Chit Chat Stocks - Investing Power Hour #56: No MSFT/ATVI Deal; Big Tech Earnings; Update on Banking Crisis

Episode Date: April 30, 2023

The CCM Investing Power Hour is a live-streamed show every Thursday. 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. This is the Investing Power Hour number 56. My name is Brett Schaefer, and I'm joined as always by Ryan Henderson. On these episodes, we talk about whatever we want in the financial markets,

investing, business news, whatever. It might spear off into a succession discussion right now for a few minutes if we ever get to that. But we got a lot of topics this week. We have new news on the banking panic, which Ryan will cover. There is lots of earnings. I'm not sure which ones we're going to talk about in detail, but we are going to talk about some. There are a lot of fun companies to cover this week. I have the Microsoft Activision Blizzard news, and then some interesting charts about housing and excess savings in the economy, if we can get to them. Ryan, how are you doing how are things earning season wise disappointing to see the activision buzzer news but maybe we'll hit that later yeah it was it was disappointing it sounds like it maybe um

still isn't over um the controversy continues but it certainly uh prolongs the acquisition period which if you're in the merger arb space um or if you're you're buying anything because you think the acquisition will occur the longer that it takes the worse off you are in terms of rate of return so um little disappointing but we'll talk about we'll talk about that later we'll talk about that later uh early season has been fun though it's it's it's been all right i feel like there's always way more anticipation than what the results bring like everyone's like this is a make or break quarter seems like they say that every quarter and then the results are always just a mixed bag and uh kind of a continued continuation of the

same stuff that's been happening before yep and it's interesting to see what narratives get built from the current earnings period it seems like there's always a few narratives that get attached and then people run with it for a few quarter or a few months until the next earning season and then we see if it's actually surviving trend or just the narrative that's driving price in the short run we got uh we got rod alsman in the chat former guest just yeah go listen to go listen to his episode on i forget the exact company name because it's so niche but it is the the engine company for trucks uh semi-trucks and or not even engine it's uh transmission transmission yeah yeah exactly i think it's called allison transmission holdings yeah been around for

a hundred years. Very fascinating. He's going to be, he's going to be rolling his eyes, but yeah, I think it is. And it's yeah, like kind of most people probably are unfamiliar with it. So go ahead, check it out. It's pretty interesting. Yeah. All right. Well, before we get to this episode, we need to talk about our sponsor and that is stratosphere.io. It is our investing home screen for fundamental research. It has key KPIs for their premium plans. They are launching stuff that they're integrating chat gpt although they just did that which i would just go check it out so you can get on their wait list there let me share my screen ownership oh yeah you want to share something i had something to share but let me you know and i was i was listening to

ourselves this week all right yeah on the podcast i gotta say it partly irritates me when we share stuff for the people that just listen so we got to make sure we like very clearly describe it All right. Well, go ahead and share it and test me and I'll describe it. Okay. Well, oh, wow. Use First Republic as well. I had that loaded up. It is a chart of First Republic. Well, we have the share price, which looks like not great. But now Ryan's going through their owner or their liabilities and asset table on Stratastro, which is nice and clean and very easy to integrate with. He's looking at total liabilities, total debt, net debt, all the stuff that they aggregate for you and make it super easy to start

really, I don't know, the research on a company. You don't have to go through the SEC filings. You can read stuff that's actually readable instead of the filings that people put through. And let's see what he got here. Total average deposits. Well, things look pretty good for First Republic compounded growth rate of total average deposits of 21% for since it was through the end of 2022. But then in Q1, everything just fell off a cliff. So not one KPI makes or breaks a company. But yeah, they have these interesting KPIs for companies like First Republic on Stratosphere that you won't find anywhere else, at least not for the price of either free or the smaller price that they offer to, which is great for individuals or professional investors. So go

ahead and check them out. Stratosphere.io, use our code CCM, get 15% off and tell them we sent you. Link is in the show notes. Okay, Ryan, let's get to the topics for today. Any comments first or no? Just Rod saying hi. Sorry, I was on mute there. Yeah, we do have another comment. ben cone resigns i i had no idea who that was that is the uh ceo of playboy enterprises um uh one of our one of the people in the chat matthias says uh he'll he'll do his part he'll step in yeah they're gonna have tough tough time filling that position yeah anyway um yeah so i don't know it's been a super busy week so probably tons to get to i should we start with the most interesting. Maybe the banking panic continues. Yeah, I think, yeah, go ahead. You had some notes

on there. You did jinx it a little bit last week, although I don't know if this still might not be a full-blown panic, but at least First Republic seems like it's still pretty much dead. But why don't you go through the details? Yeah, I probably should have thought out the fact that right after I said the banking panic was over, earnings came out in a week and it was, there were companies where we certainly didn't know how bad the problem was or we didn't know what had happened to deposits because it hadn't been publicly disclosed. And then this quarter we saw, and well, First Republic was one of those. So First Republic, I guess I'm not that familiar with the business or I wasn't prior to kind

of what's been going on. A lot of investors that I respect were invested there. They said the customer service was incredible, kind of would always go one step beyond to make their customers kind of feel welcome. However, it seems like they fell into pretty much a similar trap to Silicon Valley Bank, where they had a number of health and maturity assets. And those assets, you don't want to have to mark down because then you get in trouble and earnings look horrible. And then so any sort of deposit outflows, you start to have this risk.

And after the Silicon Valley banking crisis, a lot of investors and I think depositors were concerned that the same thing could happen to First Republic. And that fear tends to lead to withdrawals. And that's exactly what happened. So I guess just for context, I don't have the number right in front of me, but deposits, they said the deposits were only down, I think it was like 30 or 40%, but that included a $30 billion basically. I know, I mean, that's not great either. It included a $30 billion rescue fund essentially from the big banks in that deposit accounts. Well, I mean, I guess those are technically deposits, but it's a rescue fund. So if you exclude that, deposits were down, I want to say 60% in a single quarter, roughly.

So obviously that kind of leads to more concerns for anybody that's left that's a depositor that's looking at these results. And basically, I mean, there was a lot of writing about it. It's still kind of in limbo right now as to what exactly is going to happen. Can we just end it? Let's just put them in. Give them to someone for $0. Well, I think it's better to have – so here's what's happening. There's reporting from CNBC on this, and they said advisors to First Republic will attempt to cajole – that's kind of my first use of that term – cajole the big US banks who've already propped it up into doing one more favor. the pitch will go something like this, purchase bonds from First Republic at above market rates for a total loss of a few billion dollars or face roughly $30 billion in FDIC fees when First

Republic fails. Essentially, so I've got another quote here from Matt Levine that kind of highlights what would happen if they just let the bank fail. So it says, he says, roughly speaking, if some banks fail, the FDIC is a mutual aid program and the other banks join in to bear the loss. But if there's a full-blown systemic banking crisis and lots of banks fail, the FDIC is a government guarantee and taxpayers save the banks. Essentially, it would also have, I'll read another quote, the specific mechanics of the FDIC insurance fund create another argument. If you let Bank X fail, that will cost the FDIC money and the FDIC will just send you a bill for that money. So you might as well bail out Bank X yourself first. Essentially, they're going to be left carrying

the bag anyways. So if they're able to prop it up by buying these bonds, it might not solve the entire problem. There might still be withdrawals and deposit outflows. But they said if they can get the $30 billion from these other banks essentially taking a loss, it's going to lead some of the other third parties that were interested in helping give some money said they would also pitch in. So basically, they're waiting for the big banks to step in, and then they'll add some capital, these third parties, once they have a better sense that First Republic's not going to go down. The thing is, it seems like every time there's a banking crisis, they give a half response that isn't enough, and then they have to give a full response.

Where if you just do like kind of a, if you give them more capital to begin with, it probably stops it in its tracks. So it seems like, I don't know. I mean. Could be hindsight 2020 there. Yeah. Because if you give them enough, then it doesn't become a crisis and you forget about it. But you remember the ones that become an issue and have to, you have to double down on. Yeah.

I get your point. I figured people would have referenced 08. Yeah. But there's other situations, right, where… going to get sort of a buyout package or a rescue package from the other banks. So I guess the banking panic isn't over. It still continues. And I should have thought about this earlier, but it's not necessary. I don't think this is going to have a trickle-on effect. I don't think other banks are going to see this. I don't think other depositors will pull their money out of their bank just because of First Republic or whatever. But what I do think is possible is that

these banks that have long-dated health and maturity assets continue to report concerning earnings numbers. And that might lead to anyone who's following the bank's earnings to say, oh, okay, I've got some uninsured deposits. Why don't I take some kind of risk off here? Maybe. Maybe. It seems much, much, much smaller than 08, at least right now. This is not even comparable to the size of the 08 crisis. So I just don't see it. And to be honest, when deposits leave, it helps unless people are putting money under the mattress or in Bitcoin or gold or wherever, it's going into other banks. So I think on a whole, it's almost just circular and everything's fine. The banks might not earn as much as they would if they're getting caught with their net interest margins compressing.

But it'll be interesting to follow. I mean, some of these banks might be in big trouble if people start panicking even more. But in the real world, this story seems to have ended outside of the investing people who follow the investing news, financial news, business news. Yeah. And the big banks, I think the big banks are in an interesting spot because they probably aren't going to have to raise their whatever their savings account yield because no one really, I don't know, no one gives a shit, frankly. If you have your money in a Chase account, are you really putting it there for the savings rate? Are you doing it because you want to earn money on it, or would you just move your money out of there? I think they can continue to hold a really low savings yield and earn more on their assets and basically widen their net interest margin, while a lot of these other banks like Ally or any of the high yield savings account might attract more deposits, but they might have that net interest margin compression. at least over the next year or two. Here's what Rod commented. He said, an issue is the flow into money market funds and out of the banking system. Yeah. I'm going to

kind of push back on you on the keeping money in the checkings accounts with low interest rates is that it's very easy. And yeah, it's not going to be like, boom, overnight, half the people are going to say, I'm going to put something in a, what do they call them? CDs or money market fund, something that yields 4% or higher or whatever the rate is right now. And I think that is just going to steadily happen. It's just going to be a trickle, but the higher rates stay this long, they're going to eventually have to raise rates. But compared to someone like their loan book will eventually follow suit, right? They're not going to have to do it immediately. So I think everything will be fine. We've seen a bank we cover don't own right now, but follow it pretty closely,

have it on the watch list as ally financial. They're kind of in the middle ground where they don't have any FDIC or excuse me, uninsured deposit issues. Preston Pyshenko Like 10%? Yeah, very, very low. So there's not a concern that they're going to go through a panic and they're growing their deposit base, but they're seeing major net interest margin compression as some people go, they have to pay out more on their deposits and they've had to raise their interest rates quicker, or they've chose to do that just because they don't have the advantages of the big banks and their people are moving into CDs and money market funds. But eventually their

loan book has higher interest rates as well. So the net interest margin they're earning is going to even out over time. Yeah. It's an interesting point. And I probably should have mentioned it, but the big banks will earn more on their deposits, but it's probably quite likely that deposits will decrease on a per customer basis. Deposits, what do you mean? literal deposits? They don't have to raise their savings rate because people probably aren't really going there for that. We've seen a net interest margin expanded for Bank of America and I think JP Morgan as well, where they don't have to increase their savings rate, which might push some kind of, let's call it 10% of a customer's money to money market funds, but they're always

going to have a certain percentage in their savings accounts or in their checking accounts. And Bank of America, JP Morgan, all the big banks are going to be earning more on that because they're going to be getting a better yield on their loans. So I guess it's kind of a push and take, but we've seen, I think, net interest revenue at Bank of America was up like 30% or something like that. I think it's the ones where maybe you don't use them as your primary bank, where there may be more deposit outflows. And I don't know what Schwab's case is

If that's like the primary bank for a lot of people But Schwab saw 30% Of deposits decrease Year over year And move into, they're not necessarily leaving Schwab But moving into a different Somewhere where they can earn more money Yeah

It is interesting where some of the banks Not all banks are created equal I mentioned that this is way out of the It's not In the mainstream news anymore which is a good thing because a banking crisis can kind of cause itself if everyone thinks there's a banking crisis. But he said, this is Matthias, this is a little bit of you're making fun

of your friends here, but the plebs of my life, which is meaning I think non-finance folks, have moved on from sending me doom articles about the banking crisis and they now send articles about the imminent collapse of the U.S. dollar reserve status. That is true. On the rise. The Mexican peso?

we're gonna have a let's just i want them to make a global peso or excuse me a peso that's all of south america's just too confusing and it would be so much easier but i don't know anything about that issue but i i threw out a there was something i was listening to about that and again total idiots about foreign currencies and reserves and stuff like that but there there's something that made me think of this idea where let's say ryan you have two choices one and i tweet out poll if anyone wants to vote on it uh first one is you can buy a south african 10-year treasury in south african whatever dollars whatever they call it yielding 10 but it's 10 years right or you can buy a us 10-year treasury yielding five percent what do you choose i'll take the i'll

take the us treasury and i i think you could have used a lot of examples it's nothing against south Africa. Yeah, it's not specifically South Africa. I just know the market. I mean, I just

have a better understanding of the U.S.'s current situation. The thing that I will say is people talk about the U.S. dollar losing its

reserve status. I bet that's been talked about for 150 years. Well, Ryan, it hasn't. Or sorry. Since it became

a reserve after World War I. Yeah. Or two. Yeah. Yeah. I mean, remember when we went off the gold standard and everyone said the same thing? I mean, not remember like when we were there, but remember all the talk about it?

Yeah, yeah. Reading about that and stuff. Well, I mean, it can change, right? I think really, you know, the British was the reserve currency or whatever it was, the pound for a while. And before that, I guess there really wasn't one for a long time before there was true globalization happening. but i think you have to believe and yeah we're talking we're talking kind of above our pay grade here but i think you have to believe that american productivity and influence in the world is going to shrink yeah if that is your belief then yeah i don't know i guess yeah you have to believe that

yeah there's going to be a uh another superpower that takes over something like that but yeah the u.s reserve status just because someone bought some oil and didn't go through the u.s dollar i I mean, that's fine. It's probably a fair question for them to ask if they want to do that, they can, right? That doesn't mean anything. Yeah. I think Dalio has been all over this too.

Oh, Dalio. He loves, well, I got to say he has some ties to China that he may be getting some funds from over there. So I don't know. He might be slightly biased, but he loves talking about the collapse of the economy. And I just don't like that because that's almost again self-fulfilling prophecy i just i just hate that stuff right

where you have so much influence and you're like the global economy is going to collapse and i yeah if you're yeah look i just don't like that talk i mean he's also yeah i don't know i read his like or i maybe got like halfway through his principles book which was like one of the most boring reads on earth but the other he is a little hypocritical and i i don't agree with everything he's done but yeah but he could be he could be totally right and he obviously has 50 something years of experience right as an investor so yeah now that is true yeah all right let's do another yeah let's do another topic because us dollar reserve status. Let's talk Activision. Yeah, it's just astrology, as one of our commenters said. Yeah,

let's talk Activision as something more concrete. Pretty easy to see what happened here. If anyone that hasn't got caught up with the news, so the United Kingdom, it's called something, the CMA is the acronym, but it's basically the FTC for the United Kingdom. I forget what it actually stands for. They blocked the deal for Microsoft to acquire Activision Blizzard because they believe the deal would hinder competition in the cloud gaming space which they claimed is going to grow rapidly to around 11 billion british pounds of global annual spending by 2026 full disclosure here we do own shares of activision blizzard at this time so we'll try to be we might sound a little biased because we do think the deal should have gone through but again don't feel

sorry for us or anything it wasn't a you know these aren't huge swings and losing 50 of value of a position or something like that uh and yeah that that's really all that happened shares of activision blizzard fell 10 on the news kind of back to where they were a couple months ago and that's it's the obviously microsoft and activision blizzard said that the deal should go through which you would expect them to they're pretty i think harsh threatening the united kingdom essentially saying that they're the if you kind of saw some of those notes um what was they're threatening basically saying they're threatening that you know the united kingdom is bad for business the united kingdom is a bad place for mergers it's the worst place in europe

for a technology company to go they're they're saying all this you know trying to talk their book and stuff like that about how the cma doesn't understand things they were being they basically were saying that uh they they honestly sounded like a tech uh startup person or a or a bitcoin person where they say you just don't get it bro you know where they essentially saying i think i honestly agree with them we can talk about that that the they said that the cma and the ftc do not understand the video game market but discussion question what do we think of the decision here did the cma get it right or wrong run why don't you go first and then i'll have my thoughts i think they got it wrong um and you you threw out one of the big stats which is

there the big concern here was over cloud gaming which really isn't even a market yet I mean, it's not even a market. And they cited one of their reasons for, yeah, I mean, here's, okay. For everyone listening, Brett is showing a chart right now on the gaming market, and there's concerns that Microsoft could be a monopoly if they gobbled up Activision. And one of the big concerns there was because of the cloud gaming market, which we think it will grow. But if you look at this chart, today, the gaming market, I think this is from 2020, is estimated at $165 billion.

And 2022, it's about $200 billion, give or take. And what would you say, what percentage do you think is made up of cloud revenue? 1%? Maybe less? It's much less than 1%, probably less than half a percent. If we look at the numbers here of that $165 billion, we have $85 billion in mobile, $40 billion in PC, $33 billion in console. So I think the key takeaway I have from it, and this is more of someone who is very interested in the gaming market and is trying to become knowledgeable about the space, and I think we are fairly knowledgeable about this industry, is they wanted to increase competition within cloud gaming, which no one's really even figured out. Microsoft has a product and no one else is really trying because the technology isn't there. So they want to increase competition in that, which is a fake market that no one knows what is even going to look like five years from now. It's like doing competition stuff within the

metaverse market. But they're going to decrease competition in the mobile market, which is $85 billion, because now you're not going to let the Xbox store really have a chance to compete with a content offering versus Google or Apple. You're going to decrease competition within the PC market and entrench Steam and maybe a little bit of Epic Games as the dominant platforms at PC, and then you're going to entrench PlayStation as the dominant platform and console, and then I guess you have Nintendo, but they don't really compete with anyone. So yeah, that's my takeaway. And PC and console are both around $40 billion a year.

So just so much money, so much consumer spending, and now you're just going to entrench these other players and not let Xbox try to increase competition in some of these other places for cloud gaming, I saw all the people that cover the markets for newspapers and stuff like that just laughing. They're like, what is going on here? Yeah. I mean, it is laughable. They cited one of the reasons that they don't think the deal should go through is because they don't know what the cloud market dynamics are going to look like, and they think it could be a big market. They cited some obscure estimate, which no one has any idea what the size of the cloud market is going to be in five years, two years, 10 years,

you pick it. No one has any idea. And they said, some random estimate said it might be worth $11 billion, which is trivial in its own right, relative to the gaming market overall. It would still be a small part. I mean, it'd be a few percentage points, but it'd be a small part. Yeah. It doesn't really make sense to me. It shows that in the words of the little succession reference, the CMA and the FTC are not serious people. They seem very biased against big tech, which I guess as an investor, we're looking at that more from just an industry covering the industry. But from an investor perspective, I think this is the big concern we had is that these companies do have a vendetta against, or excuse me, these regulators do have a vendetta

against big tech. Now, I want to get to the next question is what do you think the likely scenarios are from here because i you mentioned that they're going to appeal the deal i think that was a little bit of talk from activision because they have to say that right and i think once they're um it's in july their deadline for getting the three billion dollar termination fee hits i think they're going to want to walk if they see this is going to take multiple years to close yeah i suppose um i guess i don't know i would like to see them appeal the deal um not if it's going to take multiple years to close and maybe that was the goal of regulators maybe that's what regulators were hoping for was let's just make this an absolute slog to get

through. It's disappointing from, I think, not only an investing perspective, but also, I mean, gamers were frustrated by this too. This would have absolutely helped. I think having Call of Duty under the Microsoft umbrella, under the Xbox umbrella, there could have been a lot of ways for them to make that game more fun more accessible if cloud does work out it in it could have been i don't know that much more seamless to have cod on xbox whatever the cloud gaming version is so um i think gamers were upset i just find it i don't know i bet the third-party publishers were upset too because playstation is a lot more anti-competitive to the third-party publishers where they they really go for these exclusive titles that um the regulators were

worried about anyways there was some there's some interesting data out there that uh third-party titles do not do as well on playstation versus xbox and playstation does have a growing part of that market there's a nice could come here from rod saying the cloud gaming platform from google was shut down about three months ago not a great indicator for the cloud market yes it's not even a working technology yet google stadia didn't work at all and there's a reason for that it's just not ready so it's it's almost like blocking a acquisition for social media in 2002 yeah and the uh i i guess my other thought here is what would and i know this probably won't happen but what if microsoft said or activision said all right we'll go ahead without the uk market

yeah i think maybe they would do that if microsoft didn't have all these other business lines because uk is probably not that big of a you know and maybe it's like five percent of their revenue i know it's an important market for them especially for the console market but they would have to forego microsoft to have to forego azure office 365 and all that stuff so i don't think the juice is worth the squeeze in that regard but it would be an interesting tactic that would maybe they could threaten that maybe they could threaten that and say look we're going to cancel hope microsoft office didn't ruin your economy if i take away excel but you don't think they could say like hey uh i mean that yeah that then it would maybe that would make it look pretty bad

maybe that would prove that regulators are needed to step in but uh the couldn't they say like okay we're just not gonna we're not gonna serve xbox customers there because what is it four percent probably maybe less of like activision's revenue so obviously they would be paying a little bit more i don't know how much they don't say in their filings what the uk accounts for but i'm pretty sure the playstation is a huge is the leader over there by a long shot yeah so i don't know is that on the table probably not but i kind of wish it was because then all the gamers in the uk would be like yo just pass it like let it go we want cod yeah and and again the other publishers which is what they're they're trying to say that they're helping out here like

the other publishers don't want steam to get more powerful they don't want playstation to get more powerful powerful and they do not want google and apple to get more powerful which in reality they just there just needs to be another app store that hops into play for the mobile department so they don't take that fat take rate without building a dedicated system because again the take rate you know like steam takes a big take rate or playstation takes a big tag group but that's because they have the dedicated hardware for gaming it's more of a collaborative process but again i'm going down a different tangent some you have something else dad and i bet like if they i'm not even sure this is how like logistically it could work but if they said like okay we're

we're going to take Xbox services out of the UK. I bet EA would say, no, no, please, no. They'd be lobbying for the deal to go through and for Xbox to stay in the UK. Because EA has, I think, a huge, maybe not as big as the US market, but a big chunk of their FIFA revenue, especially, which is their leading revenue.

Racing's huge in the UK, and they're the biggest racing game company. Yeah, I mean, I'm sure they would be incredibly frustrated by it too. So I don't know. I think I side with Microsoft putting pressure or Activision putting pressure on the UK. I think it's kind of... And when you look through the report of why they chose not to do it, it is kind of laughable because it's very clear they don't understand the market. And cloud as a percentage of gaming overall is less than 1%. How can that be a monopoly like how could that be your concern that maybe one day maybe one day it is worth two

percent of the overall gaming market yeah it doesn't make much sense i did see and they you know they had all the people from microsoft and activision doing a blitz for the media so i believe it was on cnbc it was bobby kodik the ceo of activision blizzard and i didn't catch this part but i saw someone tweet a quote so don't this isn't a direct quote but they're basically saying that yesterday or this week, the CMA met with the FTC. So I think the FTC convinced them to stick on their side and block the deal. But it's just disappointing because I think this means a less healthy gaming market going forward. And I want, just as an investor and following this industry, it's so fascinating. I want a healthier gaming market where the platforms don't

You know, there's more competition among the platform level and a platform in either the console platforms, the PC platforms, or the mobile platforms, or I guess the cloud platforms, where without this deal, I think there's less competition because I inherit competitive advantages and winner take all scenarios here. And yeah, I just look. And I think acquisitions have benefited gamers over the last 20 years. EA produces such better games because it's that much bigger and is able to have the resources to invest in it. It's not like there's any monopoly here that's just gouging consumers. Consoles have been similar prices for decades. Game prices haven't changed for decades.

They're actually down a lot in real terms. I think I saw someone do the math that they should be around $110 per game now, and most of them are actually going, a lot of them are going towards free. Yeah, I think Halo fans might be upset recently because Microsoft acquired them. But in general, yes, the acquisitions haven't really hurt the market because the industry is interesting

where there's so many studios starting up and it's all about whether you come up with a good game or a lasting franchise. And you can't just acquire your way to success. You're acquiring skilled people. you're acquiring maybe some brands but it does not guarantee at all that you'll have success because i mean for one xbox really hasn't succeeded with their first party strategy outside of minecraft no and for the people that and i'm pretty sure they acquired minecraft

initially i'm saying first party like yeah yeah they acquired them but like it's a first party game for them now and for the people that are like oh no i want as many indie studios as possible it's so difficult to survive as an individual studio in the gaming world, because you're going to have, even if you have a hit, you're going to have flops. And those flops, if you're in a big company, aren't the end of the world because you have the resources to weather it and then produce a new game. But if you're an individual studio and you have those flops, it could be the end of the franchise, end of the enterprise. Yeah. And the last thing to close on that is that's the data that I was trying to reference earlier, but I can't really remember the exact stuff is

that the indie studios with sony on playstation do not do nearly as well and they kind of target their own exclusive titles so you want more competition among the platforms for these third party titles for these indie games because if it's all sony or if it's all steam yeah steam doesn't really produce their own game so i guess it would be fine but within sony specifically on the console market they you don't want that how am i trying to say it you want more platforms out There are as many as possible that are succeeding because right now, Xbox, yeah, can offer it, but it's not nearly as big of a portion

as for revenue for these third-party titles as Sony or Steam or the mobile platforms. And yeah, it just, it doesn't make sense in general. But do you want to go to the next tech topic or you have something to final here? No, I guess we can leave it. I mean, the UK, congrats. You've now blocked the Activision deal

and you blocked Facebook from buying Giphy. Thanks for saving the tech world. That's why I think that RIP Logan Rice, when he said, I love you, but you're not serious people. That's got to be so good. All right. Spotify at earnings. Thoughts?

Yeah, pretty much as expected on earnings side, because I said it would be bad. And it was really good on the user side. but it's the rest of the world so you get it almost from a monetization perspective just because these markets have lower GDP per capita you gotta maybe divide them

by two for a lot of those so I don't know if it's that impressive but it's not a bad thing that they're getting usage in a lot of these places and yeah it was really as expected I did like how they talked about reducing dumb podcast exclusive contracts which I think

means the old celebrity contracts that they signed that didn't really amount to much where that old the prior head of content I forget her name got fired for that it seemed like so that seems better because the exclusive strategy seems smart

and then it's just really the rest of the year watching for gross margin expansion on because they said this is the year it's finally going to happen and we'll see so yeah I think ad supported was a little disappointing but they said it was going to be light

and yeah you just need that to accelerate because they have the fixed cost for the advertising spend for a lot of that and they need to grow that so anything you saw that was insightful but i thought it was really really as as as everyone kind of as i thought it would be right no big surprises here yeah and it kind of surprises me that stock still trades on user growth like they beat users and stock jumped like nine percent well subs was pretty impressive I know, but that's just never been – over the last two years, I would say that has not been a sticking point for me as an investor. I'm not concerned that it's a good product and it's going to attract more subs over time. I'm concerned that what are the economics going to look like?

What are the margins going to look like for this business? And yet the stock really still trades on those user numbers, which, I mean, half a billion subscribers or users, I think that's obviously very impressive, but the gross margins are still an issue. And I did find it a little interesting that they were kind of vague

with why their gross margins, they were like other cost of revenue increased. And someone asked on the call, like, why? and they're like well uh you know cloud computing costs or something like that i'm just like well that's not yeah that's semi-concerning but yeah i think it's just with the user growth in a lot of these uh rest of the world markets which for them is everywhere that's not latin america north america or europe if it's growing quicker that cost is going to grow and they're not going to make as much money off of that so yeah it makes sense i hated some of

questions and that's slido they always put in i put in i put in like five questions that all basically said how are you assuring that you're not hiring too many people again but they didn't like it they didn't want to ask they're not taking those i think i'll bet they have people oh yeah i bet spotify has people on the call like they're like okay let's get 10 people to like that question or they can ask whatever let's avoid yeah yeah they're avoiding some of the tougher ones um i i thought that yeah it was kind of a mixed bag or at least they didn't at least at least they didn't just say ai over and over and over again they did talk about what you think uh almost the same thing where it's just expenses everything looked fine to me

the the youtube isn't really a concern because they highlighted that they're going premium so as if advertising revenue is kind of stagnating for the time being it's not that big of a deal if their premium subscribers are growing so much because that's where the revenue is going. But cloud is great and search is fine. Yeah, it seems. And then they just... And cloud was like...

It's funny, they were like, yep, we just moved some numbers around and we're profitable now. Well, no. Oh, for the servers, the server stuff? Yeah, the server depreciation. Yeah. To be fair, all the companies have been doing this,

So I think they're showing that it's like... No, the tech's improving for sure, but... I guess, or it's lasting longer than they thought. Yeah. Kind of funny that that's all it took was a little useful life extension and boom, where gap is rough or cloud is profitable by a significant margin.

I guess that goes to show how much of the expenses related to cloud infrastructure are the hardware, The upfront costs. Yeah, a lot of upfront costs, less maintenance costs. And yeah, it's a lot of, look at Amazon's capital expenditures chart. And yeah, you can see that. But that is, they had to throw up a lot of capital upfront. So free cash flow is going to be, the faster the cloud grows, I think we saw this with Amazon, the worse cash flow looks in the near term. but depending on how strong you think the moats are you know it can help over the long term with durable cash flow generation and a part of me was like i looked at spotify's and like yeah our cloud our cloud costs uh jumped more than we were expecting or something like that and i was like well you know that sucks but i'm a google shareholder and maybe gcp revenue will be better so yeah well and it was and the he yeah that is one of their biggest customers but obviously not

just them moving the needle but back to the this honestly with spotify if their cloud costs are going up that you that means that their usage is going up from their consumers like hours spent on the platform and they did highlight that that hours spent per user is going up which in the long like that's fantastic news i thought all their user kpis were great they said dau to mau was better users were better podcast mix was better i mean in the long run it's not even users that is the most important it's consumption on the platform especially if they're going to be advertising driven which tbd if they can actually execute on that uh but yeah but on google i don't know yeah i thought it was a mixed bag um okay we have like 15 minutes there's been a ton of

earnings so i'm thinking we do i don't know which which of them you've looked at but just a quick fire thoughts let's start with meta uh a little underwhelmed versus the stock price reaction so I think if I was deciding how much the stock should be up, I would have maybe said a couple percentage points. I think the Reality Lab spend, people just forgot about it, but it's no different than they said it would be. But Zuckerberg and their executive team seems to be the only one serious about fixing the over-hiring problem in a real way

instead of just talking about it. Dropbox. Well, big tech. they're medium tech they are medium tech if they do the buyback enough they will be small cap tech and apparently the stock price stays at $20 forever

the yeah I think the usage stuff with meta seems fine it's not blowing it out of the water because if you look at a lot of these emerging markets Instagram and WhatsApp are dominating

but I think it's masking well I don't know Facebook seems to be doing fine, but I don't think the usage on there is probably stagnating in a few markets. But again, that has never actually materialized and hurt the business. It seems like fine, but I just wonder, can they really jump ARPUs that much across all their apps? I'm just not sure. But again, I think their stock is doing the best because of the right sizing and the cost structure, to use the consultant term. They're actually doing that.

How many people did they lay off? Like 20-something thousand versus- More, I think. Maybe a little over 20K versus what, like an 80K employee count. So very, very sizable versus their prior one. Yeah. It's true. Yeah. I thought the same thing. I thought the quarter was okay, but maybe it's just the expectations were so low coming into this year. The size of the social media businesses

continues to blow my mind. The fact that they're still growing at 3 billion daily active people. um but i imagine a lot of that's still from whatsapp and i don't know i think there might be i mean they're saying that like maybe reels monetization could be on par with feed and search and or not search uh feed and the other properties but i wonder if it's like structurally different i wonder if it's and they said it's like a very different feed concept or it's a very different like advertising concepts, when I think about like TikTok or Snapchat, which is maybe what it feels more like, it feels like it would just be a lower, if I'm, if I'm advertising there, I'd probably pay less for it. Yeah. I guess it depends on the targeting capabilities, but.

Yeah. I don't know how much that matters, but I think you could be right. I just don't. Yeah. how strong is the growth going to be I just part of me thinks it's great but yeah and also Reality Labs looks

worse and worse the revenue is nothing it's actually getting worse I think and then their other category which again doesn't really matter

yeah Reality Labs revenue is down 50% year over year I'm pretty sure yeah now that stuff's probably lumpy

because it has to do with like hardware launches but I still okay like i'd say six months ago we said that reality labs is going to be a flop and that this is not something that consumers are asking for like there's been no sign that this is going the right direction at least yeah i've seen yeah and we sound like super bearish on meta i'm really not but i just

don't know how like the risk award versus owning them versus google or amazon and i guess really that we own Google or Amazon compared to them at these prices, I think it just makes a bunch more sense. Here's what's interesting. A lot of the costs for the CapEx have been AI or AI-related investments. That's going to flow through the income statement. And if that's not a one-time thing and that's a permanent upspend, that's going to hurt their margins over the long-term unless the monetization is that much better. And they don't have a cloud infrastructure division to outsource the, you know, to sell those costs and capabilities to other people, which is why I just like, and we'll talk about all the negatives of cloud, all the costs of cloud

and none of the revenue. Yeah, exactly. Or they don't, yeah, they don't get to have the benefits. We're going to talk about cloud next week because as we're recording this, it's one hour before the Amazon earnings. So we want to get that context. But I do think in general, I don't know why, look, Meta could totally work from here. It could double again over the next five years.

I would not be surprised, but I don't know why people like them more than any of the cloud companies, because I think that is just so much more rock solid, especially with this AI boom. But it's an enigma for me. It's an enigma for me. I can't get a grasp on it. No, I'm so impressed by the family of apps. The social media properties and their durability has impressed me a lot. There was a point when I was saying that Instagram was going to go the way of Facebook and kind of lose its relevance with younger people. That just hasn't happened.

It's still so popular. It plateaued and now it's gotten a little bit of its mojo back. I'm reading it, right? I don't use it, but that's kind of what I read into it. Is that true, you think? Yeah, I believe Reels. There was a point when TikTok was stealing a lot of share, but Reels just basically replicated it and stole that share back, it seems like, based on TikTok's engagement data. So, yeah, I'm really impressed by the social media businesses, but it's like everyone just forgot that Reality Labs is a huge cash suck.

Anyway, all right. Other ones. Did you read Roku's report? clients at it uh yeah they gotta they gotta manage those operating expenses because again usage looks great uh market share looks great i don't know what happens with them with their how they they should be able to earn a good ad spread whether it's their first party stuff with their own channel or the take rate on other stuff i just don't why is it not showing up in the earnings why is there

why are there expenses to why are they investing in a lot of dumb stuff or what's going on like what if you kind of i think they might be i think some of the roku channel you're saying the weird al yankovic movie didn't blow your mind the content's been buying up the quibi stuff that was just totally useless and well or they work on smart speakers and smart lights yeah that r&d might be a little bit of a waste. They're also manufacturing their own TVs now. Yeah.

That could be cost savings though or the long run. Essentially. Yeah, it's kind of hard to say. But I just don't get it. It should have very... They should have the advertising and platform stuff

where they earn a little bit of fee on whatever, you know, through the distribution like any other platform. The layout's very high margins. Very high margins. Yeah, I agree. It's like there's this...

The business model, if you just described it to me without giving me any of the numbers, I would think like, wow, that's got to be really profitable, but it's just not showing up. And I wonder if some of that has to do with the negotiating leverage or the contracts between the big streaming providers, Netflix, YouTube, what else? Disney, but I think they get a lot of revenue from Disney. Maybe they just aren't very favorable contracts with them. Um, the other part, yeah, I don't think their layoffs trickled through the income statement this quarter yet. So they haven't seen that. So maybe losses look worse than expected, but yeah, there should be a way more profitable

business than it is like plain and simple. Yeah. Let me, yeah, let me look, let me throw up the stratosphere chart. See if I can, I want to, I want to look at it and see what their operating income has looked like because it just hasn't improved. And they really, they over-earned during 2021 or grew quicker. And there was a bit of the advertising bubble, but they haven't shown any ability to fix that. Let's go quarterly.

What about MasterCard? Did you look at their earnings? Not yet. I looked at Visa, but yeah. Pretty dang good business. Yeah. I want to talk about, let me, after I share this little chart for, let me describe it. So if we look at Roku pre-COVID, they were losing a little bit of money each year as

they're trying to scale the business, I guess, not a big issue. During COVID, for the first few quarters, they started printing some solid operating profits, $65 million in March, or excuse me, December 2020, $76 million in March 2021. But as kind of the COVID bubble popped in 2022, we've seen increasing operating losses. And it looks like at the end of 2022, we saw a $250 million operating income loss. Maybe some of that was one-time charges, kind of looking at the chart. And they haven't shown the ability to quickly right-size their cost structure. I guess, drink, I said that again.

And the same thing happened in Q1. So how are they going to fix these earnings? But we'll see. But here's something on the card networks. I want to show you this. And again, I'll describe it to people. but i thought it was super interesting we did talk about on prior shows about the excess savings chart right stuff like that and how we're you're wondering about when how much was really left on

consumer balance sheet so it looks like someone actually ran the math and i'll share it with uh with you here let me click on that okay can you see that yeah they're trying to recommend me that viral tucker carlson tweet can't escape it uh everyone ignored that if you're watching but here's the chart i'll describe it pretty easy to see so starting in covid because of the dynamics of the pandemic and everyone all knows that at this point there was huge cumulative excess savings in uh just from consumers and it went from basically zero to two trillion dollars and then you know the stimmies help with that it flatlined and now at in 2022 they've been drawing that down. And now we're at about 1 billion left of cumulative excess savings. And according to

this chart from Bank of America, say they drew down about a trillion dollars of excess savings in 2022, and that equates to a 6% boost in expenditures. But here's the interesting note, and I'm going to go to the next slide. All right, Twitter can't load anymore. This one is a bit complicated, but I'll just describe it. And what he said here is the above graph shows that the bottom 80% of households have already burned off the excess savings they accumulated in 2021. This is why credit card debt has expanded rapidly. See below, credit card debt is growing. So my thought here is that, and maybe you agree, I'm a bit nervous about the growth rates of the payment networks and the credit card companies right now,

specifically american express i want to see this excess savings get spent off and see how whether that wasn't how big of a catalyst that was to growth and i wonder specifically amex huh well amex visa i said the car networks visa mastercard amex i guess those are really the only ones and then i know but i mean looking at the chart i would think that the people with more that still have the capability to spend are the Amex customers. Yeah, for how long though? I mean, they're the wealthiest, it looks like.

Yeah, but the trillion dollars in savings that's left is them that's moving downwards and eventually that gets spent off, right? And how much of that was a one-time boost and how much of that can be normalized because incomes aren't growing to compensate with this. I just worry about that. Things might be fine, but I just worry about that.

with these card networks that print this growth and people go i buy this at 30 times earnings because it grows 10 a year forever maybe not yeah it might be might just be tied to at this point i think mastercard visa or basically just consumer spending plus five percent maybe maybe maybe yeah somewhere around those lines i know you said fiber you didn't mean exactly five percent Plus a little something, yeah. They're also doing things to... I mean, at this point, yes, the bulk of the business is basically global spending, but they're also doing stuff to structurally grow. They're still adding merchant locations. I think they just crossed a hundred million. The total cards in force is still up significantly. It's at 3.2 billion. I think it

was that like 2.6 a year ago so and they're so they're still growing aside from just overall spending on their cards yeah i just wonder how fast though i have no doubt these companies are going to grow over time and they are inflation resilient but are they growing faster than normal than they would be you know right now just as this excess savings i mean it's going to get spent off over the next few quarters so we'll know the question for sure i guess a year from now but We got two minutes. Last question. Were there any earnings that stood out to you this quarter? I've just been looking at outside of our own portfolio. I just looked at the big ones, and I guess Chipotle was pretty strong, strong margins. Maybe hindsight, people should have

been able to see that because of food inflation coming down and then still raising their prices consistently. But yeah, they keep knocking it out of the park. I worry about, we've talked about it, uh worrying about uh what what would you call it food quality going down but maybe that should have been a bull case because americans seem to like bad food so uh you just have a more advanced palette no we uh what are the what are the europeans always talk to us about when we talk to them about hershey's and stuff like that we seem to have disgusting yeah yeah so maybe the food quality going down was a good thing and not being as fresh anymore was a good thing for growth But besides that, that's not really impactful anymore.

Yeah, I mean, they impress me with their margins. I wonder if they can sustain 15% plus. What do you think? Yeah, I think they can. I mean, I still go on a regular basis and I don't really check the price that much as long as it's around like 10 to 12 bucks, I'm happy. Yeah, nothing where you're like, whoa, this is a huge, yeah, nothing. If it's still almost nowhere close to an expensive dinner or something like that. Yeah, that's what I'm saying.

it's still a good alternative relative to like sitting down somewhere and you get the same amount of food and it's higher quality than fast food. So yeah. And no one's still still want to, yeah, no one's replicating it either, I guess. I mean,

well, Qdoba is owned by, I think some Jack in the box and they totally botched it, but yeah. Yeah. There just isn't that many healthy, like convenient locations. For food? Yeah. And the percentage of food expenditures that are going to restaurants continues to rise. I would argue that maybe that is a bit of a bull market phenomenon because it's so much more expensive.

but a long-term trend of that is undeniable. All right. All right. It's time. That's going to do it. Thank you all for tuning in. Thank you for the few who joined us on the questions here. Really appreciate it.

These go live every Thursday. You can watch the replays on YouTube or Spotify or listen when they come out on your favorite podcast player of choice. 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 positions, excuse me, discussed in this podcast. Thank you everyone again for tuning in and we'll see you next week.