Motley Fool Hidden Gems Investing - Is AI Taking Tech To The Top?

Episode Date: June 1, 2023

With the Nasdaq up nearly 6% in May, tech seems to be soaring. Will earnings from CrowdStrike and Salesforce add to the AI hype? (00:21) Tim Beyers discusses: - If happy days are here again for the world of tech. - Why the market might be missing the greatness in CrowdStrike’s earnings. - How Marc Benioff found religion when it comes to cutting costs at Salesforce. (19:29) The war on cash is evolving. Jason Moser explains how the financial times keep changing and what it means for fintech. Companies discussed: CRWD, CRM, AAPL, MA, SQ, PYPL, V Host: Deidre Woollard Guests:Tim Beyers, Jason Moser, Alex Friedman Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

I saw my friend on the other side of the street. I was heading to school with the kids. I let go of mom's hand to wave. I had already forgotten their lunches. I ran over to hug her. She came out of nowhere. And then... It stopped.

Sometimes the moments that never happen matter most. Volvo's Automatic Emergency Braking helps ensure a safe ending for everyone. Learn more at volvocars.ca slash safety. May was big for tech. Could June be even bigger? You're listening to Motley Fool Money. Welcome to Motley Fool Money. I'm Deidre Willard, and I'm joined by Motley Fool analyst Tim buyers. Hi, Tim! Hi, Deidre! Fully caffeinated, ready to go. A lot of earnings. A lot of earnings, a lot of tech. We've got a shiny new month here. Last month, big month for tech. The Nasdaq, more tech-focused,

up nearly 6%. QQQ, which is used for this other measure of tech growth, that's up 14% for the trailing 12 months. I don't want to get too optimistic here, but are happy days here again, or should we be a little bit cautious about what we're seeing? We should be a lot bit cautious. That's not to be the, hey, get off my lawn guy here. I'm just saying that these things tend to come in spurts, and we should expect that there will be skepticism, there will be some reports that disappoint. No, I don't think we're at happy days or here again. That's not the moment that we're in.

What we are in is where things are starting to normalize a little bit. Supply chains may have loosened up a little bit and they were really tight. Maybe there's some normalized spending here. Good players that are well-positioned, that have done the work to become more profitable, more efficient. We're seeing those companies maybe doing a little bit better. The market may not be recognizing it yet, and that's OK. What's important is that some of these companies are getting structurally better. That's nice to see. You just mentioned the market might not be recognizing it. That's sort of a little bit of the theme that we saw for a couple of companies I want to talk to you about today.

First one being CrowdStrike. It seemed pretty great, revenue up about 42%. Who doesn't like that? maybe a little bit of decelerating growth, but the market didn't like this one so much. Why? It looks like because the forecast for annual recurring revenue just wasn't up to snuff. The market wanted something closer to 48%. That's not what we got. So, whenever the market is forecasting high growth for a forward-looking metric like annual recurring revenue, when the number isn't quite good enough, the market suddenly says, oh, that's it. Growth is slowing down. Not good. And I don't know that that's true. Because if we take a look at the CrowdStrike numbers, they were quite good. You mentioned that revenue was up 42%. That's right. Remaining

performance obligation also up about 41%. So, the way to think about remaining performance obligation. There's a couple of components to it, deferred revenue and backlog. But basically, this is all of the business that is to come. And a lot of it is longer-term business. And the fact that that number is as big as it is, it's over $3.3 billion right now, means that there's a lot of growth still to come for CrowdStrike. And on top of that, They're generating tremendous cash flows. They're doing very well. There are some good reasons for that. I know you want to get into this. Basically, they're doing better selling to their existing customers. Yeah. Let's talk a little bit about that.

One of the things they do is, they've got modules. As I understand it, and you can maybe clarify here, they add different aspects of security and intelligence and functionality. One of the things they said was, 62% of their customers have five or more modules, and they're growing their customer base at the same time. Is that part of the future growth story here, is grow more customers and then sell those customers more things? CrowdStrike is essentially a subscription business. As customers decide that they want to rely on CrowdStrike for more stuff, like they're going to rely on it for endpoint security, Maybe they're going to rely on identity, or maybe they'll add some other aspects of security.

And each of these modules provides some distinct features that you could add on to your CrowdStrike subscription. And so, as you scale up your CrowdStrike experience, the more modules you have, the bigger your bill, the more seats that you have, you're going to end up spending more. It's a good indicator of not just high growth, but actual profitable growth as you have existing customers adding more modules. The specific breakdown, 62% of the customer base has five or more modules, 40% six or more, and 23% seven or more. As those numbers scale up, we can expect that the existing customers are contributing very high-margin growth to the business, which leads to this tremendous cash flow we see at CrowdStrike. It's an indicator

of just how healthy the business is. Just for the sake of argument here, Deidre, super quickly, if we just look at the cash flow numbers for CrowdStrike, quarter-over-quarter, we do the year-over-year number. Profits were about $500 million. That's a massive improvement on close to a big loss. I think I'm reading it wrong. If I was to say $30 billion loss, that doesn't seem quite right. I don't think that's right. I think I've got that wrong. The point is, the net cash from operating activities year over year was up to about $301 million. That's up from about $215 million. Some of that is due to the artificial sweetener of stock-based compensation expense, but not a lot of it. Most of it is coming from better

what we call working capital management. Big increase in accounts receivable. In other words, people were on the phones saying, hey, we need your check. The checks come in, that receivable turns into cash, and that's more cash on the books. They're just getting more efficient, Deidre. When you see that, when you see a business that's routinely growing well, but also growing profitably and expanding the cash it can generate as a result of that, you should get very interested. I think the thing with CrowdStrike that's interesting that a lot of that growth is coming from existing customers who've become increasingly reliant on the platform. That's a good sign. That's true. There's also long-term

fears over cybersecurity that will continue to drive this. I want to get into something else with CrowdStrike. If the day ends in Y, we're going to be talking to AI. CrowdStrike, they announced Charlotte AI. It sounds like it's a generative AI security analyst. They called it a, quote-unquote, force multiplier for security experts. I read the release, it sounds kind of like an automated security help desk, but I think there's got to be more to it, right? Is there? I'm going to say, not to borrow too much from the great state of Missouri, but you have to show me. Show me. I'll believe it when I can see that this is actually happening. The story with

CrowdStrike for such a long period of time is, they collect a huge amount of data that provides signals of attacks that might be coming, security threats. They've had what's called a threat detection graph for years, basically since the beginning of the business. What's different now? We're going to have a new algorithm that we call Charlotte that's going to take a look at that threat detection data and do something materially different? I mean, maybe, but I'll believe it when I see it, Deidre. The good thing is, everybody's talking about AI. I'll believe it when I see it. If CrowdStrike can show me that they are getting materially better at detecting threats earlier by virtue of applying Charlotte to the threat detection graph,

okay, I'll believe it then. Until then, not part of the thesis. Makes sense. And as you mentioned, they've been really doing AI for years. This is just sort of a new layer onto what they've already done. Yeah, they've been using data for the purposes of protecting their customers for a very long time. I just, this smacks entirely of everybody's got to put AI in a press release. So let's call it Charlotte, put it in the press release and we'll get some bonus points for that. I don't, I'm not so cynical to think that that's exactly what they did. I'm sure they're actually working on something, but it's way too early, way too early to give them any kind of credit for actually achieving

something. Maybe they will. And then, hey, it'll be a big bonus if they do. Let's pivot and talk Salesforce, because their earnings came out, too. With Salesforce, one of the things they said they were going to do is, they were going to improve margins. And their margins are up. They did it. They were very happy about it on the earnings call. Mark Penioff kept using the terms incredible and amazing. This is a relatively mature business. So, should we be focused on those margins? Should we be looking at revenue growth? What are we looking for from Salesforce? We are looking for efficiency. Incredible and amazing are superlatives we shouldn't be using. Mark Benioff is Mark Benioff.

He has every right to be saying those things. We should expect that from him because he is a cheerleader. He's a cheerleader CEO. If he wasn't saying those things, I'd be worried. But should we be saying those things? No, not really. But he is right about one thing, the margins are definitely better. If you just look at the core income statement and the percentages here, total operating income, the operating margin was 5%. This is where they are on a gross basis here. That is up significantly. If you consider that 8% of operating expense went to restructuring. Without that restructuring, it would be a 13% operating margin. So, they are definitely trending in the right direction here. There's no doubt

about that. And also, the cash flow statement looks, I mean, honestly, Deidre, I don't really want to say that Benioff has gotten religion here. But off-air, I was telling you, this This looks like the difference between a formerly drunk sailor that has gotten sober. That's what it looks like, which is a terrible analogy. But it does look like that when you look at the cash flow statement. Not only was the cash from operations up, but the contribution from stock-based compensation expense was down. All of the areas where you could generate efficiency in terms of improved working capital were up. The accounts receivable, more checks coming in, $6.1 billion added by accounts receivable. That's awesome. That's up from

$5.8 billion in the same period a year ago. Bigger contribution from depreciation and amortization, net income was up. Most things were up. Here's the other thing that I find And absolutely fascinating, Deidre, they are buying back stock and paying down debt, and they are actually buying back stock and retiring it. The diluted share count was down. And they did buy back quite a bit of stock, $2 billion worth. They paid back $1 billion worth of debt. And most of that does look like it's coming through the organic generation of cash. of the money to pay for that is coming from organic cash generation. That's new. So, this is, I would still say, the beginning. But let's give Salesforce some credit for

showing some real operating muscle here. This is different. Yeah, it is different. It came at a bit of a cost. They had layoffs, they've really trimmed down their real estate portfolio. I wanted to talk to you a little bit, too, about Salesforce and AI, because we have to talk about AI. On the call, they talked a lot about data security. They talked a lot about large language models that are private or protecting, basically allowing their corporate companies to use generative AI without exposing their private data to the larger language models. How confident do you feel about Salesforce's AI efforts in general? I'm sorry, I'm going to be the get-off-my-lawn guy again. I think it's too soon.

It's too soon to know that. And large language models are arguably dumb to begin with, because they are in constant learning mode and they need a lot of work. Honestly, the large language model is really only going to be as good as the data set that it applies to. If you can apply really good rigor to the data set and then apply a really good algorithm or a really good AI to that data set, you might be able to get some really good results and really interesting things. For example, I do think that there is an opportunity for Salesforce to do fascinating things with private data that a customer generates through Slack, for example. Then allowing AI to teach your internal Slack environment to be smarter,

automate some workflows that are common to your business. Let me be clear, I do think there is an opportunity here, but to give them credit right now would be bananas. I would not do that. It's way too soon to give them credit for that. As an idea, sure, but you have to figure out the other side of it. Having large language models in and of themselves is immaterial. What you do with a well-trained, a well-designed, well-organized dataset and applying a good large language model to it or a good algorithm to it, that's where you get real magic. I'm not even close to giving them any credit for this yet. But as an idea, do I want them to integrate some AI and some good AI discipline into Slack? You're darn right I do.

I want them to be doing that right now. Because if they don't, and they don't make Slack more valuable than I think they face the prospect in the next 24 months of a pretty large goodwill write-off. As a shareholder of Salesforce, I do not want that. You called Marc Benioff a cheerleader CEO. He's a big, charismatic guy. Maybe he doesn't play so well with others. He's had a couple of co-CEOs leave. Looking to the future of Salesforce. Do you think he's learned his lesson? Do you think he can partner with another co-CEO? Would he have to leave in order for succession to happen? Looking at the future of Salesforce leadership, what do you see?

Are you asking me, is there a Kendall Roy for Marc Benioff? I don't know. To me, I look at this as the Benioff show, and it will be the Benioff show until it's not the Benioff show. I think that's okay. Mark Benioff, as the leader of this company, has been outstanding. He is a visionary leader. The fact that they are generating some real operating discipline while he is still leading the company, I think, is a very good sign. But I really frame this, Deidre as, Benioff will at some point leave, and there will be the Tim Cook equivalent for Salesforce. Or at least, I think that is the ideal scenario. What people may not remember, I think a lot of people do remember this, but what they may not remember is that Tim Cook,

for a long time, was Chief Operating Officer. And he was outstanding at turning operational discipline into a weapon for Apple at a time when Steve Jobs was still CEO. There was a point at which he absolutely killed it by going and buying up huge amounts of RAM in Asia. He just essentially cornered that market, and it helped the iPhone become a much richer device. they got the best product, the best components they could put in the iPhone. They took a huge lead on some of their device competitors at that time, and they really never relinquished it. Cook made moves that made Jobs look smart, and he has since become an outstanding leader of Apple. So, I think the next phase for Salesforce is, who's the Tim Cook of Salesforce?

I don't know who that is right off the top of my head, but I think that's what I'm looking for. That makes sense. Well, Tim, I always love talking tech with you. Thank you so much for your time today. Thanks, Deidre. Six years ago, Jason Moser put together a war on cash basket of stocks. Alex Friedman checked in with Moser about those companies and how the trend is shaking out. It's certainly been a fun point of conversation over the last several years.

And the war on cash basket, just for a little background for those who don't know, I think most probably do at this point. But the War on Cash Basket ultimately was just a collection of four companies that we felt were playing a very important role in the evolution of the payment space, the way money is moving, so to speak. It's made up of MasterCard, Visa, PayPal, and Square. Ultimately, the idea is to devote equal amounts to each company. You have four companies, you know, you divide that by four, you got 100% to buy that before you could put about 25% into each company and giving yourself exposure to a nice little risk ladder there of some stalwart type companies in MasterCard and Visa, a little bit of a more of a mid-range risk in PayPal,

and then a little bit of a riskier idea in Block, formerly known as Square. So looking over the last six years, how has it performed during the pandemic and what's going on Yeah. If you look at the actual performance since inception, and we go back to July 24th, 2017, it's certainly been a bumpy ride, to say the least. But overall, since inception, the basket has performed very well compared to the market. The basket itself, the collection of four companies is up just a bit over 110%, 112% to be exact, versus the market's performance over that same stretch, which is about 88%. Certainly, we had seen that delta a little bit greater at other times, but for the most part, the basket has done what I was hoping it would do,

make money and outperform the market. Now, you did mention during the pandemic, and I think that's something important to break out here, because while the six-year performance for the basket has been very encouraging, we saw over the stretch of the last three years or so, just a lot of volatility and a lot of change in some of what these companies are really trying to do. Just looking at the dates going from March 1st of 2020 to the end of 2023, it was a little bit of a different story. The basket actually performed fairly poorly when we thought it would have probably performed better. Now, I think it performed better in the early onset. But overall, it's not done so hot. And I think a lot of that has been due

to performance from PayPal and Block, whereas MasterCard and Visa, they've kind of towed the line, so to speak, and filled their role as relatively stable performers. But again, going back to since inception, you go back to inception, the basket has performed very well, so I'm pleased. We'll definitely dive into the performance of some of these stocks in a second. Before we do, I'm curious, how do the tailwinds continue to form as consumers use cash less and less around the world? Yeah. You see these numbers quoted everywhere. The one thing to always keep in mind, this is such a big market opportunity, but we're talking about truly a global market opportunity. It breaks down to,

how often are people using cash? I think the general trend is still very much intact that people are using cash less and less. It didn't require a pandemic for that trend to begin. I think that the last three years accelerated that to an extent. But if you look at some of the numbers out there, according to Pew Research, today, roughly four in 10 Americans, around 40% say that none of their purchases in a typical week are paid for using cash. up from 29% in 2018 and 24% in 2015. On a similar note there, you look around the world there, European Central Bank recently pulled some statistics on this and cash was used for 59% of point-of-sale transactions in 2022. That was down from 72% in 2019. I think all around the

world, we're seeing this trend play out. We're just moving more and more towards the digital movement of money. The best-performing stock in the basket has been MasterCard, which is up 187% since 2017. When it comes to MasterCard's business performance, what factors do you attribute to the success we've seen with its stock? Yeah, I think with MasterCard, and I'll lump Visa in this conversation as well, just because the two businesses are so similar, and they serve a very similar role in this basket. they've just done such a good job in leveraging their network to do more. What we've always liked about MasterCard is the business model. It's that tollbooth model where they own the payment rails,

where that money has to go along their rails to get from point A to point B, and they collect just that little toll, that little interchange along the way that really affords them that attractive margin picture and steady reliable growth. This isn't the kind of company that's going to be growing 30%, 40%, 50% a year, but it's very steady. It's a steady, reliable grower and that's the point behind it. But I think with MasterCard and Visa similarly, what we've seen these businesses do is take these massive networks that they've built out through the years through this physical card business that we've all come to know and love, and they've really just done a good job of leveraging the network to do more. You're talking about

capturing new payment flows, new ways that money is moving around, disbursements, remittances, commercial point of sale, business-to-business payments, consumer bill payments, and even buy now, pay later. We're seeing these businesses starting to take their networks and build the technology on top of that to do more. With MasterCard, it's not just a payments business. They bring value-add services to their customers, the merchants and consumers alike. We're talking about things like cyber and intelligence solutions, data and service, you had insights, analytics, consulting, and marketing. Again, they're just doing a very good job of leveraging the network to extract more value for both the consumers and the merchants. Up next is PayPal. All of the

companies in the war on cash basket have more than doubled since you put the basket together in 2017, except for PayPal, which is only about 5%. This has been a very volatile stock, initially rising 420% in the summer of 2021, and then falling close to 80% to its current price of about $62 today. So I'm curious, what are some of the main factors you attribute to the roller coaster ride that PayPal investors have faced over the years? It's definitely been a roller coaster ride. Yeah, to me, there's a lot going on here with PayPal. And I think there can be a lot of reasons as to why the sentiment is so sour really today on the business. I mean, I think it's fair to say that over the last three years, the last three years resulted in a lot of

overconfidence, not just in regard to PayPal, but I think a lot of businesses over the last three years saw things change so quickly. We saw so much growth being pulled forward at the time, feeling like everything was going to be done differently from here on out. This was just like this moment where everything was just going to pivot and we were going to be doing things so much differently going forward. Yes, certainly things have changed to an extent, but you look at the way things are going today, I don't think it's to the extent that a lot of folks envisioned earlier on. In short, I think we're back to normal in a lot of ways now. I don't know that PayPal necessarily made a lot of the right moves along the way

to instill a lot of confidence for investors as to where they are right now. It is conflicting. you look at the actual business, it's performing well. It's not a bad business. But they made some bets, they made some investments and some decisions along the way that I think have caused investors to maybe take a little bit of a step back and wonder exactly what's really driving the bus here. PayPal, it's an involved business. It's not just PayPal. You've got PayPal, but then you have Venmo, you've got Braintree, you've got Zoom, you've got Honey and Zettel. I think one of the biggest challenges with PayPal, quarter in and quarter out, is management has not done a very good job at all in really breaking out the business

and giving us more granularity into how each facet of the business is performing. We get information on Venmo because Venmo is top of mind for so many people because so many people use it. But other than really understanding where PayPal and Venmo stand, we just don't have much insight as to how these other facets of the business are contributing. I think that's been a big point of contention with a lot of investors, myself included. But folks that I know who cover the business and folks that I talk about the business with, they feel the same way. We want more, we want more information. We may get that. We are seeing a situation here where the CEO, Dan Schulman, is going to be stepping down. Now, he could

be there through the end of the year. I hope, honestly, that he's not. I don't have anything against him. I think he could have done a better job. But the bottom line is the longer that he's there, the more uncertain things are. We know that old saying, the market hates uncertainty. Right now, there's a lot of uncertainty in regard to PayPal and how they're reporting the data and how the business is performing. There's a lot of uncertainty in regard to leadership. If you remember, not all that long ago, they really had these aspirations to build out that quote-unquote super app that could do all sorts of things and you would live your entire financial life in PayPal. Those rarely work out. Most consumers don't want to place all of their

eggs in one basket. As an example, when we saw PayPal touting that they were going to bring stock trading into their platform, it sounds great, it makes for a good headline, but honestly, why? Why would they do that? What can they do to make that experience better than the companies that are already out there doing it? You're talking about something that a lot of other companies out there do very well already. There's no way it's going to be any kind of a meaningful moneymaker for PayPal, so it's wasted resources, wasted time. That was just one example of many little things that they've been doing along the way that I think have taken their attention away from the core business. It's encouraging to see that they're getting back to the core focus of the PayPal app,

the digital wallet, the checkout experience, and really utilizing the strengths of the business in PayPal, Venmo, and Braintree. We may see them trimming this business a long way. There is some word out there that they're thinking about unloading Zoom, the XOOM Zoom, which is that remittance company they acquired several years back. I wish I could tell you why, I wish I could tell you whether that was a good idea or not, but we don't ever get any data regarding how Zoom is performing. That speaks to what I was saying earlier about management just not really giving us as much information as we'd like. But when you take a step back and you look at the actual business itself, again, it generates a ton of cash. It's got this network of 400

million plus users. It's pushing through one plus trillion dollars in volume through its networks. It's got two of the most popular payment platforms of PayPal and Venmo, a tremendous backend and infrastructure provider and Braintree. There are a lot of things going for it, but clearly the sentiment right now on PayPal is very sour. One last question. When you think about owning these stocks through the different periods of volatility, what is your biggest takeaway that you've learned as an investor? Well, I think my biggest takeaway is just that really this is the purpose that the basket serves. The idea from the very get-go is to be able to identify a really big market opportunity

and focus less on trying to pick the winner of that market opportunity and more on trying to pick the winners. Because as often is the case, when we see these large market opportunities, it's not about just one winner. I mean, there are going to be a lot of businesses that succeed, right? It's a rising tide that's going to lift a lot of boats. And so, you know, I remember in the very beginning when I opened up our next-gen super cycle service, the 5G service, and I recommended all four of these companies in that service. This was three years ago, I think. And the time, I remember some people saying, I can't believe you're recommending Visa and MasterCard. Those are dead in the water. The world is moving past those businesses. It's all about fintech and

PayPal and Block and whatnot. I thought, okay, I appreciate what you're saying, but let's remember those businesses hold still a strong position in the value chain. Lo and behold, you fast forward today and MasterCard and Visa are the two businesses that are really holding their own, whereas Block and PayPal are going through some more challenging times. I think really for me, to me, it's really reinforced the purpose of the basket in the first place. It's always fun to identify those bigger market opportunities and then really try to find multiple winners in the space, because that's usually how it shakes out. As always, people on the program may have interest in the stocks they talk about,

and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Willard. Thanks for listening. We'll see you tomorrow.