Motley Fool Hidden Gems Investing - Boeing, Election Betting, Expanded Options

Episode Date: October 28, 2024

Today we’re digging into financial regulations, advanced financial instruments, and the financing Boeing needs to stay afloat. (00:21) Asit Sharma and Dylan Lewis discuss: - Robinhood’s venture into the event derivative market and why it’s no surprise to see the brokerage venture further into advanced and more speculative trading to drive transaction revenue. - The CFPBs “open banking” push and what it means for consumers and banks.   - Boeing’s plan to issue $19B in shares to pad the balance sheet and navigate a tough time for its business.  (16:32) Carvana stock has been on a wild ride Fool Analyst Yasser el-Shimy joins Mary Long to discuss why so many investors have bet against Carvana, and how that bet has played out. Visit our sponsor at www.landroverusa.com Companies discussed: HOOD, BA, CVNA Host: Dylan Lewis Guests: Asit Sharma, Mary Long, Yasser El-Shimy  Producer: Ricky Mulvey Engineers: Tim Sparks, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. We're talking capital F finance. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst Asit Sharma. Asit, thanks for joining me. Dylan, thank you for having me. You know, I usually default to finance, but I feel like when we get into some more high-minded ideas, finance a bit more appropriate. I'm always up for that. We're going to get a little wonky on today's show, some interesting stories in the world of finance and in investing. We'll start off talking a little bit about

the presidential election. It is next week, but this week, Robinhood announced that some U.S. users on the platform will be able to trade U.S. presidential election contracts. We will be sure to steer clear of some of the politics here, Asit. But let's talk a little bit about these election contracts. These are event derivatives, which I imagine some of our listeners might know about, but a lot of them probably have never heard of before. Yeah, Dylan. Well, event derivatives are interesting. These are contracts between two parties that essentially, to me, are sort of like a wager on an outcome of an event. So you can place event derivative contracts really on anything. If you or I have something that we want to place

money one side versus the other, we could use a contract to do that. Now, in just street language, we could gamble on that, we could bet on that. This is a more sophisticated way to do the same, as you said, and it follows a lot of evolution in the derivatives market. People who use futures contracts, options contracts, are already in the business of wagering on outcomes. A lot of times we're crunching financial data when we buy, let's say, a call option, or we are going with our gut instinct, maybe, if we buy some futures contracts. But at the end of the day, the length of these contracts has been shortening and shortening and shortening in the marketplace. The CBOE, this is the Chicago Board of Options Exchange, has been working on

derivative instruments that allow people to place bets that open and close on the same day, options that are really single-day dated. And you've seen this explosion everywhere, but this has taken it to the next level. And what bigger event than the biggest one of all that's on everyone's radar screens, at least until November 5th or shortly thereafter, the U.S. presidential election? Yeah, this is the Super Bowl for speculation, right?

And so it kind of makes sense that it would be coming together at this time in the calendar year. You mentioned that this feels like a little bit of an evolution in where a lot of options contracts have been going. To me, it also feels a little bit like the evolution of some other trends

like the rise in betting, especially sports betting that we've been seeing, and the rise in predictive markets. Some people are probably familiar with the idea of polymarket. That is a predictive market that has been getting a lot of attention and a lot more speculative trading and betting happening. In fact, polymarket has accumulated more than $2 billion in bets on the election, which is just incredible. Yeah, it's so wild. And some of us will question, okay, what's the utility of this? I mean, this is just people putting money on who they think is going to win the U.S. presidential election. Well, people who are involved in these betting markets will tell you this may have a higher degree of accuracy. There are professors

out there who are saying, look, if people are putting their hard-earned dollars on the wager, that means they've done a lot of thinking of the outcome. There's another instance of this, which is pretty interesting to consider, and that is the geographical dispersion of the bettors. So if you have people in swing states who are driving through their neighborhoods seeing more signs of one candidate versus the other in people's yards and then going to bet on polymarket, that may have some predictive value. There have been, though, recently a few events which make you wonder if this year's betting will mirror what happens in the actual election. And that is there are some whales coming in. We're used to thinking of whales in terms of people who come in and take big positions on options contracts. There have been some large bets placed in Polymarket and some other platforms,

which may be shifting sentiment a bit. That's going to be all unraveled after the election. But there are studies that show that these so-called prediction markets can be accurate for some events, not all events. Let's talk a little bit about the Robinhood side of this, because I can't say that I'm particularly surprised by this. I think such a large part of the company's focus over the last few years has been taking these users they have a commission-free promise and relationship with and trying to find ways to expand that relationship so that the company can move more and more towards profitability. That's looked like a couple different things in recent years. They've focused a lot more on deposit interest-bearing accounts. They've

focused a lot more on options and crypto trading. This feels a little bit like a next step in trying to build out some of those more high margin trading activity operations. I think so too, Dylan. The equity flow that Robinhood sells to its market makers, in other words, you or I are buying stocks and it's sending those orders downstream to people who are actually clearing the trades. The money they make off of that is fine. But in its original S-1, Robinhood was clearly an options house. That's where they wanted to have most of their volume. Why? Because an options contract is a little bit more complex to handle for a clearing firm, so there's a little bit more money to be made there. Once you get into the world of derivatives, options, futures

contracts, and now these event-driven derivative bets, well, those present arbitrage opportunities for institutional buyers or people who are just pretty wealthy, like the gold customers of Robinhood who might have a portfolio they want to hedge. You've got, let's say, 1,000 shares of NVIDIA. I wish I had 1,000 shares of NVIDIA. Let's not be there. Maybe you want to take some options contracts to hedge that position. Because of this trading of these derivatives across retail buyers, institutional buyers, that's a market where you want to move. If you want to lift your profits, you'll get more money selling those orders than you will the plain vanilla equity trades. Yeah. And if you look at the actual books for Robinhood recently, transaction-based revenue

up almost 70% year over year to just about $330 million. It is the largest driver of their revenue. It is not the sole reason that they've become profitable in recent quarters. They've also ramped down their expenses like a lot of more tech growth-oriented businesses have. But you have to look at the picture here and say, this is a very large part of how this company is going to be making money and probably trying to interact with their users going forward. Yeah, I agree. And That's not to say that they're not focusing on some basics. You mentioned optimizing their cost structure. Something else they're doing is realizing, hey, we could be making a lot more money on our margin. In other words, lending money to customers who want to trade

on margin. Typically, their margin rates were a little higher than the industry, so management recently said, yeah, we're going to lower those rates and have more people borrow money from us for this, because that is, again, a higher margin stream of revenue for them. a little bit of everything, and this derivatives for events is just the latest in Robinhood's evolution as this full-service house for its customers. We'll stick with the world of banking and the world of brokerages. The Consumer Financial Protection Bureau out with some new rules that will affect banks, credit card companies, and fintech companies. These are so-called open banking rules, and the idea is that it

will be easier for consumers to access and share data with institutions, also put some more limits on what data collection those firms can do from consumers. Not surprisingly, Asit, the banks are not loving this. There's a bank industry group and also, I think, a specific bank that have already filed suit against this last week. It's more rules, it's more regulation, it's more expensive operating environment, but it also feels like a win for consumers. I think so, Dylan. And the language around this is sort of vague now, so we're still piecing together exactly what this means. But let's take some simple examples. Number one, you are a customer who before was evaluated through a third-party mechanism like a FICO score. And so

you really were subject to whatever that FICO score said. In this scenario, maybe a financial institution can get a more holistic picture of you if they can have access to banking transactions, whatever you want to show them. You make your utility payments on time, for example. So that's more first-party data that should be yours to share, that now you can share, you can just opt in and say, yeah, go ahead and send this all to this other financial institution. Why are banks mad? This is sort of the second example. Let's say you are that person who holds all those NVIDIA shares and you sell some and you put it in your bank, right? So you've got this fat deposit. Well, maybe you want a higher rate of interest and you happen to share that information to other

institutions that are either banks or have relationships with banks and can offer you a higher deposit rate. Your bank doesn't want to share that information. I'm paying you 3%. I don't want to tell anyone that you've got a few hundred thousand sitting here at 3%. You can see why institutions have mixed views of this, but I think in general, it's a win for the consumer. I agree with you. It does remind me a little bit of the FTC's new click-to-cancel rule, which made some waves earlier this month, really making it easier for consumers to end subscriptions in the world of digital products, I think gyms as well.

What I see with both of these stories is, there have been some tremendous gains in digital business, and a lot of those gains have accrued to the companies themselves, and their ability to take information, marry it up with other data sets, and get a much more in-depth view of the customer. it feels like there's a little bit of a tide shift happening where some of those benefits, that ease of use and sharing information, that ease of cancellation, starting to come back to the consumer a little bit. Dylan, so much money, so much capital, so much brainpower, so much technology

has gone into answering questions like this. How can we make it easier for the customer to click and buy our product or service? Make it easy to sell this thing. but when you reverse that equation on that same seller well i want to make it easy for the customer to get the heck out of your service as well they don't want to expend any brain power or resources or money on that side and you can understand that too again because capitalist capitalism is is such a thing where we want to protect what we bring in house so i think that the tide is shifting a bit everything in capitalism and commerce operates on that pendulum principle that you and I talk

about sometimes, where when things go too much to one extreme, to make it a fair exchange, it has to move the other way. And there are two ways to do that. One, consumers will balk, and so you got to change your practices. Number two, the government will step in and help that swing back to the middle a little bit. That's what we're seeing now. If the rules stand as currently written, they will not go into effect all that soon. for consumers. The largest institutions will have to comply by April 1st, 2026. Some of the smaller covered institutions will not have to comply until April of 2030. So there's going to be some lead time, I think, on this story, and one that we'll probably wind up revisiting a couple

times over the next couple of years as the regulatory and cost picture for some of these businesses picks up. I want to wrap us up with one story that is a little bit less about the gears of how finance might work, and a little bit more about how it plays out with a company. We've talked plenty about Boeing. We've talked about the manufacturing issues. We've talked about the CEO exit. The current strike is very well documented. This week, the company in headlines for kind of a dubious milestone. It will be launching a $19 billion stock issuance in order to raise cash, and it is one of the largest issuances ever by a public company. Asit, Boeing is a $95 billion company. $19 billion would be a lot of stock to issue.

That's true, Dylan. Surprisingly or not surprisingly, the stock is not down that much today. Boeing is telling its shareholders, we're going to dilute you. But at this point, shareholders are like, okay, dilute me, bring some more shareholders in, let's solve this problem, let's keep you solvent. Let's let you finish production of the models that you need to. Let's see the workforce come back to work." There was almost some relief for this in the markets, even though, as you point out, the amount of the raise, which is potentially as much as $24 billion, it's very material to the current market capitalization of the company, it's material to what's on the balance sheet. At this point, I think what Boeing shareholders

want to see is just that they don't or shouldn't have to worry about cash flow. Cash flow has been negative several quarters. When you have delivery delays, the company can't recognize the revenue, it just pushes it out into the future. While it's a really big stopgap and it hurts, I think investors were ready for this. Because one more point here, the thing that would happen if Boeing couldn't raise this money in the capital markets on the equity side is having to go to the bond markets. One article you shared with me had it in the headline, they're saving themselves from getting a junk rating, for their bond credit rating to go down, trying to raise so much money, at least $19, $20, $24, $25 billion. Yeah, giving people a sense of the

balance sheet here, if you look at Boeing at the end of September, $10 billion in cash, $12 billion in receivables, $53 billion in long-term debt. And the problem's not getting any easier for them with the strike going on right now. They're losing millions of dollars every day because they are not able to continue producing some of their products. And the company has not produced full-year positive net income since 2018. That puts this business in a very tough spot. And I don't want to dump on Boeing here, but I think seeing a company like this struggle and then having to resort to share issuances and more creative financing options, to me, really highlights how much harder things get for a company when things are not going well

and the importance of financing when it really plays into the flexibility that a business has. That's very true. There are some companies that get a pass from investors. Boeing has been one for the longest time, simply because there are only two real choices in the marketplace. Look at the 77X program. This is a program that customers have been okay waiting for, delay after delay after delay. Now, they're starting to get closer to delivering those aircraft. But because Boeing has this duopoly with Airbus, it's gotten the pass. But that doesn't mean that Boeing can stay afloat indefinitely. So the value of having a balance sheet, which has some resilience in it, the ability to go to the capital markets on the equity side, if you need

to protect your investment grade rating on the bond side, that's very powerful here. But I will say this about Boeing, they don't have much left in that balance sheet or patience with investors to do this drill again. So this money that comes in really needs to be spent constructively and it needs to go to moving deliveries. Of course, there are some other issues still. There's regulatory risk hanging around there. They've got to get approvals to move more 737s out the door. So this won't solve all the problems. It's really show me time for Boeing if it ever was. It's now within this next, I would say, year to two years. Asit Sharma, thanks for joining me on today's show. Thanks a lot, Dylan. A lot of fun. Coming up next, Carvana has been on a wild ride.

Motley Fool analyst Yasser El-Shimi joins Mary Long to discuss why so many investors have bet against Carvana and how that bet has played out. Blend wellness into your coffee routine with the Coffee Plus range, infused with functional benefits. Choose the coffee you love with added B vitamins, like Coffee Plus B12 to help support immune function and Coffee Plus B6 to keep your day moving. Or go with the flow and choose Ginseng Delight, our new double espresso with ginseng extract. Whatever lies ahead, don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. Carvana, the used car and e-commerce company, is up over 5x since the start of this year.

Lest listeners hear that and think, whoa, the used car market must be a booming. It's worth noting that its closest competitor, CarMax, is up a measly 13% in the same time. Yasser, what is going on with Carvana stock? Well, quite a lot, Mary. And where do I start? But let's say it has not always been a happy story for Carvana shareholders. Problems started during the pandemic years, really, where surging demand led the company to kind of pursue a strategy of growth at all costs and investing massively in infrastructure for, you know, expected demand that just did not materialize, especially after 2022. too, when, you know, higher interest rates basically put a damper on people's ability to afford cars, as well as the fact that car prices really skyrocketed during the pandemic,

and that created a real affordability crunch for many households. So, you know, all of that kind of worked together with the fact that they also made this acquisition of a wholesale car car auctioning company called Edessa, which came at a very unfavorable debt terms, almost 10.5% interest on that loan. It's just saddled the balance sheet of the company. And so the market started being very skittish about the company's prospects and financial health as growth turned negative, sales growth, that is. It was still losing money. Now the balance sheet was kind of really impaired, if you will. And there were lots of questions as to whether or not this company was even going to make it. But you mentioned the performance of the stock. Now, if you actually

zoom out to Carvana's return since December 2022, you'll find that Carvana's stock has returned nearly 2,400% compared to CarMax's 5%. Now, if you invested your money at that time, you would have, you know, effectively found the stock equivalent of the Holy Grail. This was a stock that was effectively priced for bankruptcy. And frankly, it was not too far from that. So it had an extremely low valuation. 90% of Carvana shares, you know, Class A shares, I should be specific, were sold short on the market. The fact that the company not only did not go bankrupt thanks to the debt renegotiation and raising equity, but also turned around the business to become profitable and maybe on path to, in fact, become one of the most profitable

players in that market while gaining market share. So all of these factors really combine to create that mother of all short squeezes that we have seen with this stuff. So let's focus on why that short interest existed in the first place. Why were so many investors betting against Carvana and what has changed since that peak 90% short interest? Right. Yeah. So as I said, like the balance sheet of Carvana was in bad shape. It had billions of dollars of debt and less than a billion dollar of cash at the time. And that debt was accumulated basically in order to build those uh ircs as they call them uh inspection and reconditioning centers throughout the country those are our facilities that carvana wanted to build in order to service the used car market

across the nation they can effectively inspect and repair the used vehicles that they source and then flip them into and and sell them effectively but then they went a step further also to uh go ahead and buy edessa which was a one of the country's largest uh wholesale auction car auctioning companies, in order to try and be as vertically integrated as possible. So there was a lot of strategic acumen, if you will, into what Carvana was doing, that they were trying to build the kind of infrastructure and the vertically integrated business model that could support their growth for many years to come. However, this all happened at a time of, you can call it the market top of demand, if you will. Again, as I said, during the pandemic, everybody was buying

cars because also new cars were in short supply thanks to a semiconductor shortage and other reasons. You know, a lot of the interest went into the used car market and Carvana was able to sell more cars for higher prices at that time and expected that kind of demand to just keep going. Of course, once interest rates started rising, you know, that demand somewhat disappeared and And we started seeing actually, you know, sales contraction as opposed to sales growth. But even in that tough market, Carvana was able to kind of gain market share against competitors. And they have had to do a lot of cost efficiencies that we can sort of talk about later in order to get into a more healthy financial position. But yeah, it was really a confluence of factor that made the market very skittish about Carvana.

So you've got what you referred to earlier as the mother of all short squeezes kind of happening with this stock. At the same time, you also do have Carvana improving upon its fundamentals. Earlier this summer, Q2 earnings beat on revenue, net income, earnings per share, operating income. If you're a market observer and you're taking a look at this stock, how do you parse out how much of this rise is attributable to the mother of all short squeezes versus actually improving fundamentals?

So it's very hard to quantify exactly how much is attributable to a short squeeze versus improving fundamentals. But this kind of very rapid, very strong price increase in the stock usually happens in the context of a short squeeze. Not always, but usually. But that rapid and very high increase in share price cannot be sustained unless the fundamentals have improved as well. So if you take GameStop as an example, that was the kind of, you know, the stock of infamy, if you will, during the pandemic that also experienced a pretty big short squeeze, thanks to Wall Street bets on Reddit. That had a massive rise, but also has since fallen quite a bit. And the reason is the fundamentals have not supported basically that short squeeze that happened. It was almost an artificial short squeeze for reasons.

I'm not going to get to right now. But, you know, you know, like a short squeeze basically happens when when when you have a stock that is heavily shorted and suddenly there's some kind of good news that convinces investors that, you know, maybe we were wrong to be so pessimistic about this company. And that's when people who are selling these shares short, they need to cover their possessions and buy shares. So the price kind of rises and it kind of creates a feedback loop that feeds on itself. But Carvana, for sure, has shown that it has improved its fundamental outlook, both from a balance sheet perspective, where it has renegotiated its debt with the bondholders and kind of improved its cash position as well. From an operating perspective, we can see that they have become EBITDA positive for the first time in history in 2023, and they are expected to, in fact, reach a 10% EBITDA margin by 2025 and a 20% gross margin in that same year. So the fundamentals are improving from an operational and profit perspective. And that has come, of course, at a time when the used car market was in fact contracting. So that makes it all the more impressive and speaks also volumes about kind of the strict

fiscal and operating discipline that was born out of necessity in 2022 and 2023 that has allowed Carvana to become a lot leaner than it used to be. It's a father-son duo that's behind this business. There's Ernie Garcia II. He's a major shareholder in the company. And then there's Ernie Garcia III, who's co-founder and CEO. All told, the Garcia family holds about 87% of Carvana's voting share. That's as of 2023. They've both made a lot of money from selling shares in the company. The Junior Garcia sold over $2 million of Carvana shares this past May. The Elder Garcia sold about $145 million worth of share this past May, and many more since then. If you take a look at our

premium stock database, full IQ, basically all recent selling of Carvana comes from the elder Ernest Garcia. We typically like to see founders who have a lot of stake in the game. The Garcia certainly have that. How do you think about founders who are constantly shedding their shares of a company? Right. Thanks for asking that question because the Garcia family's ownership Carvana is probably one of the most controversial ownership personalities out there. If you go on financial Twitter, FinTwitter, you'll definitely find a lot of very heated opinions on that. But let me just try and kind of take a step back here and say that the ownership is, in

fact, one of the key risks in investing in Carvana and the complex ownership structure, to be exact. The shares flowed that trade on public market represent only about one third of the implied shares outstanding. And the Garcia's own a little bit over 40 percent of the overall shares. Now, to confuse you a little more, those shares that you buy in the market are class A shares for Carvana company. But there are also shares in Carvana Group, which are not traded on the public market and have more voting rights. and without getting really into the nitty-gritty of that complex structure i you know all i want to say here is that the garcias still have a really really big stake in the company through

their ownership of the carvana group which is not traded in the public market and around i think 40 percent of of the shares as i as i mentioned earlier and you know they had bought a lot of the publicly traded shares in Carvana Company when they were raising equity as part of their renegotiating the debt with the bondholders. So now that the market seems to have adopted a more constructive view on the company, they might be just trimming that extra exposure that they created for themselves and taking a little profit in the process as well. But as I said, they still have a pretty big stake in the company, this is not like they

are kind of selling with abandon and heading for the head. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis, thanks for listening, we'll be back tomorrow.