Chit Chat Stocks - Q3 Roundtable with Ian and Brad

Episode Date: October 7, 2021

This week Ian and Brad join us for the Q3 Roundtable. About once a quarter we want to share some of our biggest stories and opinions from the financial markets. Brett, Brad, Ryan, and Ian discuss topics such as fraud, Apple's legal issues, Twitter, and even a little bit of China. Enjoy the show! Our Thursday Deep Dives are sponsored by Quartr, the new way of doing company research. Access conference calls, presentations, transcripts, and more for FREE on your mobile device. Download Quartr on the App Store here: https://apps.apple.com/us/app/quartr-investor-relations/id1552412128  Download Quartr on the Google Play Store here: https://play.google.com/store/apps/details?id=se.quartr.android  Subscribe to 7investing with the code "CCM": https://7investing.com/subscribe/aff/4/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested in more of Ian's work? Follow him on Twitter: https://twitter.com/IanGrayLive  Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ  Contact us: [e-mail]  Timestamps Brett's Story | (2:08) Ian's Story | (17:13) Brad's Story | (31:08) Ryan's Story | (44:00) 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 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. Okay, welcome to Chit Chat Money. Today, we have a bit of a unique show. So no deep dive today. This is going to be a roundtable discussion. Some people, our OG listeners, the longtime

listeners actually like when we kind of ramble on about nonsense. So we've basically done that today. We brought Ian and Brad along. We're all going to have kind of a story, something to riff on, something to talk about, and then we'll kind of pose questions to one another. But before we get to that, we want to talk about our friends, our sponsor, Quarter. If you don't know, Quarter is an investor relations app, pretty much comprehensive investor relations app that allows you to listen to conference calls, look at presentations, read transcripts. You can listen to them at two times speed if you're really smart um or i know brett you're 1.5 times two i'm 1.2 yeah slow a little slow but i mean you gotta you know quality over quantity they have uh it's 100

free it's on the ios it's on android they have tons of companies i don't think i've ever looked up a company it has been on there so and they're working to improve it every i don't know all the time yeah uh go ahead check them out it's you can follow them on twitter at quarter underscore app It's Q-U-A-R-T-R underscore app. Without further ado, let's talk stories for the week slash quarter, literally, like a quarter, not a sponsor. Yeah, we're not doing these every week anymore, but we may be doing maybe once a quarter. We think we're going to call it the quarterly roundtable. But my story is going to be on forecasting fraud and how to mitigate any chances of fraud within your investments. So I have to ask to start out, Ryan, have you heard of Aussie media at all?

this story well i've seen a few references on twitter all right brad ian have you guys heard of this just as i've heard of it all right okay we should uh we should make sure all right how about we have to choose someone to go first when we ask these questions so brad ian brad goes first and then ian if we pose the general question all right ian's gonna have to be patient uh all right but i'm gonna get into aussie media so aussie media was slash still is a digital media startup founded in 2013 to shake up the broadcast journalism industry. It claimed it had millions of viewers and used it to raise $70 million in five funding rounds. However, views and readers were way lower than expected or that they shared. It was just like, I think it was like 300,000, 100,000 or

something like that. And they kept that hidden for many years. And apparently, when attempting to raise more money, the co-founder impersonated a YouTube executive on a call with Goldman Sachs saying the company was getting a lot of views. And I think they got caught with that. So it was one of their founders and they were like trying to imitate someone else's voice on just a phone call. Pretty funny.

But now the board of directors is trying to raise a law firm to investigate the situation, but they all decided to resign instead. And then the only remaining member of the board, founder Carlos Watson, canceled the legal investigation and said, as of this week, the company is just going to keep on going.

I think it's just him now. But clearly investors were totally defrauded. And I think this situation, hyped up investor presentations, saying views are a lot higher than they are. That kind of reminds us of other things like WeWork, Theranos, Nikola, stuff like that. And that $70 million that was raised or invested is probably going to zero. So the question I want to ask is in the quote golden age of fraud here, what are some ways that you look to identify potential fraud in investment to try to mitigate that risk? Because we always know that there is that risk, especially with early stage companies. I maybe can give a few that I look for. One that I try to do is can I interact with

the product? So if you can actually interact with it, say an easy example would be Netflix, or Spotify. That one's really easy. It's definitely not fake because you can see everyone else doing it. You use it yourself. There's always a chance they're inflating numbers or something like that. And then I always like to ask, is it providing me or the potential customer any value? That one's pretty simple. You're probably asking that with any investments. Another question I like to ask, does it have a history of operations and profitability, the longer is the better. And I guess if it's shorter, you know, it's probably a riskier investment or more of a chance that they're fudging the numbers. Does the founder

or leader make kind of religious type references, not direct references, but kind of, you know, you know what I mean? Like the Adam Newman, this Aussie media founder said that this moment was his Lazarus moment or something like that. I'm not, I don't know much about the Bible at all, But I think that was something about how someone was coming back to life, which was a good comparison. I think if you were trying to make a metaphor there about how you're going to make his comeback. And then the one thing I think is big here is, is the company

relying on a technological breakthrough and is it an unproven disruption? So if it's yes, then that's riskier and a chance of fraud. Nicola, I guess, is an easy one that we remember all now. The last two and I'll go around the table here. is the information being given to me supposed to distract from something else and i a big thing i look for is is this quarter did they hype up some sort of metrics that were way different than the previous year and if it was why have they stopped looking at those ones that they were hyping up one to two years ago and then uh the last one is does management have a track record of dodging or

hiding negative information that is only in sec filings but never talking about it anywhere else or have asked about it on a conference call or something like that, they kind of say, well, you have to look at our disclosures, stuff like that. And I know there's plenty others. So I guess we'll start with Brad. What are some things that you try to look at or write any of them? I'm going to pose a second question after yours, which is, have you ever accidentally or intentionally, have you ever invested in something that turned out to be a fraud? Okay. Well, yeah, we'll look at it. We'll ask that next. But Brad, what are some things that you look at maybe to say like, okay, is this a fraud? Are they, you know, manipulating the

numbers or are we getting on the right track? Sure. Well, well, first of all, just, just rigorously studying whatever information is out there on the track records of morality and candidness from the actual management team. A lot of these people have decades of experience. And if you can dig deeply enough, I think like on track was, was the last one I remember where It looked amazing. And then there were some red flags on management. And just whenever that is the case, I mean, no matter how mouthwatering the opportunity or the prospects seem to be, it's just a no touch for me. But but I mean, occasionally I get I get tricked and I think we all we all make mistakes. So for me, the way I invest young, high growth, speculative disruptors, it's all about allocation and not letting myself get hurt too badly if I'm too optimistic, which I do lean slightly optimistic. So that's really important. And then and then Brett was what was that bullet point on?

So technological breakthrough, unproven disruptor, just a perfect example of that is Nanox, which I have a very small position in. And I call it frequently my most speculative position, the highest chance of going to zero. And just tying that into position sizing is so important. And that's why the fixed finite losses that stock markets inherently provide in the infinite potential upside is so compelling and why I really am okay with this, because I can be wrong a lot and still not be hurt. So try to find any red flags of fraud. But if you don't find any and you dive into a company enthusiastically, just don't go all in. I don't think that's ever a good idea. Have you fallen victim, Teddy? I think some people would say Nanox is a fraud at this point. I still have a small position and I still don't think it's a fraud, but I think that outcome is more likely than it may be. Maybe I thought it was like half a year ago, but still holding out hope. The only other one is Aurora Cannabis.

And that really, it wasn't a fraud. It was just me being really new to the investment world and not knowing what to look for in, in just trusting a really charismatic culty leader. Um, so, so I guess, I guess that's the other, uh, key takeaway is every single CEO has an incentive to talk up their book and to make their company sound as amazing as possible. So, um, I, I do generally trust them, but just, um, but yeah, just position size is the key because, because we can be wrong. I can be wrong and I will be wrong again. Yeah. And I guess I'll say mine, uh, because we already hit my notes here is the iqe if you if you know that company the netflix of china back in like three four years

ago uh this is when i was a total rookie uh i said you know like i just saw like all right netflix of china it was at some i don't know sales multiple i thought made sense and i was like all right i'm in like i'm gonna invest and it has been a train wreck ever since i mean i've been out for like three years now, but, uh, I think it was definitely a fraud. They were hyping up their viewer numbers. They're doing some partnership thing that didn't make sense. There's some people that wrote some really good short reports that I've looked at recently. Uh, you know, that one was totally a fraud and I guess we'll talk more about China later. We don't have to hammer on that point, but Ian, do you have any kind of notes you have on what you look for, for identifying any

potential fraud? Yeah, I think what you guys have mentioned has covered a lot of what to look for in a fraud. But one other point that I'd like to cover that's actually kept me out of at least one fraud was when management starts talking about the big quarter, right? They kind of push all their chips to the table. They say, hey, it's going to be this quarter that's happening. And it's like, at the end of this year, or sometimes they talk about, oh, next year is when all the the revenue growth is going to come yeah don't look at our numbers now but but in quarter four we're just going to have this blowout quarter and you just got to believe it and um that was actually something that kept me out of on track which brad was mentioning earlier i was kind of

looking at the company and somewhat intrigued but didn't really like some of the operational history as you were talking about earlier and um i looked at they just kept saying oh our q4 is going to be huge our q4 is going to be huge and i just was that made me a little uncomfortable on top of some of the other concerns. So, um, that's one that I stayed out of. I think in my current portfolio, I also am a, uh, Nanox holder. Um, that's one that I think has a very binary outcome and I'm kind of willing to ride with that. I don't think that that's a fraud at this point, but you know, I guess you have to be determined. Um, and then, uh, we've got, I've got a couple other kinds of micro caps or small caps that, you know, it just, it's always, there's a fine

line between a fraud and a struggling company. So I don't want to label any of the other companies I have as frauds, but there's definitely some that have been not performing as well as they could have. Right. Okay. I think that makes total sense. And the fraud aspect, I think it's not like you don't want to avoid fraud a hundred percent. Like you're not, well, you want to, but I think you're going to be exposed to some throughout your years. And if you're investing for decades and you're taking a risk on early stage companies. It's kind of a given. For Ian and Brad, both of you invest in stuff that might be earlier stage riskier. Do you guys like assign probabilities of say like, all right, there's probably like a 50% chance this doesn't work, but if it does work,

you kind of calculate the upside. How do you go about that from considering the downside and the upside of something like that? Brad, do you want to go first? Sure. I think it's probably a very case-by-case basis, but I'm looking for that cliche company that can return multiples what its price currently is. I wouldn't say 10 bagger, but several times. So even for a company like Nanox where that probability might be a little bit higher, I'm not going to put a number on it because it's probably a little bit biased if I do that. But if I see the margin expansion and the growth and the runway and everything that I like. I don't really, I don't really care about the probability of it going to zero because again, if, if it doesn't, and if I'm right in it and I,

I see, I see what's actually there, then the reward just makes up for, for so many times when I can be wrong, then it doesn't, it doesn't matter in the, in that very long run. But I mean, but I mean, yeah, definitely always, always a probability attached when you're investing in anything and probably or definitely higher when when you're investing in the lemonades and the nanoxes of the world like like i i dip my toes into right in yeah for me nanox was a little bit of a special case where i did did have that type of calculation i looked at and i said hey i think this is successful and they hit these numbers that they're talking about then this is going to be worth you know i i think i kind of calculated it out in somewhere between six and ten times um

more than it was today and you know the risk for that was that it wasn't going to pass through these fda clearances and it wasn't going to um ever be whether you know on top of that it might not be able to distribute even if it did pass the fda approval so um a lot of risk and i looked at it and basically said hey i think this is a binary it's either going to pass and it's going to be successful or it's not going to pass and not be successful um and i got pretty comfortable with as brad was talking about earlier with position sizing and saying hey i'm willing to put this much of my portfolio in and if it goes to zero i'm okay with that and if it um because i because i want a little piece of this upside so for me that's typically sometimes i don't do as much

calculation as i did with manox but um for a lot of these ones that are a little bit riskier a little bit more speculative i do um start my position thinking about is this am i comfortable losing all of this money um in most cases i don't think these companies are going to go to zero but that's always for me, that's always a good gut check that am I comfortable with this goes to zero. And, um, I probably have a higher tolerance for that than most people, but, um, it's still, even, even I don't like to lose a lot of money. Um, so, uh, the that's, that's something for me that I, that I, that's the way I kind of deal with that. It's just the gut check of, am I comfortable losing, losing all of this? It's, it's interesting because even you look

like the best companies today and i'll bet every one of them at some point in their lifetime had something shady something that they weren't super forthright about let's say something short to look at and say that's not up and up i mean take it's funny now when you look back on it all right tesla's like the primary example but you look at say google they had they labeled their first building building 46 it's like in the in the time would you have thought that was like manipulative. Yeah. That's a small one, but I mean, it's like a little fat, it's a factor and those kind of add up, you know? Yeah. For me, something I like to look at and I'll kind of keep mine quick is like management's focus on stock price. I think those that I align with

don't really care that much about the stock price. If they're constantly commenting on it, it's a bit of a red flag for me. The other thing is a focus on short sellers. It's okay if you're like, yeah, we saw it, we think it's wrong, or even disregard it. I know shareholders always want to hear from management after something like that, but to focus on it, it just always ends up striking me as a red flag. And I can proudly say that I don't think I've fallen victim to any frauds not yet not yet i was close on looking uh and not to champion my intuition but something told me no so we uh yeah we actually were uh i think what what was it what no it's almost two years ago now that was something we were looking at like this looks good numbers

400 wow like that's fast the numbers outright looked good yeah there's a reason all right uh do we want to let in his story for the week? Okay. Yep. My, uh, story for the week is Robert Kiyosaki's tweet from a couple of weeks ago. Um, he tweeted, got it right here. He tweeted, uh, well, he tweeted a few things, but the big one was giant stock market crash coming October. Why treasury and Fed short of T-bills gold, silver, Bitcoin may crash to cash best for picking up bargains after crash, not selling gold, silver, Bitcoin, yet have lots of cash for life after stock market crash. Stock's dangerous. Careful. So that kind of made the rounds on Twitter. People were poking fun at it and bring up a couple of things. First,

I want to just say something about if you're not familiar with Robert Kiyosaki, he is most known for writing Rich Dad, Poor Dad, which I think is a book that does have some value for people and kind of learning about trying to add value to your life, trying to buy things that are going to lead to economic prosperity rather than things that are a drain on your resources. I think there's some good stuff there. My family and I bought his game, which is called Cashflow, and it's a really fun game, actually.

So there's some legitimacy there, at least in some of his works. But since then, he's become more kind of the boy who cried wolf. He's often out there making grand claims about the stock market about to crash. He's made comments that like the only way to make money in stocks is through insider trading, basically. Lots of kind of out there type things over the past couple of years. And there's a great graphic on Twitter that shows like some of his tweets predicting crashes over the last few years. and oftentimes he's made these bold predictions only to see an up to the right chart so um not saying that he's necessarily wrong about the biggest crash in world history coming but

um he doesn't have a great track record and so kind of the topic i wanted to touch on today is just market prognosticators and macroeconomic indicators so it seems like pop culture is really obsessed with bubbles and market crashes. Um, we hear about, um, Michael Burry and the big short, and we see all these clickbait articles about, you know, the markets, the markets diving and you need to get out of stocks and you need to buy gold. And we hear advertisements and all sorts of stuff every single day. It seems like about bubbles and everyone's trying to predict the next bubble and what was the last bubble and what can we learn from it? And where are we going now? And it just is very obsessed with, like I said, these bubbles and these market

crashes. And we also see that in some of the financial media, especially with CNBC. And just constantly, it seems like any day that the market's down like 2%, we see like panic alarms on CNBC and market crashing, markets in turmoil. The whole world is falling apart, basically. And it's generally over like a 2% drop or a 3% drop or things of that nature. So there's a lot of pressure, I think, in society about looking out for the bubbles, looking out for the crashes. And understandably so. Right. We do. People don't like losing money. And so it's kind of easy to easy to prey on that. Despite that, I kind of think I wanted to kind of get your guys's thoughts on whether you listen to any sorts of market prognosticators or if you care about macroeconomic factors at all. And some, just to kind of bring up a few macroeconomic events that I think do have some bearing on the stock market, GDP numbers about how fast our country is growing, Federal Reserve announcements about the lower end of the yield curve, unemployment numbers about how much of the U.S. specifically is unemployed or looking for work.

And then I think there's also a lot of industry specific numbers that can sometimes be valuable to investors. So for instance, like housing starts, right? There's a lot of these kind of macroeconomic factors and indicators that seem like they might have some value. But what do you guys think? Do you consider macroeconomic factors at all when you're investing? And do you listen to any market prognosticators in general? Brad, do you want to go first? Sure. So I'm pretty maybe unique. I don't really know. I'm extremely micro based and stock by stock and laser focused on finding that company that can compound at 25 or 30 percent profitably for the next several years. And in my opinion, my philosophy is if I found those companies and being patient enough to hold through various political environments and rate rising or rate lowering environments, to me and the research that I've done, revenue growth and profit growth at the end of the day is going to drive the vast majority of stock market alpha over the long term. So just kind of using I use these macroeconomic events kind of to be counterintuitive, I guess, or or not counterintuitive, but greedy when fearful or fearful and greedy, I guess, kind of like Buffett talks about. And the other quote that kind of comes to mind is Peter Lynch's. It's something like way more money has been lost waiting for the next correction than has been lost in corrections themselves. So I am of that opinion that the macro noise just provides opportunities and just sweeps up unhealthy and healthy companies together indiscriminately, something like that, which to me, if I'm keeping up with the companies and I'm understanding the fundamental performance that they're putting forth, I kind of tune that out and use these pullbacks or macro noise as buying opportunities.

And, and, and I guess I should mention, I'm saying I'm staying in and tuning out the noise, but I do usually keep a 10 to 20% cash position just because my holdings are so volatile and just because peace of mind and sleeping well is important to me. And, and because I have this cash, I find like the macro turbulence and the macro noise that, that, that, that inflicts stock market pain is exciting instead of, instead of terrifying because I have this cash position. And so I just generally, just for FYI, for whoever's interested, I don't trim or add a lot, but I, or in large portions, but I do trim or add somewhat frequently. So just taking off really small pieces of positions when things are getting really fun

and adding really slowly and consistently as things are getting bad. So just, and the cash position fluctuates between 10 and 20%. So just, I'm kind of going off on a rampage there, but that's kind of, I treat macroeconomic fear is opportunity more so than portfolio construction and using that as evidence on how to go about investing. No, that was great. Ryan, did you want to first on? I don't really consider, it doesn't all like macro economic factors don't alter the way

I structure my portfolio, but I'd be lying if I don't like, if I said I don't like listening to them, like- It's fun. And I mean, some like Kiyosaki, no, I don't really listen to, but when Burry was doing it like earlier on twitter i i found it so exciting and part of me was like you know i hope he's right granted we're all beneficiaries of longer time horizons as opposed to a lot of other people so even if it wasn't noise and it was news and a lot of the macro stuff um say there was sort of a recession it's still to our benefit so because we can kind of collect

uh pieces of companies at cheaper prices so no i don't care about it i imagine as i age i'll pretend or start to care more and then think i have some edge in it i think that's the life i think that's the lifeline of most portfolios especially yeah exactly yeah um there's definitely a life life uh cycle uh hopefully we we're gonna break it but uh uh you know that's the trend everyone goes i think for me i don't look at it in general but for a specific stock it kind of sometimes you have the question like are there any macroeconomic things or events or interest rates whatever that could really affect this company's either stock price or ability to generate cash and that's mainly on a case-by-case basis and if so typically if there's something that some sort of macroeconomic

factor uh for example we just covered a company lenar group which is a home builder and they have you know a lot of i don't know there's supply chains there's the demographics in the us there's moving a lot of things are affecting the company that is out of their control and when it's a macroeconomic factor that can actually for me be a downside or a negative excuse me to a potential investment because if they can't control it as a management team it's just a lot of uncertainty and things could go wrong even though everyone's acting uh like uh with a lot of skill i guess you know with their management yeah or there's certain business models that are just simply interest rate sensitive uh like it's banks or whatever that's one we own brad what do you have

i guess a stipulation that i should add and i agree ryan mack will probably become more important as i as i grow up but or as i age not as i as i as i grow up and become a big kid um but as i'm kind of investing or entering new countries, like the one that comes to mind is Ozan. Part of my thesis was, okay, everyone's using the internet. Everyone has a smartphone and no one's using e-commerce. So really low hanging fruit. So I guess that's kind of macro thinking and kind of as macro as I go. So just when I'm investing in a country or something that I don't know a ton about um looking at kind of consumer trends and preferences i guess is sort of macro and that that is on my radar all right ian you have something yeah i was just gonna throw in that i totally

agree with kind of that's my process too with what you guys have been describing that trying to find the secular trends in the macro economy and um and see how it affects the businesses that i'm looking at i don't want to i don't really structure my portfolio based on just macro economic trends in general, but I do try to, um, kind of align it. Like if my, if my thesis is dependent on some sort of macroeconomic trend, I want to be fairly, um, convinced that that trend is going to continue. And, um, you know, like Brad was saying, I often try and invest with companies that are going to do well in any sort of environment. Um, but it's, it's, uh, you know, it is something that's becoming a little bit of a factor in the way I look at, uh, the market.

And sometimes I build some small cash positions when I'm a little bit uncertain about the future. There seems to be some excessive volatility in the market that I might be able to take advantage of. And so typically, I've just immediately taken my paychecks and put them straight into stocks. But when there's a little bit more uncertainty around, I sometimes build some small cash positions. Now, that typically is like 1% to 2% of my portfolio, so still fairly minor. But that's been one way that I've started dealing with some of the macroeconomic uncertainty a little bit. Yeah. Another one, like another kind of scenario that we try to go through is let's say something bad macroeconomically were to happen, say like hyperinflation or whatever, 5% inflation or like the shipping crisis were to persist or something like that. how would that affect my company? And if you kind of hope that, or you look for companies that are

durable through that. So digital companies with pricing power tends to be like, I don't think the shipping issues are going to hurt Netflix or Spotify. We don't own Netflix, but those kind of business models. Yeah. I have one, I guess one more thing to add is that I like to do a tiny bit of like scenario planning where say you have a stock and you're worried a bit about the valuation. It's like 40 times cashflow or something like that. That typically means you're investing because it's in the growth factor and, or not because it's in the growth factor, but it's probably classified within the growth factor. And if you think, and I think it's probably true that if interest rates rise, I have no idea when that would happen, but if interest

rates rise or something like that, there's correction, blah, blah, blah, then that factor would get hit pretty tough, pretty hard. And that stock, uh, or company would probably, you know, have a really sharp, sharp drop in share price. And if you think that is going to happen, if those things happen, then I kind of think position sizing and being ready to add to that. I know Brad kind of has, uh, was describing that kind of in just a different way of, all right, this company might be slightly overvalued. Now, if interest rates go up, something can really created the share price by like 50, 60% within a year. But if that does happen and I'm still really bullish on this company, that could be the time to back up the truck. That's something I

really do think is probably top of mind when doing portfolio management. Yeah. I don't ever see a world where my portfolio is structured around a macro thesis. I mean, maybe when I get older i'll i'll get that's where that's where that's where managers go to die right rad yeah yeah i guess just my i i invest in the cannabis industry and and like that the 20 kegger through 2030 that's projected it is also i i guess a large part of my thesis i'm just trying to um kind of i guess i'm agreeing with you guys just tying in those macro um secular growth trends to the actual individual performance and ability to perform of management

and historical performance and all that wonderful stuff is probably the best way to go about it. Okay, we're going to have a quick ad break and then afterwards, Brad's got some App Store stuff and then I'll be talking China, my expert opinion.

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from a shady link and now all your computer can play is red color red color where are you all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply all right welcome back in i'm gonna let brad go first here and you're talking app store take rates which i think we all have a bit of an opinion on um everyone does yeah yeah yeah everyone seems to have some hot take on it so brad uh what do you have yeah sure thing um and i should start um by saying because my opinion on their 30 take rate maybe is not as as positive as some of the others um but i think it is crystal clear and objective at this point that the apple app store has uplifted countless developers um

all of their careers. But 30% take rate at the same time seems a little predatory. So just going into the timeline and some of the pressures on that take rate in recent weeks. So the first piece of news that circulated about this was Apple preemptively taking the stance that we're going to allow people to plug into external third-party payment options, which is Apple forcing the internal usage of payment options is where this 30% take rate came from. So theoretically, that take rate would have come down a lot if people can link to external payment options. But they made this this qualification that you have to be a reader app. And they said reader apps are kind of media apps. So Spotify is an example of one that they lumped in. And I

think Netflix was even named explicitly as a beneficiary. But just thinking about some of stuff that I own, like revolve, they have, um, they, they have an app. They're, they're not a reader app there. I mean, they, they, they sell things, but, but, um, and, and, and it was more, more generally speaking that the, the companies that, that have, um, in-app purchases as a large part of their businesses would be excluded from this. So Epic games and Fortnite and, and all of these, these video games, um, and Epic games was really that the company that, that, that kind of pushed this forward, I guess. So after this Apple kind of announcement, which was kind of seen by me, at least as a way to kind of appease regulators without having to actually give up

anything important, because these in-app purchases are such a large part, I think like 70% of their app store revenue. But then a federal judge more recently kind of broadened this forcing of linking the external payment options to all apps, not just reader apps. So theoretically, every company with a consumer facing app that sells in the public market stands to benefit. And I mean, just personally, the option or the thing that comes to mind for me, we did a show on Duolingo and it's a small position for me, but I mean, they have like a 72, 73% gross margin. And in their S1, it just says the vast majority of our input costs are being paid to Apple and Google in their app stores. So companies like this, I mean, Match Group and for you guys, Spotify,

and I mean, the examples are endless. I mean, the gross profit margin tailwinds from this, the implications of this could be massively positive for so many companies. And I think I don't really know what to expect, but I think it's more likely that there's pressure on this take rate than it has been in the past. We also have Microsoft announcing last week that they're going to allow third-party app stores from Epic and Amazon initially and others next to integrate with its own app store without any take rate. Facebook is pouring money into what they're calling the next iPhone. So clearly, hoping to have that hardware center that they kind of build applications around on their own without Apple. These are trillion-dollar companies, multi-trillion

in the case of Microsoft. So you have this regulatory pressure and competition from just the deepest pocketed companies in the world. And Apple certainly might actually be the deepest pocketed company in the world. But I think that there's real momentum to erode this take rate. And again, the implications for so many companies in my portfolio, and I know other people's portfolios could be massive. The first question I want to ask, I have a couple, is for the last five, six, however many years you want to say, we've had these cycles of hearings on the Senate and the House of Representatives, and we see Google's executives and Facebook's and Amazon's and senators say really mean things to them, and they get really fired up and passionate,

and then absolutely nothing happens. So do we think that I, and please tell me, please tell me if I'm interpreting this wrong, if kind of this federal judge ruling maybe isn't as important as I think it is. And if kind of this is all bark and no bite and Apple is just going to continue to have this amazingly profitable and amazing app store business. I'll comment there. There is difference between the regulatory hearings and peer litigation between two companies the regulatory hearings seem like absolute nonsense after the question we heard last week of whether or not facebook will get rid of finsta um i don't know if you saw that video but it was pretty hilarious well let's get the age cap in there right yeah it sounds like most of uh apple problems

are actually like pure litigation so in epic's case and then also spotify has seen them in the eu i think there's been uh there was a rule with match group to assume them all over yeah there's a big it's all i think it's almost class action i'll let uh i'll let ian go first because he's probably gonna have a different take than brett and i yeah maybe so for full transparency my largest uh single holding is apple actually and um so i am a little bit biased in that sense but I will say, I think I don't like to see government action in these types of things to take down what a government or what a private entity has set as its price. Even in a situation like this, I think people would claim that it's a monopoly. I don't think it really is a monopoly. I think

it's actually one of the things that is closer to a monopoly than most things in our society. But I think some of the factors that Brad was highlighting show us that if this is an unfair price that is getting brought down and whether, um, through, uh, competition, right. And other, other firms just bringing the price down because they're, they're lowering their own prices or whether it's through, um, innovation. Um, I think that, that Apple, I think that 30% may be a little bit unfair in a sense, but I think that Apple is going to have to make, um, moves if it wants to percentage a little bit or, um, kind of change the types of services as we saw them do the types of services that they charge that 30% on. So, or provide alternatives for people to pay in other

ways or things of that nature. So my opinion on it is, I think, I think that 30% take rate does have to come down. Um, but I think that that's Apple's decision. And I think that it would be a bad business decision by them to maintain this 30% rate, um, across the board for everything. I think that if they brought that down a little bit, it would probably be good and better for their business. And I don't think that getting the government involved in this situation is really a precedent that I'd like to see set. Yeah, I guess a lot of our holdings would get impacted positively by it. So it's something I've been thinking about a lot. But I do think just personally, yeah, I agree with Ian. It doesn't seem necessary for the government to step in here on something like this. It's not like a, I don't know, it doesn't really seem like that big of a deal. This business is just really well done really well.

However, I think just realistically, it'll probably come down either through regulations, probably not going to happen or take forever, like Brad and Ryan were mentioning. But the litigation seems like there is a lot of bite there, and it's already in progress. Match Group is sidestepping the App Store in certain countries with a virtual currency. I don't know exactly how it works. I assume you have to go out to like a web browser and something like that, but they're sidestepping it somewhat. I think that's going to happen a lot more. And I do think that the Apple's best move or the move they're going to be almost forced to make is to bring down the take rate to like 10% or 15%. And I think from an investment perspective, I kind of think about it that it's not going up and there's a high chance

it's going to go down. So it's got a benefit company. You know, I think it's a high likelihood that these app store companies like match group, the video game companies, duolingo, Spotify and Netflix have already evaded the payments where since they're only signing up for subscriptions, they kind of actually still just evade it and send people out. That'll go away.

But then I think the true regulatory threat is the one that impacts Apple, where they have their services that compete with Netflix and Spotify and others while they own this app store. And I do think there is merit that with the quasi probably close to a monopoly, if not a monopoly in certain areas, that they cannot or it's unfair to serve Apple Music in the way they have done where it's pre-downloaded, all that stuff, where it gives them an unfair advantage to Spotify who has to go through their app store. and while spot you know spotify and all the other companies have claimed that apple when they compete with them is incredibly adds a lot of friction when trying to get updates you know to their apps and it's really unnecessary so they're kind of and i think they're making solid claims that apple is holding them back from the uh the competition that that's that's a little different than the take rate part but i think there's regulation merit from there but the take great i kind of think it'll probably come down but in some form or another i don't know if maybe

it will just out of pure social pressure but the idea that it's going to get like innovated away if they don't seems overly idealistic because the moats there the moats yeah especially in the u.s like no one no one cares if facebook launches a phone and it would be a waste of facebook's resources because no one's going to buy it vr could be you know five ten years maybe but yeah maybe that could be a disruptor but in the u.s if you have three different apple devices you're never switching um until there's a completely new technology that makes you have to switch um i think they do have a bit of a bit of a monopoly here and i would not be surprised if they held the take rate as long as they could yeah yeah i don't know brad or i think personally

it'd be 15 percentage points of pure margin to match groups so yeah i'd love for the take rate to disappear but yeah it's not realistic yeah i disappear no but but come down um i think is somewhat realistic and hopefully i really i really do hope it'll happen and i agree with you guys that hopefully also it'll be private market forces and competition from these formidable mega caps that forces their hand and bringing it down instead of Elizabeth Warren or somebody else telling them to. But yeah, I do think that 30% is kind of unsustainable and kind of 15%, 20%, that range seems a little more likely. I do think it'll stay elevated just because of what you guys we're talking about. I mean, I don't, I don't use non-Apple devices during the day. I mean,

we all have iPhones so that our, our, our text bubbles are not green so that our friends don't get mad at us. Oh yeah. Brett is a rare green bubbler, but so I, so I apologize. I don't attach myself, my identity to a mobile operating system. I'm just going to put that out That's fair. I guess, I guess I do. So, so, uh, but, but yeah, I, I do think it'll come down not as much as I would hope to see it come down, but hopefully it does. Yeah. Uh, do you have any, do you have another question or we already hit the, the investment one? Now that kind of looped in all the questions I had into one. So let's move on to, to Ryan's. Okay. Uh, I'm talking China. So, uh, I'll just go ahead and, uh, say this outright that I don't,

I'm not an expert in it by any means, but I do want to, a lot of people are just kind of hiding behind like the China crackdown without actually going into it. So I kind of wanted to talk about some of what has actually happened and then I'll kind of shoot it over to you guys for your takeaways. But the focus of most of the actions have been taken, the focus of most of the actions the Chinese government has taken are centered around the idea of common prosperity. And so the idea of common prosperity was first mentioned by Mao Zedong. I might be butchering that last name. No, you got it. Usually go.

And so if you see the references of it's like president, she, the new Mao, that's kind of where they're coming from. There's a lot of articles that have been kind of highlighted like that. And so in 1950, he was kind of the one that proposed it. And then it was carried on by another, another tongue twister here, but Deng Xiaoping, I think I'm saying that right. And Deng Xiaoping was actually the first, I think, leader to propose that maybe letting people get rich would speed up overall economic recovery. And so the idea was sort of short-term capitalism as a means for long-term socialism.

I think I'm basically getting that right without hopefully offending any cultures. But all the policies are primarily focused on redistribution of wealth, especially some of the ones that have gone on recently. I'll go through some of the actual policies. I saw a lot of these from Rob Vinal's letter to investors, which is well worth a read. And it's actually pretty interesting because these are all problems that are often talked about here in the US as well. There just hasn't really been action taken on them. So the first one was to choose one. And so this was a rule that was passed that prohibited online platforms. So think like Alibaba from allowing or from forcing suppliers to work exclusively on their platform or not allowing them to work with others. This, I believe,

was the driving force behind the $2.8 billion fine for Alibaba. I think practices like that get scrutinized here in the US also. The other one, and this one may sound familiar, is there was a crackdown on the gig economy, which was, this is basically rules that were set forth to make service platforms, the gig service platforms. So like the Airbnbs, the Ubers, except obviously invert it to China. They were forced to kind of provide extra employee type benefits to its workers, something that's obviously been proposed, I think, particularly in California. And then the third one, financial stability.

This is basically a rule advocating for conservatism from financial companies. So I think it required them to post collateral for have a, have a certain percentage of collateral and group probably induced this policy because a lot of leverage in their related parties. Yeah. The other one is afterschool tutoring. So if you had any education stocks over there, you probably know of this one because it required any and all afterschool education companies to convert to a not-for-profit institution for

which that's usually not very good for shareholders. And then online, the last one I'll talk about was online gaming. So a state-owned news site referred to video games as spiritual opium. And the proposal is to limit the amount of time school-aged children can spend gaming. I believe Tencent came out with a figure

that only 3.5% of their gamers are under the age of 16. I could be getting that stat wrong, but I thought it was kind of fascinating. So I don't think it's as detrimental as people thought initially. I'd also say that in August, the government began limiting the debt levels that property companies were allowed to have. I think this might've been an action as part of the financial stability proposal. And this is what caused the Evergrande crash that so many people talked about because they

had to start liquidating their assets and they were basically levered to the moon. So as we're recording, it's still going on. If there's something that big that gets resolved in like a month and you're listening back, this is way early October. So it's still possibly ongoing. But I thought I'd mentioned the stock returns from their highs of some of the notable ones. So Alibaba is down 54%. First of all, Charlie Munger in the Daily Journal reported their 13F this week, and he added.

I thought that was kind of fascinating because he's been- By the dip at 97. Yeah, he is buying the dip. And then Tencent is down 41%. Baidu down 56%. Pinduoduo is down 57%. And then I saw another chart that I found really fascinating, and it's China's GDP. It's referencing China's GDP versus the total return index for China.

And so China's GDP since 1995, take it with a grain of salt because it could come from a low base and it might be misreported numbers, is up almost 3,000%. But during that same time, the MSCI China total return index is up less than 100%. percent uh and i think that's kind of the indicator that for me is really telling chart i think anyone that looks at that is kind of gets the idea or the common prosperity notion that china's trying to implement so my question is to you guys um is china china investable for you do you guys think it buying companies in there is uh worth the risk and then is this crackdown i guess cause for concern for any domestic companies you have that operate in China? I'll let Brad go first.

So, first question, no, I do not and am not willing to invest in China just because, I mean, when you have a government who just can do whatever the heck they want with the snap of their fingers, and who has these seemingly objectives to kind of create a more socialist a society in the future, I can't get behind any kind of company. I mean, that is where macro becomes a big part of my thought process and kind of precludes me from entering in. And I even own, I mean, I own Ozone, which is in Russia, but it's just, and a lot of people are not willing to take that geopolitical risk, but just, it seems that much more intense

to me in China, not to mention just like the work camps that we've seen in the news for Uyghur Muslims and some of these human rights abuses. Yeah, it's just, it's way too hard to get excited about investing in anything. And do you want to go? Yep. So Brad took a lot of kind of what I was going to say there, and I think said it really well. So I won't, I won't just reiterate that. But for me, China is not investable just because of, as Brad was mentioning, a lot of the geopolitical risk and the fact that things can just change on a dime in one in one one second based on a government's decision. There's also I'll bring up kind of some of the fraud risk. There's just less regulation over there with the companies. And so we've seen some examples of fraud. And then the last thing I'll mention on on whether it's investable is they seem. And you brought this out well, Ryan, but they seem to just not care about corporations and businesses and don't believe that businesses are essential to the success of the company and or sorry, to the success of the country.

And so that's a pretty different view than most people in the United States have that there's a sense that businesses are good for us and that businesses create prosperity and things like that. then there seems to be a thought within the Chinese government that businesses are not essential to their future growth. All of that combined just makes China uninvestable for me. And I pretty much don't even, I don't look at anything in China anymore. A couple of years ago, I would look at things, but never actually invested. At this point, I'm not even looking at things in China. As far as, I think the second question you asked is pretty interesting too, which is, um, whether this is a cause for concern for domestic companies with operations in China. So I was looking at these in the last couple of months, I was looking at, um, kind of this idea

in the last couple of months. And for me, I do have some holdings that are, um, that are, have a lot of, um, Poland, China that are, that are dependent on China to some extent between, uh, Apple, even Costco is getting more into China. So it's something I'm a little bit, I'm concerned with, but I think that there's enough, uh, there's enough sway with, from America that, and, and much enough kind of mutually assured destruction that China won't totally crack down on American companies, um, in the near future. But I, it's something I'm keeping an eye on and something that I'm definitely a little bit, um, concerned about and, and, and something that's, like I said, kind of percolated in

the back of my mind. All right. Yeah. I'll hit mine. Uh, China is not investable for me. there's been a lot of you know recent history of fraud that we've all been over i think i have the same views as all of you guys uh but you know i look at stuff over there and like jd.com looks so cheap but i know it's cheap for a reason um i did used to invest in chinese companies

uh like i mentioned earlier there was that one that i think was probably a fraud i che is still trading so uh maybe avoid that one but for the domestic companies i think it's more of just a risk you have to incorporate. And you really got to look, they have to put it in either their 10, maybe it's just the 10K, but I think it may be in the 10Q as well. They have to put their geographic distribution. So there's some companies like Apple or Nike or something like that, or Starbucks, they may have 20% exposure to China. And that's pretty important. But if there's a company, I know there's some video game companies that Ryan and I were looking at that probably had 5% exposure. And then if this stock is selling off 10% on news that China's cracking

down on video games, that might be more noise than actual news. So I think you have to really look at the geographic distribution. And you also have to look at their future growth plans. So I know Starbucks, their big growth driver was supposed to be China and has been, right? But if that's where all their future growth is going to come from, you have to maybe reevaluate that and your own decision but i think on a case-by-case basis the domestic companies uh are i don't know there's not gonna it seemed very very unlikely because it would almost be it'd be a very malicious act to like cut off apple or whatever you know everything's all connected it seems like nothing's just going to be cut off but there could be something slowly that impacts that or the

economy in china might not do so well or the redistribution of wealth or whatever these new rules are or any other new rules they make up could impact those companies growth plans uh sometimes china likes to or it seems like they like to lean on domestic producers or not producers domestic companies which is why amazon got crushed in china or that's a big reason why that's probably because alibaba pinduoduo j.com and the others were just better but you know if you're banking if you were banking on amazon you're doing well in china you didn't really have to in the long run but you know that might have been a bit far-fetched um but in general china investable i'd say uh not worth the risk there's so many countries i mean even in the us there's thousands of companies

especially if you're looking at microcaps as well and then internationally there's so many other markets out there that why bother there's there's a lot out there you know you're not going to get bored just because you don't have China. Yeah. I think I agree with all that. Brad? Yeah. I forgot to answer the second part of your question. I just want to say for my portfolio, specifically, Duolingo is the company that comes to mind for being impacted by these decisions, just because it is an educational app. It did have an office in Beijing, or does, I think, have an office in Beijing. I've heard nothing from the company. I reached out to the IRS department about it, but it's a small chunk of revenue. So I was honestly crossing my fingers that it would

pick up a little bit more steam and attention, um, kind of, um, for the reason that, that Brett was talking about, because it's not that, that integral part of their business, but it is a small chunk. So, so it's definitely something, something to keep in mind. Um, the only other one is Boeing. Um, and, and they, they're the people, the Republic of China has been trying to figure out how to build commercial airplanes for a long time and they have not figured it out yet. So I don't really see them sidestepping ordering planes from Boeing in the short to medium to long term. Yeah. And I got to hear people, you know, there's a lot of people out there that are probably investing in Alibaba right now. And if, you know, the crackdown doesn't go

through as bad as we think, the stock looks pretty cheap. And if they're doing as well as, you know, as reported, it seems like it would be a great investment. You know, there's a lot of people that are smarter than us investing in it. But I think what sums up for me was, I believe it was, well, I think he keeps his name private now, but Willis Cap on Twitter said, look, guys, I made a sheet of all the cash distributions I'm going to get from Alibaba and Tencent from now until 2050. And then it was a table of just all zeros. And I think that's the really big fear here is that you don't really have a claim on the future cash flows. It's just kind of like a third-party thing

with the VIE structure sometimes. And do you actually own the shares? Is that risk well enough? Do you even understand the country at all? I know I don't understand anything that's happening in the country. I think we're all in the same boat. Yeah, I mean, that's something we haven't even talked about either, which is there's regulatory risk,

but there's also the cultural risk of habits and consumer habits just being different. i'm not investing in india you know yeah i mean part of part of me just doesn't understand the actual like uh consumer landscape over there as well so um yeah i i guess it goes in the non-investable category for me it seems like we're all in unison there unless we have anything else i'm gonna go ahead and hit the outro um but thank you all for listening uh this we are not financial advisors anything we say or discuss here on chit chat money is not formal advice or recommendation We are, however, general partners, Brett and I are, however, general partners at Arch Capital

and clients may have positions in the securities discussed in this podcast. Thank you all for listening. We'll see you next time.