minutes left well speaking of DoorDash Roku and DoorDash launched a partnership this week to deliver delight to Roku users with free dash pass and access to on demand delivery from their TVs this was a long time coming

what do you I'm surprised this didn't come earlier it's for DoorDash from your Roku well yeah it's strictly for Roku and DoorDash bag holders that's strictly that's what they're

that's their marketing team no hey we're we were Roku bag holders at one point but the thing is I don't think people like I don't know

I don't know if this will really be utilized that much just because like Roku's in general Roku's in general are like a little more clunky I think than ordering via

your smartphone that's what I was gonna say everyone has a smartphone so I don't really get this but hey but I mean theoretically

I think the the audiences probably overlap but yeah And you could send it to the smartphone, maybe a direct little link to the smartphone, but I don't know how this is going to work. Roku seems to have just a wild idea. Okay. So complimentary Dash Pass.

New and existing Roku accounts with a link to streaming or smart home device can get six months of complimentary Dash Pass. Dash Pass is DoorDash's membership program that offers members $0 delivery fees on eligible orders. Shoppable ad offers as well. So for the first year of the partnership, DoorDash will be the exclusive marketplace ad solution partner for DoorDash U.S. restaurants and grocers that buy interactive shoppable ads on Roku. I don't see this being utilized that much. Yeah, me neither. It's cool, I guess, but this is a nothing burger. let's see

what do you all think of the boring STKL oat milk uh yeah Favre you're gonna have to

redo that question I don't know if that is so yeah I heard someone you know like

uh talking about how much they like Oatly this week I said well you know really

good like them while you can but I love when I make like jokes about like companies that i think are like imminently gonna go bankrupt and people like what who cares like non-finance people are like this all right whatever yeah they're like i still

like i still like the product it's like what uh yeah yeah yeah but only has my favorite dad joke which is no motley sun opta i'm not familiar with it yeah um oat milk yeah i don't i don't I don't like that. There's been no brand. I like oat milk. Yeah. Oat milk's fine. I think it's a big-time commodity, though. Another interesting thing, Activision, the acquisition of Activision by Microsoft

seems to be getting a lot of pushback. FTC filed a lawsuit, which I think a lot of people already knew about, but it sounds like European regulators are probably going to do the same. um united kingdom right i saw that they're big kind of yeah something it's so confusing with that stuff but or it sounds like they're going to have like contingencies so um basically like microsoft is going to have to say that they will never take a call of duty game in the house kind of thing if they want to close this acquisition like they're going to have to

give up some there's going to have to be some remedies apparently this is fairly common just it's a way to allow acquisitions without being too anti-competitive it's funny how the regulars do not understand the gaming

market because they seem to think this is going to turn into a monopoly when xbox really is struggling they're the fourth player within the platforms by far you got playstation crushes them continuously steam on pc nintendo is steam larger than xbox oh yeah steam steam might be uh yeah oh yeah oh yeah

it's the it's a great platform um it's all pc though yep it's like the pc gaming say app store it's that same sort of model makes sense without the hardware the uh yeah people i i always forget how big the pc gaming market is like that is the true avid gamers honestly yep just as big as consoles they're about the same size i think the microsoft yeah we got a comment here i have steam i use steam as well for the one or two games i ever play um yeah it's i think so forgotten about i think i i gotta be honest i think activision blizzard is a little interesting here they got a huge cash pile

call of duty is cooking yeah it's not that cheap and then they get a huge they get a huge breakup fee if the deal doesn't go through blizzard seems to be on a good front what are they going to do with it

just sit on the cash the same way they always have well they were sitting on the cash before because they wanted to acquire zynga that's out the door now I think and they were waiting to get acquired so i think we'll see but yeah i mean they do have that you know they they were very conservative their cash balance it does look like a decent risk reward situation because the spread is so wide on the deal if it doesn't go through the floor doesn't

seem that low just because how well the business is doing right now i know both of us have long-term concerns about a little bit uh of their culture just yeah the culture plus the fact that you're relying a lot on a single title which is just tougher when call of duty isn't guaranteed to succeed each year although it's succeeded mightily this year yeah in my opinion it's also not the business you want to buy when call of duty is putting up phenomenal numbers it's the one you want to buy when they haven't released one in a while, engagement is kind of low, and then it's going to, all

of a sudden, you're going to get the next Call of Duty. I know that's hard to predict, but look what we did last time. We kind of bought it at peak Cod bookings. And it kind of bit us in the ass. Yeah, we did. Went out

on the war zone in Mobile Hype. Although this spring, though, if the deal wasn't there, the stock would have collapsed and it would have been a very, very goodbye I also worry what this business looks like looks like operationally I've never

owned something through a termination of an acquisition like what does anything happen operationally were there employees that were planning to work that were kind of hanging on because they thought well we'll be under Microsoft and Bobby Kotick

will be gone that don't want to be there anymore I don't know I also the spread's wide though that arbitrage spread is wide though very wide

yeah it's interesting for sure there's a lot of I mean with any acquisition I think there's a lot of uncertainty but we will see I have my

reservations about Activision management wise if it operates independently but yes I think I wouldn't say necessarily the floor is that high

but Really? It could. If I knew that they were going to buy back with the cash they have plus the break fee, then yeah, the floor is pretty high. But they haven't done that in the past, so I wouldn't feel too confident in that thesis. Yeah. Well, they haven't in a long time. they bought back yeah like 2014 but they haven't really since then it's interesting yeah they

i yeah i don't know they'll have like 12 billion or 13 billion in cash 10 billion net cash something like that i think and their earnings multiple yes it's could be a little elevated because of the success of cod now but that doesn't really roll through you know it takes time for a successful cloud to roll through it hasn't it's only been a couple weeks really uh at least from when we seen earnings um they're trading at a very they're trading below their competitors or at least kind of the average gaming one they're almost down to depending on how much they grow this year they could get down to 12 times earnings 13 times earnings feels like a floor to me if you believe that there's a little bit more durability if you believe king can continue to grow if you believe

blizzard came back on the right footing although we're gonna have to pause this discussion i'm sure to talk about activision again it is 10 30 pacific time so thank you all for listening far have had a comment there at the end i'll try to get on tonight seven right i we only do these uh at on thursdays at 9 30 a.m on the pacific coast now we used to do them at four o'clock pacific time which was seven eastern time we've moved them up we're kind of experimenting to see what kind of resonates with listeners the most, but no, we will not be back on. Yeah, it seems like people like this time better,

just given how many people are tuning in. So we'll probably stick with this one, but yes, 9.30 for the time being. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast.

Check all the disclosures there. Thank you again for tuning in and we'll see you next week. Thank you.