Chit Chat Stocks - Investing Power Hour #60: $NVDA AI Bubble; $BBBY Post Mortem; Icahn vs. Ackman

Episode Date: May 28, 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/ ****************************** 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 a recommendation. Now, please enjoy this episode. This is the Investing Power Hour number 60. My name is Brett Schaefer, and I'm joined as always by Ryan Henderson. We had some technical difficulties today. Ryan's audio or speaker

might be a bit off uh he's giving me a something right now that he that he's uh can't hear me apparently but uh yeah if there's any bad uh audio uh don't buy max people don't buy max like i say real work's only done on windows but we'll power through it uh no one else cares about that. Let's talk about what's going on in the markets this week. This is the, like I said, the investing power hour, alcohol free, as I maybe should be our tagline now. But we talk about basically anything that's happened in the investing world the last few weeks, business world, anything that's come to our mind, anything that we read or watched or listened to that was interesting. Looks like this week, of course, we're going to

be talking about nvidia's earnings we're going to be talking a bit lows we're going to talk about ackman discussing his arch nemesis carl icons uh potential i don't know i even know what to call it but we're going to get into it and then what did you have ryan something about bed bath and beyond yeah kind of the the story around what happened because it's been a wild ride and kind of a sad tale maybe it depends how how much you care uh about the gamblers feelings but uh there was a really good write-up this week from ben hunt uh epsilon theory and i'm gonna go through it all right let me guess lots of analogies to media in that he loves his analogies but i'm guessing it was very good write-up uh always entertaining the way that they write over there

at Epsilon Theory. If anyone watches, yeah, I should actually say these go live Thursday mornings on the Pacific Coast about lunchtime on the East Coast on this Chit Chat Money YouTube feed, but you can watch the replays wherever

or listen to the replays as most people do wherever you get your podcast. We don't prefer which. I'm in a new location, so my lighting is not the best, but I don't think people actually care too much.

I'll try to fix it. I'll make it a little bit better for next time. as we work through, as again, it was a major technical difficulties week, but let's go right into it. Ryan, what do we want to talk about first? I go with anything, really. I think we should go Bed, Bath & Beyond.

All right. It looks like you got a lot of notes. Go right into it. Yeah, it's a bit of a story. So this might take a sec. Just look up Epsilon Theory on Google if you want to read the whole story. Ben Hunt is on Twitter. He's a really good writer.

I think it's worth kind of just reading the story, but I'm going to describe it as well. Basically, Bed Bath & Beyond has been a struggling business for the better part of 15 years, maybe. Maybe even a little longer. But throughout this whole time, it has enriched the people inside the business at the expense of outside shareholders. And so I'll go through kind of how that's happened and the different stages. and Ben Hunt lays it out into different, he calls it a bust out, basically lays it out into three different periods for the business where someone else is enriched all along the way at the expense of, initially, it was probably genuine long-term shareholders, and then slowly

it became what you would probably call gamblers or meme stock investors. But let's talk about the first period. So the first period, this was a little more, I think, probably better intentions, I would say, at the onset of this. I mean, the people involved made a lot of money, but really, they probably thought they could turn around the business. So bust out one is what they call it. And this is the period of which Steve Tamara's and then the two founders, Leonard Feinstein, and let me get the other guy's name. They're basically two founders of the business. Can we get context on the time period? This was around, I'd call it 2014 to 2019.

Okay. And the two founders were, let me make sure I get the names right, Leonard Feinstein and Weisenberg, something Weisenberg, Warren, sorry, Warren Eisenberg. And basically, this was them just committing to buying back stock. The business itself was deteriorating. So margins were – free cash flow margins were declining steadily in the business. They began to collapse more and more, but they kind of – first of all, Steve Tamarez, who became the CEO, he kind of worked his way up, but really he was a real estate lawyer and then kind of slowly moved to CEO. he instituted this buyback of a pretty large buyback well above their free cash flow that

they generated. And all along this time, he was being granted stock by the board. And so here's a quote from the write-up. It says, over the six-year period, that's 2014, 2013-ish to 2019, the board and management of Bed Bath & Beyond spent $4.4 billion buying back their own stock on total free cashflow of 3.6 billion. As their stores deteriorated and their margins collapsed, this company spent all of their free cashflow and then $800 million more buying back their stock. Steve Tamarez, that was the CEO, he was granted over the years a total of 5.2 million shares of stock, either as options that he immediately sold or stock grants at no cost, but he never bought a single share himself. He ended up selling, I think in total, what would

have been worth north of $150 million worth of stock. Hard to calculate because different selling prices, right? Different selling prices. He also went through like a family trust to sell some of some of his money uh or some of his options and then there was also like weird benefits um one was i want to find this one it was i think he received 230 what was it 230 250 000 for car services annually um that's weird i don't know what kind of a car he had yeah i have found that those strange maybe not strange but maybe those small little greedy things where they say oh we're paying for the gym memberships oh we're paying for um the social clubs we're paying for the big car service we're paying for some weird thing where you're not even getting paid for like uh

something with like strange with a co-private jet ownership it could be a bit of a red flag i found over the years and there is a correlation between self-serving management teams as you're getting into and having these things approved by the board. Yeah. I've got it now here. Basically, it says in some, Steve Tamar has received well in excess of $200 million in cash from Bed, Bath & Beyond shareholders. Because keep in mind, he sold a whole bunch of stock worth basically $150 million, but then he had annual salaries, which were pretty expensive. And then he had that $230,000 in car services. But then Eisenberg and Feinstein, however you say it, they were the founders. They

basically progressively sold $300 million each. However, I think Ben raises a good point here, which is they were the founders. So I don't think it's as bad to have the founders who build the business sell their stakes as opposed to a CEO who comes in and just basically draws $200 million from the public. But there was some other egregious parts here. For one, Bed Bath & Beyond used corporate cash to spend $86 million to acquire Bye Bye Baby from Leonard Feinstein's son so total totally separate business yeah i mean they acquired a company from his own son to i don't know maybe bail him out but 86 million dollars sounds like our favorite uh ceo over at our favorite social media website which oh yeah uh there's some parallels there anyways so

So basically the buyback throughout this time, and we love buybacks, but in this case, it was basically just propping up the stock so that executives could receive their stock grants, receive their options and sell them. And I'll talk about the lessons here at the end, but if free cashflow is deteriorating and the only theme is that they're levering up to buy back. The business isn't getting any better. A levered buyback program on a growing business can be great. A deteriorating business, it can be fatal. So that's kind of what was going on here. And it was allowing them to get out by 2019. Activists, and keep in mind, this is the CEO, this is the founders, they know what's going on.

They know if they're struggling and they know probably what impact Amazon was having on the business. By 2019, activist investors stepped in, three different big activist investors, and were able to remove both the founders and the CEO. And after they came in, they took on an additional $2 billion in debt. At this time, they also had a pretty rough – they named a new CEO as well. They had a rough 2019 Christmas season and then right after, as everyone knows, COVID hit. So clearly a difficult time for them, but God bless zero interest rates because they actually got out with a modest gain. Within 15 months, all three of the activist investors were fully out. I think that's probably something to watch. if you see a business where three activist investors take it over and then are out in 15 months, that is your signal that they knew something. They probably got in there and saw what was happening in the background and decided it wasn't worth owning. However,

that was kind of the start. And this is what he calls bust out to free cashflow. The business fundamentals were deteriorating. They were by 2021 free cashflow negative. They were not generating any cash. And at that time they announced a new buyback. So once again, if you see a deteriorating business and they announce a buyback, that might not be a value a creative buyback, that might be a let's keep the stock price afloat buyback. So the then current CEO and COO, Mark Tritton and one other guy, both began selling more stock, more options that they were granted into this buyback program, basically, that was keeping them afloat. However, then comes in Ryan Cohen, Ryan Cohen of sort of GameStop fame, took an activist stake. He came to some

agreement with the company. Stock went up for a while. It was kind of COVID period. So it was a little weird, but started to drop. At one point, Ryan Cohen was underwater. Then out of the blue, there was a short squeeze now there is no proof of any sort of intent on Ryan Cohen's behalf but I don't know I find it suspicious personally and what time period is this again sorry this is 2022 i think the start maybe maybe mid 2022 when basically that big uh i think bed bath and beyond was up 600 in a day and there was just this giant short squeeze and ryan cohen at right at basically top ticked the short squeeze um sold all his stake and was out i find it kind of suspicious that And he was the primary beneficiary probably behind both GameStop and Bath & Beyond.

With that said, I don't think there's any proof that he coerced this short squeeze. I mean, maybe encouraging it would be in his best interest, obviously, but there's no proof that he did anything. So he benefited again and he got out. And then after he sold, obviously the stock began to plummet. The stock went from, I want to say like north of 25 down to five within really a matter of months. And then this is where it gets kind of, all of that is, that was where you started to

see some of the speculation, but this is where it gets a little sad was they were, Bed Bath Bed Bath & Beyond was functionally bankrupt by the start of 2023. And so here's a quote from the article. He says, coming into 2023, Bed Bath & Beyond was functionally bankrupt with negative cash flow from operations, negative growth prospects, and long-term debt of approximately $2.5 billion. Keep in mind, they have used their cash to continue buying up the stock so that a lot of people on the inside can get out. A new interim CEO was put in place at this time.

and everyone, every executive in that business at this point knows where Bed Bath & Beyond is heading. I mean, it's very clear that they're not going to make it out of this on their own. Now, the bondholders who lent them a whole bunch of money are obviously not excited by the idea that they're going to be kind of left holding whatever's left, I guess, of this business, probably a whole bunch of real estate assets, maybe some inventory and kind of no cash on the balance sheet. And so they, I'm assuming, I don't know who comes up with the plan, but my thought is it's probably the lenders here decided it'd be a good idea to sell a billion dollars worth of stock. Why not? You have people that are, and if you look in the Reddit threads, it's like the greatest speculators, you know, gamblers, people that saw what happened with GameStop and said, this is our, this is another chance to get in on the ground floor of one of those.

Conspiracy theorists. Right. So, I mean, Bed Bath & Beyond leans into it. And the way they do this is technically legal, apparently. And Matt Levine had a lot of good, I guess, write-ups describing the actual technicalities of how they did this. But they go through sort of this intermediary called Hudson Bay Capital Management. In this equity offering, this billion-dollar equity offering, they said Hudson Bay Capital Management is going to put up $225 million of their own money and up to $800 million if things are going well. However, they're not actually technically buying stock. um they are i want to let me pull up what matt levine says uh okay it says as a technical matter bed bath was not selling any stock into the market instead bed bath was selling big slabs of convertible preferred stock to hudson bay and then hudson bay might at its option convert some

of that into common stock then it can sell it into the market they were doing they were giving to them at a discount. So theoretically, as long as trading volume is high, Hudson Bay Capital Management can earn a spread on that. And they can raise cash by selling that to Hudson Bay, Bed Bath & Beyond can. And that is exactly what happened. Hudson Bay was paying for the convertibles and instantly turning around, selling them into the market. And it raised a lot of cash for Bed Bath & Beyond. It worked out pretty well in total. Bed Bath & Beyond raised half a billion dollars basically to give to its creditors. Today, I mean, the stock was, it was worthless. They knew it. That's why they did this. And people kept bidding it up. So maybe there's a moral

aspect where it's like, should we be exploiting these people that don't know better? And obviously, I mean, these are SEC filings where they announce basically, hey, we're bankrupt. We're going to do a billion-dollar equity offering because maybe there's a turnaround. They are very complex, hard to read by design, not design. I mean, it's not meant for the average retail investor or the meme stock investor to understand. And so they're basically doing this all along. They're kind of filing to make sure everything's legal, raise half a billion dollars. Then they go into kind of total bankruptcy.

And the funny thing is the stock today trades at 17 cents. Keep in mind, this should be worth zero. The equity is worth nothing. It already has the Q on it. Yeah. If they could keep selling. It's pretty much zero. You know?

Yeah. But the point is there are people still holding out. There are people still saying, you know, this can work out. basically and still speculated over it that's the point is that if bed bath and beyond could continue to sell they probably would and ben hunt kind of goes on his conclusion is basically how sad it is right now that in some corners of the financial market and really anyone that wants to do this probably could do this the informed the insiders could unload crap onto the less informed because there's kind of this gap in and he goes on to kind of explain some of the sad

parts of america which i don't know if i agree with everything that he said but he's a bit of a dimmer i think the funny part the funny part is the first comment on his post which i mean the The whole post is basically saying like, look, there were these well-informed executives, lawyers, bankers that saw they could dump all this crap on retail investors and they did it and they'd still be doing it if they wanted to, if they could. First comment on the post says, ouch, painful to read as I'm quite invested in this one. I hope you're wrong and I'm not that weak or gambling. I think it's a big time and what do they call it?

The cognitive bias, you know, classic one. I can't remember the exact term since there's so many. I guess my take on this, the first two sections, I completely agree with the analysis. You see those things, total red flags. They were definitely mismanaging shareholder capital. They were doing unsustainable buybacks to pay out the executives most likely, even though if they didn't explicitly say that or that wasn't their explicit goal, it definitely was an outcome and maybe they were not unhappy about that but i'm not as like you know he says

it's a sad state that the country is in is this any different than any time period in in in any in human history right the smarter people take advantage of the less informed i don't think it's more accessible for the less informed yes yes yes i mean yeah okay we've you know we've studied that 1900 to 1920 time period and there were punters gamblers speculators whatever you want to call them but it was harder to become one like really poor people had a really hard time buying into some of these equities today anyone can do it yeah anyone does it look uh i uh is there an argument you can make that this is immoral maybe but i look bed bath and beyond has a responsibility to its bondholders i i honestly have and that's exactly what they said

And it's our fiduciary responsibility to sell this crap. Yeah. Over the last few months, I honestly have no problem with what they've done. Unless there's more to this story, I have no problem with what they've done. And to be honest, I have no sympathy for these retail investors. The information has been presented to them and they won't listen. I think, okay, I agree. They're in the wrong.

If you're going to put your money, you got to know where you're putting it. I think that's true. I think there should be maybe some best practices or rules around clarity or how you communicate some of the information in some of these filings. because if it's simply unreadable, like if you've, and I don't know how you determine this, but if it's such a complicated transaction, it's not made very clear to your, maybe this is why it's better to invest in managers

where they're really good communicators. But it, I don't know. That's the part that frustrates me is, let's be honest, even if we looked at this thing and we look at SEC filings on a regular basis, it probably would have been pretty hard for us to understand oh yeah definitely i mean a lot of the times there's stuff in sec filings where you try to read it and you're like all right this

look they're trying to confuse us here but i don't know how that problem can be solved also i don't the burden shouldn't be put on these companies when they're doing things that are completely legal maybe someone can sue them if and you know take them to court stuff like that but the burden should be on the regulators here that is where you should draw all your complaints i think the people like look ben hunt does a fantastic post kind of exposing how potentially unethical or immoral a lot of the executive team and board of directors has been at bed bath and beyond but the stuff that you're doing is legal you do not have to buy this stock it is up to you you can never buy the stock i'm uh actually we owned so we i did trade this stock during the

during the march lows uh i think i bought like uh fifty dollars worth of call options which if i would have held wow would have been had a gambling phase yeah but look it was with a tiny amount of money college and it was fun money but yeah so let's just say it was not it was not very much money. And yeah, no one's forcing you to buy this thing. The executive team is not doing anything illegal and they're trying to get the best outcome for their bondholders. If that means doing things that take advantage of retail investors, I think if I was in that situation, i would not disapprove of doing that if i was with that if i was currently on the executive team at bedbath and beyond deciding this i don't know if i'd feel bad doing it

they have presented been presented with the information and they continue to be delusional they continue to be conspiratorial just like they are with all these other meme stocks or conspiracy stocks like mmlp amc gamestop it's not like you can tell them what's happening and they're just not going to listen and if you're quote-unquote taking advantage of them i don't think it is because they're not lying to these people now ryan cohen may have been very disingenuous by saying he was going to save this company and doing a potential let's fully disclaimer here no proof potential pump and dump i have a much bigger problem with that what do you think do you agree or disagree it's i think it's easy from the outside to say like these what they did was

unethical but if you're in their seats and you're given the ceo job of bed bath and beyond and you have bondholders it is your fiduciary obligation to unload this crap if and especially if people are willing to buy it it's it's even more so your fiduciary obligation to keep doing it i guess what would be your takeaway okay i think at the end it was very clear that you know don't buy this that's that's a strange conspiracy situation yeah don't get into those but what would be your takeaway from that 2014 to 2019 time period? Because there's an investment case to be made. And I think there was a number of deep value type investors who are trying to make that case who said- Yeah, VIC write-ups, I bet there were probably five or six over the last 10

years. Yeah. I mean, they're buying back a lot of stock. If there's any sort of a real turnaround, They were generating cash. Revenue was stable. What lessons do you take away from that period? One, betting on turnaround stories in industries that are declining is very tough where you have to make an industry transition. Also, I think I might be cutting you off, But if it's a turnaround, buybacks can be a huge problem because if it's a turnaround, that probably means they need the cash to change the business so that they're generating cash. So even though it might be the most opportune time to be buying back, that cash could ruin the turnaround. Well, it's definitely increasing the risk reward profile. The risk is going up, the potential reward is going up. So it's generally a riskier bet, but your outcome

could be much better. I would definitely do, if I'm in a situation like this, I would just chart buybacks, annual per year, free cash flow generation, annual per year, maybe go back through their buyback period and chart the cumulative, like Ben Hunt did in this post, cumulative free cash flow generation, cumulative buyback generation, and then look at the balance sheet and look at the net debt and say, okay, are they buying back stock by just increasing their net debt? And if they aren't, then maybe it's okay. And then look at just the changes in free cash flow. If you believe it's durable, if it has been durable, that's probably a good sign. But the big question is, and this is the hard question with every investment,

is do you believe the free cash it all comes down to this if the unless the balance sheet is a total mess or something else or you believe management

is incompetent but let's say like you they both kind of the boxes get checked off there if the free cash flow is durable then you'll be fine if it's not

you won't so I think it all comes down to is is the business going to be okay yeah I mean

I agree alright that was fun that was fun um great little start there you have any closing words because i want to talk about the most fun bubble nvidia no but let me turn this to a business where let me just uh get this one out of the way because you have more fun stuff but um this is where this is like you're gonna flip it like a good example yes okay lows reported earnings two days ago i think it's two

days ago. And they have been buying back stock hand over fist. But this is a business, watch me just be totally wrong too. This is a business where it's growing and the fundamentals are improving. Now, if you look at the last quarter, revenue was down 5.5%. So it looks like it isn't growing. But if you look out over a five to 10-year period, revenue is clearly growing, earnings are clearly growing but uh revenue was down really due to a combination of factors but it's the covid comps right we're kind of just moving through that they're still digesting that a lot right that's certainly part of the headwind but they also sold their canadian retail business which was so uh some of the revenue was gone from that and then lumber lumber prices have come down

significantly. And since they're just basically passing the cost through to the consumer, when lumber prices come down, their revenue comes down. A housing too, right? The housing market slowdown is, did they say anything about that or not really? I think that's tied probably to the consumer side of things that do it, the DIYers, less do-it-yourselfers if less homes are being purchased. So I think a lot of people will, when they buy a new home, invest in it, put more money into it. So since transactions have slowed so much, I think that's leading to a bit of the headwind, but the pros business is doing well. And in general, they're expecting, I think, $88 billion in revenue this year.

Inventories, there's been a bit of a buildup coming off the COVID kind of supply crunch. And so that's hurting cashflow. But really last year, so in the last five years, Lowe's share count has declined by 27%. That's really accelerated in the last three. So last year they put $14 billion into buybacks. The year before that, I think it was 13 billion. They were reducing share count by 7%, then by 10%, and then they bought back $2.1 billion this quarter. I'll share your screen so you can – anyone – yeah, but keep going. They are reducing – if they do the same quarterly amount they did this quarter over the next three or four, they're going to reduce their – they would be buying back about 8% of their market cap. um they are returning cash to shareholders at really an accelerated rate and then they're also

uh they also have dividends included there as well so two percent dividend yield roughly this is bill ackman's largest position i think it's an extremely durable business it's there's clearly economies of scale home depot benefits from it the same way it i don't know to me it's it's kind of intriguing is this something you'd look a little closer at yeah definitely i think for home depot and lows those are one that go in my bucket of well okay if i was much older and i wanted to stay wealthy instead of kind of build wealth and maybe take you know riskier bets is basically what we do uh but with a little not just for the excitement but because we think there's better long-term return potential from compounding. But if I wanted to stay wealthy,

I'd definitely look at these things. And I think they would be quite intriguing at a very depressed multiple. If we go into a big bear market, they could be very interesting depending on how their balance sheets look, because they're a type of business that's going to look really bad if the economy suffers. But if they hold their competitive advantages, if they retain their duopoly status coming out of the bear market, coming out of a recession or whatever it is, they'll start doing well again.

These companies have managed through a recession before. So it's definitely one that would be on the watch list. They're easily understandable, but I would not want to buy unless there's a lot of negative sentiment against them,

which is probably what happened to Lowe's when Ackman was buying, correct? Because they had a big, people loved Home Depot compared to them. And now Lowe's is kind of catching up. Yeah. I mean, I think it's kind of maybe, I don't think this is ever, and maybe I'm wrong. I don't think this is the business that trades at mid single digit cashflow multiple. People know the quality and the durability. I mean, they have-

I'm going to check. I'm going to check. Some of their debt extends out to 2062. People, the lenders know how durable this business is. But I mean, right now, even though it's only, I think it's 16 times operating cash flow on a market cap basis, obviously the enterprise value is higher because they have a lot of debt. I think you could make the case that cash flow is kind of depressed because of the inventory buildup. And as that, it's going to look a lot better moving forward. So normalized,

I think you're paying kind of mid-teens, maybe high-teens cashflow multiple for a business that has an easy formula to get good returns on the capital they invest. I think they even put it in their 10K. They have like a 30% ROIC. And I know sometimes you can massage those calculations, but But clearly, when they put money into new Lowe's locations, they generally, on average, tend to generate good returns on those. Yeah, interesting. Yeah, I mean, good business. Yeah, good return on invested capital.

I'm looking at the earnings ratios right now coming out of the great financial crisis kind of in the 2009 to 2010-11 period. They were right around, I think maybe they hit 10 times earnings. For a short period of time, but they, yeah, yeah, sure. It's just a wide charts. Thank you Motley Fool for giving us the, the access to all, to everyone. Yeah. Let me, and I'll describe it quickly.

So load, let me change that. Always difficult to share the screen for some reason. Okay. So if we look at kind of the 2009 ish period, and yeah, this is at the bottom. They were trading at about 12 times earnings. But what I want to make a note of there is that these are probably very depressed margins. So if I add on the price performance, I mean, the stock's up 600%. And I think a lot of that is probably because, look, the stock's not going to get down to

seven times current earnings in a recession. And look, not every recession is the same, and not everything is just going to repeat like the great financial crisis. I think that was probably especially painful for someone like Lowe's because it was so housing related. But when you get a company like this that could go down to, say, 12 times earnings on a trailing basis in a very depressed economy, which could be six, seven times earnings if the economy was in a better spot. I think that's when you want to be looking at these companies.

But the thing is, it's going to be very, very painful to buy that stock because the numbers are going to look terrible. They're going to be moving in the wrong direction. But it's one of those where you got to be saying, okay, am I confident that the moat is still there? And if it eventually things are going to work out yeah and i i think the i mean the comps probably right now don't look quite as bad as i'm guessing 2008 or 2009 looked i'm not sure i haven't looked at those numbers but um i think this is maybe one where it's better to buy on a dip in cash flow margins than a dip in necessarily the multiple. Ideally, you get both. 100%. Yeah, yeah, yeah, yeah. I agree with you.

But I think management knows the earnings power of the business. And every time there's been margin reduction, I think it's incrementally improved over the years. So potentially, we're in one of those situations because revenues are declining, cashflow margins aren't what they were two years ago because the inventory buildup, I don't know, looks attractive to me, but we can maybe do a not so deep dive on that at some point. That could be a fun one. Yeah. Yeah. I think so. And yeah, what's interesting is one of those where it's going to look optically, not that cheap because look, you're going to be like, this is what everyone's going to say. It's at 12, 13 times earnings and the numbers look terrible.

Yes. That's the point. Cause the numbers are going to get better. That's one of those situations where you got to really be calm again it all comes down to that the competitive advantage but yes we have about i think well we started a little late we got about 20 to 25 minutes left so i want to hit these two topics i think it'll be perfect timing yeah let's let's do some bubble talk yeah let me tease these nvidia earnings ai bubble and then we're going to close with the ackman versus icon the iep icon enterprises something uh debacle or whatever is going on with that right now. But let's hit NVIDIA earnings first. So I guess some numbers. They reported yesterday, Wednesday, the 24th quarterly revenue, $7.2 billion. It was pretty much all driven by

Data Center, which has the AI chips in their revenue of $4.28 billion. That was up 14% year over year. Quarterly numbers were good, slightly above market expectations. But as you may have noticed, Nvidia's stock is up 27% today and is going to go down in the record books as I believe a top five market cap gain for a single stock in history. I was looking at the historical ones with Apple, Meta, I believe Alphabet maybe, or maybe Amazon. They were all about $200 billion in market cap gain and Nvidia is getting there and it's about a trillion dollar valuation today. I think it's a little bit lower. Who knows? By the time we close, maybe it'll hit a trillion dollars, but I think we're about $950 billion as of recording. So what happened? Why did the stock

soar so much? Well, one reason, and it is next quarter's insane revenue guide. So in the current quarter that we're in, NVIDIA is expecting $11 billion in sales, which mostly is driven by demand for these AI chips when analyst expectations were just $7.15 billion. Now, before we move on to my valuation quick work here thoughts on that how like just seeing that number one analysts don't know how to you know it's impossible to predict a company like this and second i mean how impressive is that yeah i mean it's hard not to bid the stock up when you see a raise like that but to put it into perspective, and I saw someone else mention this, and so I'm stealing someone else's take here. They added more than a Salesforce in market cap in a single day. Salesforce generates more

cashflow than NVIDIA. Keep in mind, NVIDIAs will probably eclipse that, but that's kind of insane to think about. Yeah, that's true. I think NVIDIAs might in Clipset this quarter. They gave out guidance on their expenses as well. Just did a couple of quick math on that. I think I did the high end of everything. So again, this is kind of the optimistic look here. But if we look at their expenses guide and kind of copy that out, operating income is expected to be around $5 billion next quarter, which is kind of insane. Because remember, last quarter, or the quarter they just reported, they did $7 billion in revenue. Now, annualizing this number, which again, I would say is extremely dangerous, given that

this is a cyclical industry. This is a company that is probably seeing tremendous pricing power right now as supply is restricted with these AI chips during this boom period. But if you do that, NVIDIA's operating income is five times four, $20 billion at a $1 trillion market cap, which I would assume NVIDIA is at if we fully dilute their stock options at the current price, which, you know, give or take, would probably be a trillion dollars.

You're trading, I think some people can do that math in their head there, at 50 times earnings. So first question, Ryan, was this the moment that we officially, in the history books, started the AI bubble? Or no, we got really, like,

this is the you know how there's kind of an s curve of a bubble where it kind of starts and then there's just kind of a boom and then it kind of peers out and then it collapses we're in the middle of the s curve right now you think yes but i would say chat the the launch of chat gpt was the start of the bubble because it forced everyone to say ai 30 times on their conference calls well that was i think that was the boom and this is the stock market bubble right because open a yes but here's the interesting thing okay so forced everyone when chat gpt launched it forced every single company to be asked what's your ai strategy and so maybe they didn't have one and so they had to develop one and so in order to do that they had to buy a whole

bunch of chips from nvidia my thought here and i hate to play the pessimist but what if next year a whole bunch of companies say, you know what? These AI investments are a little too expensive and it doesn't really help our business as much as we thought. We don't need to buy as many chips. Yeah. Or I mean, in reality, it's the cloud providers, but yes, there's just an intermediary between there, the chip demand and the companies. Most companies aren't actually buying the chips, but I guess your point. I guess what happens to NVIDIA's revenue at that point? And that's the only thing that concerns me is that it isn't – I mean, obviously, everything right now looks like there's going to be more and more demand for NVIDIA's chips over time. They're the leader.

I get it. I'd be lying if I told you I understand NVIDIA's business that intimately. But it's not subscriptions. It's not recurring, right? It's not SaaS, right? Are you defending software as a service, Ryan? are you it's demand dependent no you're you're totally right i mean yeah which can fluctuate quickly this exact same thing happened with crypto and nvidia the exact same thing there's a boom in

crypto or a bubble definitely a bubble and the the people that do the whatever the mining and all that stuff bought nvidia's chips nvidia's chips got there was a supply restriction they They had tremendous pricing power. They had tremendous margins. There was a boom in their gaming revenue, which is the type of chips that these crypto people used. The numbers looked insane. NVIDIA's stock ripped. And now that segment is nowhere near the same.

Now is AI a little bit more legitimate than crypto? Well, 100%, because we think crypto is, I think a lot of people think crypto is just kind of, you know, nothing burgers. But the stock is trading at 50 times projected earnings if they keep up this earnings power in this boom time. The way this works is if they double earnings again, that's really the only way this works, right? And they sustain that. And look, right now,

how likely is it that they are over-earning with supply restriction? Do you think that, look again, Ryan just said he's no chip analyst. but I think that makes sense. Do you think that thesis makes sense where they're going to have these tremendous margins in the short run

that are not going to be long-term sustainable as supply comes online from them and all their competitors? Yeah, I think it's possible, obviously. But maybe they have the technological advantage. Maybe they keep that up and maybe people are forced to buy theirs because they're just more valuable

for whatever it is. Yeah. I don't know. I hate to be like a pessimist on NVIDIA because anyone that knows the business better could just be like, you know, you don't understand it, which they'd be a hundred percent right. So, um, I don't know. I feel like I'm talking out of my ass sometimes when I'm like, yeah, but it's sustainable, you know? I don't appreciate their advantage enough. Yeah, yeah, that's a good point. Maybe I don't as well.

I would say one of our most popular podcasts was our interview with 7investing's Luke Hallard. What was that, like six to 12 months ago on NVIDIA? He lays out the bull case. Honestly, he got a lot right in that interview. Go listen to that. If you just search NVIDIA on your podcast player, it'd be one of the first ones that pops up.

Here's what I want to talk about with NVIDIA because we can talk about the AI bubble all day. We are clearly in the AI bubble. I liked seeing, they mentioned like some of their partner companies like Google Cloud, ServiceNow, even Medtronic, I think was a partner with them. All the companies that were just mentioned in NVIDIA's press release and investor presentation were up today. And those companies had no relevant news to their business.

That is classic bubble behavior. Classic. But that's textbook bubble behavior. What? that Google added $30 billion in market cap because they were mentioned in a conference call. Yeah, yes, 100%. Here's what I want to close out on this

is my favorite investor who I think is the best investor of all time is Stan Drunkenmiller. I always pronounce it as Drunk and Miller, but I always, I don't know, however I talk, I call it Drunkenmiller by accident. nvidia is his second largest holding as of the latest 13f he bought 208 000 shares last quarter so that's in either january february or march to up his holdings to 791 000 so he already had a

big position before this and yes this is just whale wisdom so could be off here it is nine and a half percent of his portfolio. He also bought Microsoft as an entirely new position in Q1 to 9% of his portfolio. He re-entered Google, 4% of his portfolio. Amazon, 3.6% of his portfolio. TSMC, 2.3% of his portfolio. I think that's kind of the gist of the AI beneficiaries here. Is this the greatest momentum investor? like yeah like how how does he always it's uh it's quite impressive i'd say is right riding this bubble because he's gonna dump it on these guys about six months from now yeah it is funny because so many someone tweeted it out like i want to say a couple months ago

that said you all want to be like stan truck and miller but none of you are willing to buy ai right now and i think it was i can't remember who it was but it was totally right jerry capital the anonymous account yeah because everything looked overvalued and it felt like we were in an ai bubble we probably even said that a number of times you should write out the bubbles i guess if you know how to time it right but i also think a lot people tried to copy the strategy they would get killed it's a dangerous game yeah you yeah god it's a dangerous game but he's so good at it um here's what i think here's here's what separates there was okay in early in say january and february there was a sentiment around ai just

the you know people trying it and stuff like that that there was a bubble it hadn't really hit the market as a bubble yet google was still kind of going down and video was going up yeah but it hadn't really taken off. And I think there's a difference between that is not really a bubble. That's just kind of a boom because it's not a market bubble. I think someone like Druckenmiller sees the boom and then says, is extremely good at saying, okay, where are we going to go from boom to market bubble? And look, we don't invest like this at all. Everyone, do not try this at home. I don't want to say that enough it's very dangerous

but it's quite impressive to see it in action if you can write out the bubbles and sell at the top obviously that's a great strategy but you know the math works out okay we got about I think

10 minutes yeah the timer going alright let's close out with Ackman versus Icon which is again. There's a lot of news this week. I think it's quite fun. So full disclaimer on this. The asset or the entity or the stock we're going to talk about is a complicated asset. There's a lot of stuff that goes on here that it's a strange asset. We may have no idea what we were talking about, but I think there's some interesting facts here. I also have no idea what the outcome is

going to be because again, Carl Icahn is a legendary investor and it seems kind of strange that he would do this, but maybe that's why they got away with it for so long. Just some context for everyone. Hindenburg Research

wrote a short report on, what is the actual name of this thing? So people can look it up. The ticker for anyone that's interested. Icon Enterprise Partners?

Icon Enterprise LP. Pretty good. Pretty close there. Limited Partners. Limited Partners. The ticker, again, is IEP

for anyone who wants to look up this. Hindenburg wrote a short report on them that you can go read and then Ackman, Bill Ackman who we don't need to go through all that again was Carl Icahn's kind of investor rival

they're not very nice to each other I do not think they're friendly at all he apparently read this report and then wrote a long form thread which basically sums up what Hindenburg wrote for maybe a more bite sized audience but given his credibility

and his Twitter following of 700,000 people I think it's shown or shined more light on this strange situation. I have about eight bullet points here that can sum up the long form tweet. It's a little bit complicated, so I'll try to go slow and Ryan, ask for contest if necessary. One, IEP has a controlling shareholder and icon. That's very important. Two, this allows him to have a trade at a huge premium to the net asset value, which is the actual assets of the investment company. Three, this allows him to secure margin loans tied to these premiumly valued shares that can fund other investments. You kind of see how the circular investment chain works here. Four, the IAP large dividend yield, which is paid to

outside investors and is paid in kind, I believe, to Icon, who again, owns 85% of this, is not supported by cashflow. So it's only supported by selling stock or, how do I say it? It's a 40% dividend yield. And if you run the math, that is not very sustainable at all. Five, Ackman notes that the stock is highly illiquid, given that Icon owns 85% of it and is not, let's say, going to want to sell because that would cause a little bit of a panic, right? Six, he believes that even after the share collapse, that IEP still trades at a 50% premium to NAV. And then six, to close it out, I think he did this one a little bit, And maybe as a jab to him, he says it reminds him of Archegos, which, remember, was the giant pump and dump by Bill Hwang, and says Icon could use some friends, which we don't need to talk about that part.

But IEP is now down 63% year-to-date, which is causing Icon to post 65% of his shares for margin. I believe I'm using the Twitter thread as my source here. So, again, things can change rather quickly here. What is the likelihood this blows up? It seems like ICON really made a mistake here. It's down 63% year-to-date. And keep in mind, ICON's the biggest shareholder. So the 15% shareholder base that's left seems to be saying basically a lot of them are giving up.

uh i don't know it's a very complicated structure probably by design on the half chance that they are wrong that all the shorts are wrong or anyone that's criticizing it is wrong it does have a 40 dividend yield geez dude i'm in there's no way it's sustainable but the i don't know it seems so weird for icon who And I think as a track record speaks for himself, he's a really good investor. He knows what he's doing. He hasn't been great over the last decade, but it seems weird to me that he would do this to himself. Yeah, because he didn't need to do this, right?

What's the motivation? What's the point of the margin loans? I don't get that. Okay. Yeah, that is a key point here. I want to hit it again. So this is what Ackman kind of saw, and I think is maybe the most important thing here that could be not illegal, to be clear, but unsustainable. So you have the net asset value of the investments, right? Okay. Since ICON holds 85% of this, I don't know exactly how it got up to a huge premium to now, but it traded a gigantic premium to the net asset value of the investments, when in reality, an investment fund like a publicly traded one like Ackman's typically trades either at or a slight discount. to the net asset value. With the net asset value so high, he is able to take margin loan against

the stock and then buy more investments that go into the company and theoretically, or not theoretically, but most likely increase the net asset value. You see what I mean? It's a little bit risky, but I guess if the stock keeps trading, it's like the opposite of a buyback almost inadvertently. If the stock keeps trading, again, we're getting maybe some of the intricacies wrong here, but I think the general reasoning is there. If the stock keeps trading at such a high premium to the net asset value, it allows you to do this circular thing to almost fund it through the margin loans. But again, it's super dangerous. They responded to Hindenburg. I do not believe they responded to

Ackman but I believe they responded to Hindenburg saying that it's just like things are fine but I do not have that side of the story so maybe to come back to this next week we get Icon's

side of the story unless he hasn't really said anything then we kind of wait for his response I have heard that Icon's a little like old now so maybe i know he's old but i've heard that he's like kind of lost some of the maybe sharpness he had at one time as an investor so it could be whatever his team his team could respond

whoever's actually running yeah i'm looking at his twitter account right now and every single tweet is read our open letter to illumina yeah at the same at the same time they're doing an advisory board to, or excuse me, an activist battle with Illumina. I think, yeah, there's not really much else to say about this. When we get maybe an update, we'll keep following the story. It sounds fascinating.

With two minutes left, I think we have two minutes left. You were excited to read about this. I thought it was hilarious. What did you think of Bitcoin Miami 2023? I thought it was absolutely amazing.

top-notch material content to look at it's smaller than it was a year ago unsurprisingly it it is crypto winter um which is i'm sorry but i love that term i just love it i want to be the night king what what if the long winter is here like yeah i don't know what if it never goes away uh anyway there was some absolutely hilarious reading from people summarizing it let me find well i mean they're just good bit okay yeah and to be honest like these guys are funny like i want to go like i don't believe in any of this stuff but it sounds like a good time it sounds like people are wasting a lot of money on these guests or maybe the guests are wasting a lot of money and the things they do honestly they're comical it's great stuff sailor was there

oh it was like this video yeah there was a video of like people that were there and the like the place is empty like there was not a lot of people and it's just sailor like still on his soapbox trying to you know kind of like one of those it's kind of like one of those uh those trump rallies that they would you're like oh wait they patted the crowd you're like oh this does not seem as big as i thought yeah uh so it says on thursday the first day of the conference that is reserved for high access ticket holders people uh broke conversations when paul bearers and black gospel choristers approached belting out when the saints go marching in the paul bearer paul bearers struggled to lift an open casket over security scanners as they made their way into the convention

center inside was a slew of dollar bills and a label reading hashtag fiat funeral one chorister carried a sign reading hallelujah bitcoin this is not a cult it's not a cult this is honestly it's a sigh up from the fed to get inflation down because they're just throwing these dollars away and they're not going to go to the economy you know what i mean it's actually it's it's actually deflationary it's great um yeah i mean it reminds me of qn on at this point kind of reminds me of the same thing it's kind of fizzling out i'd be surprised if they were still holding these kind of conferences just given how expensive they are someone talked about the tuna someone talked about the there was a sushi thing and the tuna was significantly smaller this year so

bear market in in tuna and last year they had two and i think because they couldn't afford the two larger tunas apparently it said hashtag tuna winter yeah i mean at least they're like at least they know it's just a meme at least they're like self-deprecating about it in some ways but that's just sad i mean it's just sad because it's like all right you know it's over yeah look yeah i want to go though i want to go really bad i wish it was closer to where we live the hey you know what i told you all bubbles peak in miami that's right i love i love miami by the way great great city great area but all bubbles peak there you like i like it i do but i teach you some so much excess like the i feel like every time i'm down there i get new scuttlebutt where i'm like okay

what is going on but um and i guess it's not surprising that there's i mean maybe all conferences or i think a lot of conferences go on down there but the bitcoin yeah no matter what just because of the weather year round all right well that's gonna do it i think there's a lot of we keep tracking here the ai bubble we can stop talking about housing for a while because we got some some fun things to talk about um and the earning season is to a close so maybe we're going to get into some more esoteric, unique topics over the next few weeks as there's less earnings to cover or talk about that we think are fun. But let's see, to wrap things up, these go live on Thursdays, right around lunchtime. It kind of depends on our schedules.

You can watch the replays on YouTube or listen, like I said, the replays on Spotify. If you want to support the show, the best way to do that is to just give a review on Spotify or Apple podcast it takes you, I would say approximately what? Three seconds, Ryan? So we're not asking for a lot, but it's pretty easy. All right, that's going to do it. Remember, we are not financial advisors. Anything we say on this show is not formal advice or recommendation. We are general partners at Arch Capital. Clients may hold securities discussed in this podcast. Again, thank you all for listening. We'll see you next week. We'll see you next time.