Chit Chat Stocks - Investing Power Hour #47: Walmart Smells a Recession; Coinbase Earnings; Microsoft/ATVI Update

Episode Date: February 26, 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. It's the Chit Chat Money Investing Power Hour. My name is Brett Schaefer, and I'm joined by Ryan Henderson. As always, today is our show where we cover really anything in investing,

finance, business, the FinTwit universe. Ryan, how are you feeling this week? It's kind of the Small company earnings are coming through. There's tons of different earnings reports. And it's kind of exciting to see how some of these small cap growth, small cap value, maybe deep value stuff, some of the companies that soared during the pandemic kind of have their recovering as we get back to normal. Anything catch your eye this earnings season besides the two topics I saw you had, which was Coinbase earnings.

And then we're going to talk a little bit about Meta's new verification stuff. yeah um i don't know if anything really like crazy caught my eye there were a lot of bad reports that were kind of like interesting but not not in the way that not an optimistic way it was i i am curious now we've gone through a period with such like easy money like we're easy borrowing financing um i'm curious how many when the bankruptcies will will start to come when we'll start to see like some because we're starting to see i think a lot of companies with big cash burns that just can't hold on to it um because some of that maybe you know and we'll talk about this i guess with the coinbase earnings maybe some of these can be dragged out for a long

time. They can just operate unprofitably with all the money they raised for a while. That is true. That is correct. That burn rate, I guess, is important, but eventually, who said it once? You have to show a little leg to the investment community or else they're never going to believe you. It's true. It's true. Should we talk about our friends? Oh, right. Yes. Yes. The sponsor before we get into today's episode, Ryan, and why don't you pull up the shared screen so everyone can see uh let me share my screen here uh all right technical difficulties let's do that quick no i always forget how to do it i'll let everyone see the arch capital portfolio today not looking so hot yeah that is uh oh you know the market's down

okay you should be able to share yeah today's episode is presented by stratosphere stratosphere dot io it is our investing home screen for fundamental research as you can see we have our portfolio loaded up right there it's super easy their dashboard tool lets us easily track our investments and stocks we're researching with the nifty news feed scc file aggregation and a fundamental charting tool to compare companies plus plenty more that they have to offer and they're in you know they're a startup and they're trying to really you know get their product better so if you're an early user like ourselves we're able to you know tell them hey here's a product that we want, or here's a feature, or here's a KPI that we would like to

have as they're trying to build all these unique KPIs for people. I just messaged them and said, hey, it'd be cool if you could have a thing that tracked employee count at a lot of companies, because almost all companies have to do that on at least an annual basis. And it's something that as a fundamental investor, we would like to track as well. And it's very hard to find that. And they said, yeah, we're working on it right now. So the product is just getting better day in and day out and there's plenty more that they have to offer and you can try it for free that is the best part for free at stratosphere.io the link is in the show notes that is stratosphere.io and use promo code ccm for 15 off any paid plan we love stratosphere and we think any listener of

the show who likes fundamental research will as well okay ryan you see this change yeah the bar charts well we will be utilizing um yeah i'm sure we'll be utilizing yeah i'm going to be utilizing uh some of their long-term what do you call them earnings charts or kind of you can go you know see the multiple decade charts on operating income stuff like that and i want to look at that for walmart because i think it's pretty interesting we're going to look at their earnings but why don't you go first ryan talking about coinbase earnings um how were they i didn't look i didn't want to look it's always a tough report to look at because it's like 30 pages of uh nonsense right gobbledygook oh god yeah no it's i mean

it's a headache to read some like the shareholder letter because they just mask everything they just basically it's not even like they just paint every bad piece of news in such a good light like okay we were fined 50 million by this regulatory body like it's awesome that we settled that like okay you were fined 50 million um or oh like this is a crypto this is another where we're at the bad part of the cycle. That'll be positive coming out the other side. I'm like, okay, your numbers are horrible. And I even read a part of this and here, wait, let me just go through some of the numbers because people might care. So total revenue year over year dropped by 76%. It was actually up quarter over quarter. I'll

explain why that was, but they have two different, well, they have a couple of ways of generating money, but there's transaction revenue, which is sort of your typical exchange commission based and transaction revenue declined 86% year over year. And it also dropped sequentially. So quarter over quarter, however, they have the second line item, which is subscription and services revenue. There's a couple of things in there. All of them minus one item continued to decline. So all their other subscriptions that they offer saw revenue fall. However, there was one part interest income, which last year in Q4 was at $7 million. And now it's at $182 million. And that is just, is that the stuff they're loaning to people or stuff that they're

earning just from cash on their balance sheet? So part of it is, yeah, which is not a subscription. uh so part of it first off yeah you're right it's not it's fiat though i want to say it's fiat it's not uh it's fiat in both cases actually so there's two things that are driving this so the first one is that they levered up in 2020 i think they bought a got a bunch of convertibles and now they just have cash they on the balance sheet so they just buy treasuries and i think they earn like 40 something million in interest each quarter right now, which listen, like maybe just take your gains and go like you got, you got free money at the top of the cycle or at the top of the bubble. And you have a real business where you could literally just take the cash and earn

$40 million in interest every quarter. But when you have a diminishing cash base, that interest income might go away a little bit. So that's my concern is, you know, they could, they could theoretically just survive on this interest income if they just cut everything else to zero, but not going to happen. The other part though is, and I could be getting this wrong. So sorry for any crypto proponents that are out there. You know, we, we suck with this, but so they entered into this like kind of joint venture with a company called Circle where they issue USDC, which is like US dollar stable coin, I think. It's just like pegged to the US dollar. It's a crypto that's the US dollar. And so what happens is I believe if I want to buy USDC,

I will put up $30 worth of US dollars and I'll get, and I'm not sure what the price is, one us dollar coin and they will give me interest like a bank account i believe this and i think it's like one and a half percent annual percentage yield so i think probably a little less than what you get with like an ally bank account and then they earn money on those customer funds so they just like invest those in interest-bearing assets i believe it's mostly like u.s treasuries and stuff like that could be wrong it could be some weird staking project i'm not sure um so it's like offering uh savings accounts i think however people could just sell their usd that's a risk oh ryan you froze you froze on me let's go back five seconds yeah sorry for any

listeners but keep going oh my apologies yeah so uh they just sell on usdc which is essentially like giving them a savings account, but anyway, they could sell the USDC. So that part's a slightly at risk, but the other part is interest bearing on the cash on their balance sheet. So that led to the quarter over quarter revenue increase in total. My question here is like, how is that? Doesn't it feel disingenuous to say that subscription and services revenue? you're you're just like buying treasuries is that a subscription i don't yeah it's not a service it's definitely not a service because yeah usually people and i've noticed this among a lot of tech companies maybe a lot of fintech ones as well where they're trying to say they really have this

subscription and services side or they define a segment like that because the investment community really likes to see subscription revenue they like to see service revenue and they put a high multiple on that but i guess sometimes most of the times they're legit but sometimes with coinbase you dig into it and you say okay you're defining it as this but in reality you're just earning you know interest on the customer balances yeah um here's the other good stuff free cash flow for the year, a free cash outflow, $1.6 billion. So they lost $1.6 billion in free cash flow. However, earnings before interest and taxes was negative $3 billion because they paid $1.6 billion in stock-based compensation. So that was a big discrepancy. They also had crypto asset impairments.

So the mark-to-market of the crypto that they hold basically dropped. Crypto prices dropped. They held the crypto, whatever the sellable value of that crypto has to get marked down according to GAAP. However, it's not in cashflow because you don't lose money until you sell. So as long as they continue to hold it, I guess they're not technically burning cash. But here was the stat that really circulated that was incredible. I've never seen a number like this. Stock-based compensation was 68% of revenue this quarter.

And was free cash flow negative this quarter or did you not? Most likely, I guess it would be. Yeah, I'm pretty sure it was. So not only do you have- But I'm like- Yeah, sometimes they don't put the quarterly in there. So you're telling me that not only are they losing cash, but they're diluting shareholders at close to a 70% rate each year.

Well, maybe not. excuse me, revenue, it might not be at one times revenue, but they're dilute out of their revenue. They're taking 68% of it, almost 70% and giving that to employees. It's it's yeah, that's a number. That's a number for sure. And they didn't give the quarterly operating cash flow. Yeah. So some companies don't do that. I know it's always frustrating. I'm like, God, you're really going to make me go to Q3 and do the math. But yeah, I mean, that's an insane number. And also, and there may have been,

I think there was like a one-time stock comp benefit that was issued this quarter. So that might've led to part of it, but still it's a ridiculous amount and it's been increasing every quarter and their guidance for stock-based compensation relative to next quarter's revenue. Well, they can't really guide for next quarter's revenue,

but that was also pretty egregious. And- Like if you're an employee, maybe they don't give you the option. Maybe they're saying you have to take the stock or you can't take, or you'll have like half, you can either have half your compensation in stock or half your compensation. I guess you take the half in stock, but you're kind of jeopardizing your entire employee base. Like if your stock drops again this year, everyone's going to be pissed.

Well, unless they're RSUs, then they'll be okay. And they won't be too upset, I guess. I wonder if there are user options. The big thing, though, is that eventually, if people are getting stock comp and the dilution is just crazy, eventually no one makes any money because the dilution just takes care of everything and everything just gets watered down too much. I wonder if, well, here's two questions. One, this is a little bit rhetorical.

What are the employees doing at Coinbase all day? I want to know. Two, I don't think they would be able to have all these employees if they paid in cash because they're already burning cash. They would need to probably fire, what, 20%, 30% of their employees if they got rid of all this SPC. So, yeah, I think that's why they have to. Yeah, well, they'd have to fire even more. Yeah, no, I'm sure they would. Yeah, I don't know what they're spending money on or what the employees are doing on a daily basis.

The thing is, and the beauty of an exchange is, theoretically, you don't need that many employees. And theoretically, margins are very, very high. But what's that quote? In theory, theory is the same as practice. And in practice, they're very different or something like that. I think you're close on that. You're close on that. Let me see if Stratasphere has any good KPIs on this.

But you keep going. Anyway. Yeah. is there would you ever own this would you ever own coinbase at any price i saw your question there so i was thinking about it and yeah we've discussed before about how there are companies that you know they could go bankrupt and you you don't trust the management team so that you probably wouldn't pay up anything for them just because you think the risk you know your equity could be worth zero regardless of whether you're paying below some sort of book value or some sort

of intrinsic value or whatever you want to define it i think coinbase goes into that category kind of the lowest category we have where it's never invest no matter the price because my thinking is everything is that they they're doing is is worth nothing plus i don't trust management team to allocate capital rationally or return any capital to shareholders all that that good stuff agree or disagree last year no i think you're right i want to find the last year or in december of 2021 this is an important this is an important lesson uh coinbase traded at a price to free cash flow i believe of i believe it's three and a half times so and there were a lot of people that literally just quoted the trailing earnings or trailing

free cash flow and said like you know let's take a flyer on this why not because it's so cheap this i mean this is an example where the uh the denominator can change right the denominator in that case uh yeah where the earnings you know quoting trailing earnings on a business that won't generate money in the future is not uh it's not the proper way to value anything yeah and uh i got the stratosphere chart loaded up here side note i did see they have an employees thing i'm circling under their ratio so they got that out quickly not really relevant for coinbase because they just went public so you're going to be comparing like two years there but i think that can be so useful for companies that are 20 years you know in history and you have to find that the

bottom SEC filings. But either way, I got the PE ratio that Ryan is mentioning. If we go back to the latest they have since they just went public, March 2021, PE of 21, June 2021, PE of 8. So you're like, oh, PE of 8. PE is cheap, right? It's below 10. Oh, my God, it's great. And then we pop up to PE of 29.4. Then we go back down to 15.7. And then in 2022, we are negative, which means, as Ryan mentioned, they aren't making any money. So I think that just shows that, and we all do this. I think at first you probably do this too, Ryan. I think we all do it is when you first start out, you think, okay, low PE, low PE ratio, I'm going to buy. But in reality, that is not telling nowhere near the whole story of a stock,

especially if you're going to buy an individual investment. yeah and also i think just goes to illustrate how much earnings can change and how quickly they can change because i remember and i we even made this mistake where um we looked at businesses that were growing 30 40 percent top line and we said well let's uh you know let's assume a conservative scenario that growth drops down to 10 next year or five percent next year and And in reality, revenue declined. It can really swing rapidly. I mean, if you looked at Coinbase and it was growing, I think revenue was growing probably,

I don't know, triple digits last year. You could say, well, let's assume something real conservative that it only grows by 5%. And in reality, revenue dropped by 75%. It just goes to show that unless it's a critical service that people are going to pay for, regardless of the environment, there's no telling what could happen to the top line. Yeah, and I think for companies that have been public for a long time, you can really look at, hey, over the last 30 years, have they had revenue declines? What periods were they in? Did they coincide with recessions? And you can tell, okay, if this company had really no periods of major revenue declines, that's a company that might be very, very important to its industry or its customers.

And if it's not like Coinbase, I guess there's other factors like cyclicality, but something like Coinbase might be more of a discretionary thing, or it might be a very cyclical industry. I think we would not describe, some people describe crypto as cyclical. We would describe it as an egg, useless, a zero. That's how we- Yeah, how many times does something have to drop? How many times does something have to drop before you can actually determine that it's a cycle? Because if it's dropped twice, if it's dropped 75% twice, I would not say that it's a cyclical industry. It might just not be an industry.

That's right. yeah oil energy it's got to happen some time more than times some you know commodity metals those could be defined clearly as a cyclical industry a few others crypto i guess tbd maybe it'll just go through a cycle forever all right next topic ryan you have what meta verified i have a hot take on this but i'll let you discuss it first yeah so this week mark zuckerberg posted i think on facebook um he said good morning and new product announcement this week we're starting to roll out meta verified a subscription service that lets you verify your account with a government id get a blue badge so that check mark

get extra impersonation protection against accounts claiming to be you and get direct access to customer support this new feature is about increasing authenticity and security across our services meta verified starts at 11.99 a month on the web or 14.99 a month on ios a little shot across the bow at uh old apple we'll be rolling out in australia new zealand this week and more countries soon um first of all i would just say that this subscription feels like bullshit because they're monetizing the worst parts of their platform saying that we will allow you to actually talk to someone if you're having problems, but you got to pay $15 a month to do it. We confirm this isn't just a eight person team in Russia pretending to be the church of

Latter-day Saints that you've joined a Facebook group on. They should be doing that for free. Yeah. And okay. Uh, the other stuff you get extra impersonation protection. So the flaw of your platform that anyone can impersonate anyone else, you're monetizing that. That seems like a bit of an issue. Um, maybe you do need an ID to potentially do that. I don't know. I'm not on that side, but it's obviously one of the pitfalls of the social media platforms. So I've had an experience where, and I know a lot of people that have had this experience, they got an account hacked. I had an Instagram account. It got hacked a long time ago, was able to get it back eventually and just got rid of it because they don't want to have to deal with it again. But you're concerned if you get hacked, you're concerned that whoever the hacker is, is going to send something to your family or friends or whatever

coming from your account. And so you try to reach out to customer support, which does not exist. The only thing that exists is FAQ, frequently asked questions. I found that with Google as well. Not to get on the red tier, but when you're dealing with the mega cap companies,

they, yeah, the customer support is a bit weak. You've got all this AI investments and you can't even like have a functioning chat bot that helps you get your account back anyway. The, uh, so now if you pay $15, you can, you can call somebody that's, I don't know. That feels like just a screwed up subscription. Do you think it'll work? Well, my question is, okay, here's my hot take.

And then I'll have a question for you. I don't think it's gonna work in driving revenue because I don't really think that that many people are going to sign up for it. my hot take is that this entire thing that zuckerberg is doing is to show that apple is being pretty egregious with their fees i think that's the the number one reason they are doing this that's a pretty lame way to do it to be honest i think apple probably saw that and was like uh all right well no one's gonna sign up for that anyways or if they do i mean maybe the

people that care a lot about their accounts but do they really care about paying an extra three dollars to not have someone shill crap to their family and friends um i don't know i don't know if he thinks this is the blow to apple that he thinks it is they should start running ads next holiday season perfect gift for grandma this holiday season is your grandma got hacked by joining facebook groups from indonesia that that are pretending to be the church group from omaha well meta verified is for you okay here's the other question i have i'm looking at the chart here the kpi chart um that any watchers have been watching for the last three minutes i've been showing them here we have da use daily active users at meta so across all their stuff at two

billion what's your guess on what percentage of these say it's rolled out globally say it's you know cheaper in india and stuff like that what percentage of the daus are going to be paying for this less than one percent yeah i tend to agree well it'll change how many what percentage i think this the the most value that the subscription provides is just hacked accounts which i know is a flaw in the system whatever but if you want to get your account back yeah you'll probably pay especially if you like this is something that you live for whatever you you know you love social media no one admits that they love social media but if you spend more than an hour a day on this or something you're going to pay 15 a month to get your account back i yeah i could see i could

see some people on instagram using it um because i think as one of the key uses for instagram is for younger people to try to meet people of the other rate of the other uh gender or people that they're attracted to right so they want to make sure that those people are real right they're talking to the right person i think that could be helpful right but it's really you could have also said like just could have said $20 a month no ads yeah

I think people would I think having just an ad free would be more beneficial yeah some people like the Instagram ads though they use them for buying shit that's why they're so good I think it's true they should just offer ID verification

for free it can't be that hard you partner with a company and they do some ID verification, right? They prove that you're a real person. They have the two-factor authentication to know what accounts connect or know what devices are connected to you.

And they should be able to prove that you're a real person because that's one of the big issues, I think, holding them back. I think maybe why these platforms are so hesitant to do that, because you're trying to think like, okay, it's so obvious, right? They've probably thought of this.

Maybe it would be such a hit to revenue and all the content when all the bots, all the troll farms all the stuff from all i guess all sorts of countries that are posting stuff online pretending to be people if that goes away then you lose a lot of the stuff on there and people are like oh wait i was talking to someone you know this thing is just totally fake oh i guess my feed is a little bit worse or what do you think on that it would hurt them you know financially i think maybe is the the thing there you think like not having bots would i heard financially i believe and this is the stat i think it was 19 out of 20 of the most

popular christian groups on facebook were fake from russia wherever eastern europe something like that 19 out of 20 at one point think about that all that usage think about all the people spending time on there they're they're going through the group they're seeing ads they're clicking on ads, those get unverified. I see it. I don't know. Because I'm trying to think

why they don't offer this for free. Because they got to pay some customer support people in Indonesia or whatever to like do this and they would rather just have the customers pay for it. For ID verification?

I understand on the support side, but just to verify your account. Just the support to get your account back and stuff like that. That cannot, no way. What is that going to cost them? A billion a year? That's chump change to them. Yeah, maybe this whole thing was just to prove that Apple has high fees. That's my working thesis because it doesn't make any sense any other way.

all right let's talk through your news um i'm getting like a lag on your audio so i'm gonna try to change my headphones out and uh while you're talking okay all right my news was an update on the xbox activision blizzard deal so as anyone who is unaware the deal's supposed to close this summer and since it's such a big deal within the video game industry and i guess the entertainment industry in general. They have to go through all the regulators around the world, especially because both Microsoft through its Xbox platform and Activision Blizzard sell products globally. So you have the regulators in the United Kingdom, the regulators in the United States, regulators in China that are super important. And a lot of them have talked about how they're

not going to let the deal go through. So Xbox has been making new concessions, new offerings, offering things to the industry so regulators around the globe can get more comfortable with its merger. And this week, the Xbox president announced that Xbox slash Activision are committed to bringing games to Nintendo hardware for 10 years under a quote, binding contract. I put up quotes here, but that's just to say what they exactly said. It is a binding contract. And they're also committing to bringing the content to Steam and nvidia's geforce now cloud gaming service although geforce now not um not too relevant and then as a note so i guess you kind of have the big you know there's four big platforms i

guess in console gaming you got our console and pc gaming since they overlap you got steam dominates pc as the distribution store then in consoles you have nintendo sony and xbox they've locked up a deal with nintendo and steam and they've offered this 10-year deal to sony but they actually haven't gotten any reciprocation um i have a few questions that i think would be fun to discuss here because we follow the industry closely and i think you kind of read through the tea leaves here but thoughts on these new offers in general ryan when you saw the news anything anything to add before we hit these discussion questions well it makes me feel like the deal is going to go through for starters because if the concessions are this is the

concessions they're looking for the only reason this deal isn't going through is because sony's holding out everyone's going to look at sony like they're bitter especially now that everyone else has agreed i also find it hilarious that like i don't know geforce now they're like we got geforce now okay all 10 users or whatever is on there it just that felt more like microsoft just saying that everyone else has agreed uh even though no one really cares about geforce now um and maybe we're wrong do you know do you have any idea on user account for geforce now if we can't get any i'm assuming it's low because they would brag about it if you know nvidia is a very press release happy company and when you see them if they hit 10 million users wow 25 million users there we go

oh that's not bad yeah but but but remember oculus had this is kind of a how many people have downloaded it and we'll see i mean i guess it's better than um stadia from from google you know maybe maybe it's good yeah it says it has 25 million registered users so i'd like to see the usage on that because people are comparing oculus to sony or oculus to playstation when oculus had basically no usage and sony was what 50 hours a month something like that incredible usage one of the most used things when people you know as their core customers maybe you know maybe we're underselling geforce now but still they're not a big player yet either way any any other thoughts ryan no just i would say that i'm pretty sure this was the british regulatory

body's main concern was them taking cotton house and so this i think alleviates a lot of that which means i think if the british regulatory body says gives the aok here i assume it'll be the same in the eu i think this deal would probably go through yeah it's interesting when at first you kind of think microsoft's the big bad monopoly here but they have been losing to xbox there's nice tweet here from sony uh or sony yes yeah thank you for the correction his name is benji well he goes by benji sales on twitter popular video game analyst don't know his last name but benji sales be able to find him i think by looking him up during microsoft's presentation to i think regulators uh they talked about how playstation has dominated xbox market performance comparing

the two on sales and if you look at historically um europe goes favored 80 20 in favor of playstation japan is 96 4 which i guess is because sony is a japanese company globally it's 70 30 in favor of playstation and then end of 2022 it was 69 to 31 so basically 70 30 as well really sony has tried to use this method before and they have used it they've launched plenty of uh first party games exclusive to sony to try to get people to you know switch from xbox to playstation and what's interesting is if if these companies are not able to do the first party exclusive kind of vertical integration thing i think it bodes well for the third party publishers that aren't um they don't have hard they don't you know produce their own hardware because then

regulators are going to really be on the watch for anti-competitive behavior from someone like Microsoft if they own Activision Blizzard yeah that's fair I mean I think at this point like well I guess if Activision goes in-house to Microsoft maybe

I mean the majority of game time is not spent on Sony or Microsoft's own games right now so they kind of are at the leash or at the whim, probably, of the third-party publishers in some ways. Obviously, owning the platforms gives you a little bit of power as well. But the big brands like FIFA, Madden,

Call of Duty, Call of Duty could potentially be in-house here. They are going to command probably a lot of the negotiating leverage. Yeah, I agree. What do you say? Yeah, I agree. I don't think it's going to change too much and if say microsoft tried to pull anything funny with cod the regulators are going to be right up there you know right right on them uh the other thing that i think was interesting in regards to the nintendo announcement was the fact that call of duty cannot run on the nintendo switch right now so a lot of people are theorizing that this means that the switch 2 is coming and it's going to be more powerful because even it would be such a bad experience and you

know nintendo is known for doing that sometimes but it would be such a bad experience if you ran the modern call of duties on the 2017 hardware for um or 2017 processor on the nintendo switch what are your thoughts on that yeah i think it implies that there's a new iteration of the switch coming at this point it just i don't know i i saw some tweets about this as well kind of like the whole thesis rests on whether or not and it was from louise our friend uh basically saying the whole thesis restaurant on for nintendo rests on whether or not they're going to release a new switch um and i i agree the thesis does rest on that but i think it is and maybe there's a chance this doesn't come to fruition but i think they are pretty obvious now that a new iteration of

the switch will come out yes i i would agree with you that they are you i saw hesitation in your voice they are a weird company so you never know what they're gonna do but i would and you can't say 100 guarantee on anything but given what the management is saying now given what all they've done with nintendo switch online because why invest all that money to put all the game boy uh nes what are the other ones nintendo 64 stuff on nintendo switch online if you're just going to drop the platform one year later i think it's in i would probably handicap it as a 95 chance that a switch 2 is coming out the name doesn't have to be switch 2 but an upgrade one is coming out my bet would be spring 2024 because that's when the mario kart dlc ends and then probably

would launch a new mario kart along with um the new switch as that's their flagship game kind of like uh i thought the new mario kart dlc was coming out uh like may time frame right with the release of the mario movie yeah so that's one of the sections so if you pay them how the dlc works is it started when it was last year i think in the spring probably a year ago when they released it and i think it's 25 maybe 50 but you get different packs every quarter so i think like a pack of eight carts for if you pay the one-time fee each quarter you get a pack of eight new courses or historical courses and it ends i believe spring 2024 so that's kind of my thesis of when they're planning on launching the switch to all right um you want to talk through the

consumer side of things walmart's earnings yeah i think yeah we hit the other question too on will the deal go through you already said that so yeah let's hit walmart earnings i think what's the what's the spread on that deal on activision well let's do some quick math 96 dollars a share 95 we're at 76.9 a little over 20 percent yeah do a little math let me i'm trying to do math in the google search bar um and i guess there's no timeline on when it would close but if you're looking for a speculative or potentially minimized risk, 20% return, this has some potential, although there's downside if this obviously doesn't go through. I know. That's the famous last words. It's a low risk 20% bet this summer. I want to know what

people are thinking and why the spread is so wide, but I guess there's got to be a reason. there's got to be a reason. And maybe it's because if it breaks, it's going to drop down to $40, $50 a share. Okay. Yes, let's go to consumer. I'll load up some stratosphere charts, which will be very insightful. I thought this was really cool to look at over the multiple decades. So Walmart reported their earnings, fiscal year 23, giving an update on the state of the US consumer. And since they do $600 billion in revenue a year, and the vast majority of that being in the United States, it can be a great indicator on what the economy is doing. Yeah, maybe the people that aren't the ultra rich, but that's okay. We can just look at LVMH results

for that. Revenue grew 6.7% in fiscal year 2023, but operating income declined by $5.5 billion to $24.4 billion for the year. I think a bit of that is them trying to win customers over with their low-cost stuff during this downturn as other companies are struggling, and a bit of them also struggling to keep up with inflation. And then at $111 billion in revenue, they have a measly operating margin of 3.3%. Before we get to guidance, I'm going to load up this chart here. Yeah, on Walmart. Let me share the screen. I know it's tough for the listeners, but I will describe what it is because I think it's very fascinating.

Okay. Walmart. Oh, there we go. Go quick here to operating margin. They have actually seen declining operating margin since the 90s. So if we look at, let me look all the way back

to as far back as we can go. Let's not go back to all the way when they're unprofitable. All right. This is going to be a tough listen. Yeah, this part especially. I'm trying to load it up quick. But I know what the chart looks like.

We'll actually see it here. If you go to the 90s, they had an operating margin of approximately 6%, 7%, something like that. And today, as I just mentioned, we're down to 3.3%. And I was wondering why that is. Like, okay, what happened? Was it the e-commerce competition? Because in January or fiscal year 2013, they had 6% operating margin. And that kind of been the same as they had been for years.

I mean, it declined a bit in the 2000-2002 recession. They held up really well in the 2008-2009 recession. But yeah, if we look back at operating margin in 1995, it was 4.7% just for reference. But we've seen it decline a ton. And it's down, as I mentioned, 3.3%. I tried to figure out why, tweeted out. And our friend Jason Hall, who's been on the show before, said it's because they've won so much market share in grocery and that has lower margins.

but now they've become the one-stop shop for a lot of shoppers out there. On one hand, yeah, that's great. You're getting more volume and it is gross profit positive. On the other hand, though, I kind of think, especially if there's the inflation risk out there, that having so much exposure to grocery can be tough because you could, would you be surprised if inflation ran hot for two more years that Walmart's operating margin continues to slip it easily could it's just tough and even this this margin deterioration is happening sorry i'll let you go when advertising revenue is growing at i think a 30 rate and is making up you know a larger part of the business now well yeah okay part of uh part of this recent

operating margin deterioration is the inventory management side of things just having to mark down a bunch of stuff on on the inventory side but i would say if you asked the ceo of walmart in the 1990s, would you like to be the leader in grocery too, but you know you're going to have to sacrifice some points on margin, but it'll be clearly gross profit accretive. If you would ask shareholders, ask the CEO, the answer would be yes. I think it was the right thing to do, even though, yeah, it does tighten margins a little bit. It also probably makes inventory a little more difficult because there's a shorter shelf life there. Depreciation's a little quicker, but I don't know if they'll ever have a purchasing environment. Well,

I shouldn't say this. As big of a swing in purchasing habits as they had in the last two years. So it's very easy to mess up. And pretty much every retailer did it that I can think of messed up inventory in some way where they had significant write downs because of it. um so i i think margins will probably stabilize here in the future but here's yeah they'll probably stabilize lower and on the positive side as well the lower the margin walmart has the i think and maybe costco can compete but that's kind of a different you know they have sam's club the harder would be to compete with walmart from any sort of startup, any other grocer, even someone like Kroger, because Walmart is willing to go for

that lowest margin as possible. That means, especially because their employees are usually not paid that well, no one can compete with them on price and stay profitable. So I think in this case, this is one of those clear examples where the margin is the moat, the low margin is the moat. And as they go lower here, yeah, the gross profit might be a little bit weaker. The operating margin might be a little bit weaker, but I think having the dominance in grocery, they mentioned this quarter again, that they won market share in grocery that widens their moat over time. Thoughts on that? I've looked at a lot of these retailers and I'd be cautious owning a lot of anyone really in the retail space because, and you mentioned Walmart actually is not that cheap

of a, like their wages are not that low relative to some others, if I'm not mistaken, and I believe they pay like a decent amount and they're trying to follow Amazon. I guess, yeah, maybe that was 10 years ago. Yeah, they have gotten better recently. Yeah, correct. But you've got potentially a big write-down environment. Consumer purchasing is,

or the consumer looks weak in general in terms of how much they're wanting to spend and with inflation, you've got labor jumping or labor costs potentially jumping. It feels like it's just a big recipe for margin compression. So I would be worried, although I think Walmart has plenty of durability, I'd be worried about the coming years. Maybe Walmart comes out better for it.

But yeah, I think just being a retailer right now is just such a difficult period. So many companies had big discounts this quarter and a couple of them were able to sell more inventory that that they thought than they thought but a lot of them were not able to win who are the good ones let me guess nike lululemon was that the ones you're thinking of or no something else i think nike was solid sonos had did better than management i was expecting some of the bad one under armor did pretty poor um those were just kind of the couple ones that i remember looking at but obviously that's kind of brand dependent i think walmart has more um predictable consumers because it's just value conscious customers that are always

going to be there um whereas i think there's a lot more discretionary spending at those brands but yeah i don't know i kind of forgot about your question so well here's here's here's some other notes they had from the the news release i think it's interesting and this kind of plays more to the broader economy so guidance for next year and they did mention that there is some uncertainty here. So they said, don't take this as 100% certainty, but they said they are guiding next year for a decent slowdown in growth to 2.5% to 3% in constant currency. If inflation stays high or higher than that, I think that could really impact their margins like you're mentioning. And then on the conference call, the CFO said that they continue to see impacts on discretionary

items, which I guess makes sense as there was a huge boom in discretionary physical items during the pandemic. And they are being very cautious about how they invest for growth right now or whatever they're doing because of the US savings rate charts. And he was talking about it in executive speak, but he was basically saying, well, look at that chart. We're at the lowest level ever. People are spending like crazy and it's not that sustainable. And it eventually is going to revert back to normal. So we're going to get impacted by that and we're trying to prepare for it. Yeah. I appreciate that. I think there's some CEOs that are very candid about the environment. Walmart apparently, or Walmart's executive team seems to be one of them. Maybe

it was the CFO. I can't remember what you said. But the other ones are just kind of, I think, faking it and saying, yeah, we're seeing this, but we might be immune kind of thing. i i don't like i don't want to touch retail at all right now yeah i think that makes sense that makes you think that has ripple effects on marketing oh yeah it's got to at some point when we've seen companies talk about a lot of advertising companies talk about the impact of the crypto collapse when what was it a year ago probably a year and a half ago at this point right? During the crypto boom, there was a huge boom in crypto advertising spending. We all saw at Superbowl commercials and that flowed through. Well, not the majority of, you know, the digital

advertising industry did have an impact on their growth. And then when that collapsed and all the advertising has come in now, that actually impacted their business. So I think, you know, we're not going to see a 80% drop in advertising from some of these companies, but that does, it does have an impact when your industry goes through a slowdown. There's only so many dollars out there yeah that is actually something that kind of upset me about uh we own iac and we read this i read the shareholder letter and they have an advertising segment basically they have a business that's run on advertising and they said we saw you know year-over-year declines in in advertising revenue and they're like wow the crypto advertising wasn't sustainable who would

have seen that coming and it's like almost taking a taking a shot at crypto but i'm like okay it's one thing if you can if you do that and like you predicted it like oh you thought whatever it wasn't going to be sustainable but if you were impacted by it then you didn't insulate yourself well enough i'm i'm not sure if they took direct crypto ads but if they did then i don't think there's room to like take shots at crypto advertising if you were one of the beneficiaries of it yeah i mean whatever would you i mean okay so let's say someone wanted to run a crypto ad on our podcast would you compromise on or you're like well this kind of seems suspect but uh they're gonna pay me would you take it no i mean no but our i think our advertising is different than a

programmatic because then you don't know it's kind of a self-serve right because we can really parameters yeah that's fair that's fair but yeah i mean it's not it doesn't really make sense to make fun of your advertisers and they were talking about making crypto investments in their incubator a year ago and they're guessing they just shut that off so yeah i think it's strange to looking at the consumer economy that doesn't it seem a bit i'm kind of a bit uneasy because it seems like everything is going as we stand today is going through almost exactly what the general consensus has been and it's really kind of a steady slowdown in discretionary spending and the But the boom is over and it's slowly trickling away back to normal, possibly with high inflation, possibly with a small recession.

I think that's a bit strange because I'm waiting to get surprised by something. I'm waiting for some sort of shoe to drop, but maybe it's not going to happen this time. Yeah, it feels like this was the recession that was predicted. Yeah, it's just kind of been real easy, like not too bad. Steady decline. There's going to be difficulty for some people and it's going to hurt some retailers. There'll be less spending. People will tighten their budgets because they have to. That was kind of what, as opposed to one fast, dramatic collapse, it feels like that was what everyone was expecting to happen after the big influx of capital from the Fed. yeah like oh this will this will trickle through and reverse but it'll be slow yeah and it seems like interest rates so far are working their their magic i mean

the other thing we'll see what happens though with the real estate market i am as someone who knows nothing about real estate i am nervous about real estate we saw commercial there's some commercial real estate people that are going bankrupt filing for bankruptcy the residential stuff looks the least you know the affordability charts are worse than the gfc right now and if inflation stays high that man i wonder what's going to happen there and i wonder how that big the impact could be and how quickly but you had something else to say yeah i kind of i kind of lost my train of thought but the on the residential side kind of segues into another piece of news that i saw zillow reported earnings this week didn't we talk about those we talked about

those last this last week okay here's the other important part costar group also reported earnings this week um and costar groups like one of the leading uh commercial real estate databases the leading if i'm not mistaken um however they also own homes.com homes.com said they surpassed 20 million monthly unique users which was up double from which apparently had double traffic doubled in recent months that and they have like a much cleaner advertising model for agents it's just your listing your lead that you know you pay for the listing you pay for the lead um the i don't like is zillow's kind of moat that they've held for so long which is just that so many users go to their so many eyeballs go to their platform is that finally going to erode and are they going

to have the difficulty of because for the longest time they've they've been able to mess up as much as they want because of the eyeballs on their platform. But if we start to see a real winner like homes.com, does that start to take away? And is it more of a structural issue for them? Yeah. Zillow's in my too hard pile for sure. It's definitely in my too hard pile.

Well, it's in my might not ever generate cash pile. I checked out their investor day And they expect 24% annualized revenue growth through 2025. They put that based on their 2021 numbers and their 2022 revenue was down like 16%. Say that again. Say that again. What was the number? They put out like guidance or whatever, investor day guidance, and it was 24% annualized revenue growth.

through 2025 yeah well the stock would be cheap if that works however they keep let's show the cash flow no way everything yeah that's doesn't seem likely especially if housing and what's interesting is we always see this stuff you see it online you see you know everyone's interested in the housing market a lot of people have exposure to it you always see zillow economist predicts or redfin economist predicts or someone else that's not the digital ones any sort of person they're biased because they're they're incentivized to have the housing market be healthy right their incentive is to say that home everything is going to be good there's going to be lots of demand there's going to be lots of buyers there's going to be lots of liquidity

their incentive is not to say the other thing so i don't really trust those people when they talk about all that stuff and their guidance and the guidance for the industry because they're biased. And you know what's funny? Even with their obvious incentive for real estate to do well, real estate marketing to do well, they have all come out and basically said, there's an affordability issue right now. And that it's going to have to have some sort of an impact. Rich Barton said it in a shareholder letter this year, which is the CEO of Zillow. Redfin has reports and they honestly props to them because they have reports like every week that are like mortgage applications are down 50%.

I'm like- Let's cut those. Let's cut those expenses. How many economists do you have on staff? Let's cut that in half. They got heavy salaries. You guys need to make money first. Come on.

We don't need these reports every week, right? But it's nice. I like them. But as an investor, I'd be like, hey, let's cut that. Let's cut that out. I mean, yeah, I appreciate the candor, but I'm like, dude, this is going to hurt your business.

Like, you know, you're hemorrhaging money and you're seeing these reports every week. last thing i'll say because we're about to sign off uh there was a little this is kind of a little more fun but howard schultz ceo of starbucks or temporary ceo for the time being said they have come across a new transformational drink it's coffee with olive oil is this is this the tailwind starbucks needs maybe they say one thing about howard schultz he has been pretty innovative from a product perspective oh yes he's this could play stands the consumer this could play big time into the keto bros you know don't people aren't people like oh we put the butter in the coffee it's some

magic formula i think this could work with that people love talking about it they're like oh healthy fats there we go that's it's a big right isn't that kind of a trend i don't know i've seen that online? I don't follow the keto fat enough. Yeah, I follow the nutrition stuff. Here's my last question that I had on Walmart on inflation relates to real estate a little bit, I guess, because of interest rates. If inflation stays elevated, because we're seeing operating margins fall at Walmart, if inflation stays elevated, is it possible for general corporate profit margins, say the average corporate profit margin of the S&P 500 to not decline. Because when I see that, I think, okay, the earnings that we're earning, or excuse me, the earnings that the people are

stating the S&P 500 is multiple of like 20, it might actually be 25, it might actually be 30. That is not the way we invest, but it's just something that concerns me. And it feels like there could be some opportunities in 2023 if that occurs, because the market, No way the market would be at a PE of 30. We'd see another 20%, 30% drop. No, yeah. Margins would have to compress. Either – here's my statement that might not make sense initially.

If the cost of eggs continues to increase by 9% each year, and the cost of eggs is just a microcosm of inflation generally, housing prices will drop. or you will have a widespread recession across the across the rest of the economy yeah and by eggs you mean anything wherever the inflation is high yeah yeah rates have to stay high which means that like either no homes will be sold or a very small percentage of homes will be sold or prices will have to come down there's no other way to do it we talked about this last week i'm sure people say but you have a circle like say there's a circle a pie a pie of um money that a person has each year their personal income or household median income in the u.s yeah yeah if 20 of that more is going to household spending or 20 more is going to something else

it's not like they have a magic place to get more of that well they did during the pandemic stimmies but those aren't happening anymore and yeah it'll just be fascinating to see what happens? Where will the dollars flow? Because we know they'll obviously go to food because that's key and they have to go to shelter, but it depends what type of shelter. Are people going to lay down these mortgages at 6%, 7% with these prices? Are consumer discretionary items going to just go fall to bed? Will travel pick up or collapse? It'll just be fascinating. And unless you have anything else, Ryan, we are running at two minutes late. So I think it's time to wrap things up. uh if you're a regular yep nothing else uh these go live 12 30 p.m eastern time on youtube

every thursday look up the chit chat money youtube and you'll be able to find it you can subscribe to it and if you even want you can put the notification bells but it's 12 30 p.m eastern every tuesday if you want to ask us any comments and you can watch the replays there you can listen to the replays sunday mornings as most people do on apple podcast spotify wherever you get your shows. If you like our shows, subscribe to our newsletter to keep up with us. It's the Chit Chat Money newsletter on Substack. Give us a review on Spotify or Apple Podcast to help support the show. Remember, we are not financial advisors. Anything we say here is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities

discussed on this podcast. Thank you everyone for joining and watching. We'll see you next time. We'll see you next time.