Motley Fool Hidden Gems Investing - Is Buffett Targeting This Bank?

Episode Date: March 14, 2023

Just because the "Oracle of Omaha" has been quiet lately doesn't mean he isn't sizing up his next big buy. (0:21) Bill Mann discusses: - The latest CPI numbers and the current state of play in the banking industry - One bank that fits the description of something Warren Buffett might be interested in - Meta Platforms announcing another round of layoffs (14:58) Sanmeet Deo and Tim Beyers face off against one another with stocks they believe are a better buy right now. Companies discussed: FRC, SCHW, SIVB, PNC, META, XPOF, MNDY Host: Chris Hill Guests: Bill Mann, Sanmeet Deo, Tim Beyers Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. meta platforms is back in the headlines and our version of march madness continues motley fool money starts now i'm chris hill joining me in studio motley fool senior analyst bill man Thanks for being here. Always a delight to see you, Chris. To lay eyes on you. Particularly on a day when the sun is shining, at least here in Alexandria, Virginia. And on Wall Street, everything is awesome. Everything's up. No bank failures. First Republic shares up big. Charles Schwab bouncing back up. We got the CPI number, which I think was kind of a Goldilocks

number, right? Consumer price index up 0.4% month over month, up 6% year over year. So, look, if you want to look at it and say, well, it's still going up, you can do that. If you want to say, hey, it's the slowest growth since September 2021, you can do that, too. All we needed to do on this hillbilly pirate ship is just have a couple of banks walk the plank, apparently, and then everything is fine. Where do you think we are right now? I mean, part of me, as someone who does not own shares of any of these companies, any of these banks, I look at all of this, and just as someone who is rooting for the general health of the underlying economy and the market in general, I got to be honest, this morning as things were

playing out shortly after the market opened, I thought to myself, is this the scene in the horror movie where the idiot says, oh, everything's fine? I don't know. You're more experienced. Let's hide behind these chainsaws. Right. You're more experienced and knowledgeable about this than I am. So, I guess one of my questions is, what are you watching for next? You know, it's really hard to say, because we are in one of those periods of time. By the way, I just had this vision pop into my mind of you being Rob Lowe wearing the NFL hat at the game. Like, let's just hope both teams have fun. Let's just hope everything's great. I want to focus on Silicon Valley Bank as opposed to the two crypto banks, because the two crypto

banks are an entirely different situation. But we are coming out of a period now, and the Fed has made a move, and it's essentially helping other banks protect their balance sheets. Now, you might ask, as I have asked, why banks need to have their balance sheets protected. And it's because they got too clever at the wrong time, and they got caught out. And so, they left themselves no real outlet by virtue of buying a bunch of assets that had long durations, which meant that it removed some of their ability to be nimble at a time at which interest rates were going up quick. So, that required some nimbleness. So, we have known that Silicon Valley Bank was functionally insolvent since November, at least. But for banks, functional insolvency and actual insolvency

is a liquidity issue, right? So, I'm not saying it doesn't matter. What I'm saying is that there was a lot of risk that was being built in, and all you needed was a lit match. So, that lit match happened. We experienced one lit match, and this was the result. So, we are still in a situation where a lot of banks have balance sheets where there's a mismatch between their deposits and the amount and the kind of assets that they're holding. And it's not good, but I think it also probably calls into question any further tightening at the moment by the Federal Reserve. Let me go back to something you just said, which is Silicon Valley Bank has been functionally insolvent since sometime last fall. Let's pretend to go back in time on a financial

television network, imagine there is a bull and a bear sitting on the set talking about SVB, and the bear says, hey, they're functionally insolvent. What does the bull say in response to that? Because I've heard versions of what you just said a couple of times over the last 48 hours, and as someone who has never looked at that stock and seriously considered it for my portfolio, that's a question I'm like, well, wait a minute, what's the response to, hey, they're functionally insolvent. It's incredible that you asked that question because this actually happened. And we're not planning this, by the way. That was a follow-up question because it came up in September after the quarter that ended September 30th. And the

chief financial officer of Silicon Valley Bank said, there are no implications for Silicon Valley Bank because, as we said in our Q3 earnings call, we do not intend to sell our held-to-maturity securities, which is, in fact, true, because you don't want banks to have to respond to what you might fancily call quotational risk, right? You don't want them to have to respond to things that are volatile. But the thing that has happened with Silicon Valley Bank, and up until the Fed came in and started big footing around, there were a bunch of other banks that were in the same boat, is that it was a quotational risk that was only getting worse. And I don't understand why local regulators weren't whispering to Silicon Valley Bank and

all these other banks, it's great that you're holding these securities till maturity, or you believe that you will, you still need to raise capital. Let me go to the part of this story that has nothing to do with the securities that SVB was holding. And it's the part of the story that I think unnerves people to varying degrees. And I think that's reasonable that they would be unnerved. And it is the speed with which this all unfolded last week, which I think caught even experienced market observers by surprise. Part of that was social media. Part of that is someone as influential as Peter Thiel coming out and saying, pull your money out of this bank. And I think that's part of what leads to what we saw yesterday with First Republic and Charles

Schwab and what could potentially happen with other regional banks, which is to say, hey, regardless of what this bank is invested in, what's to stop this from happening? What What is to stop a run on, I don't want to say any bank, but lots of banks? Yeah, exactly. I want to be sure that I make clear that some of the things that I'm saying, I have in deep conflict, right? That what we have created is a moral hazard. And so, as I answer this question, I want all of our dozens of listeners to recognize the fact that I'm not, what I'm about to say is not a panacea, right? there are issues always. But there's that old quip, like, how'd you go bankrupt? Well,

slowly and then all at once. You have to remember that the banking system in this country, really in every country, but banking regulations in the U.S. are meant to hold depositors mainly harmless. That's to say that you don't want to require depositors to get really sophisticated to figure out if the bank they're putting their money in is going to fail, right? And we can agree that there are definite downsides and moral hazards to that, but that is a basic principle. So, when you had a big, not huge, but a big mid-level bank like Silicon Valley go suddenly get a deposit, a run on its deposits, you have to ask yourself as a depositor at any other institution, because your deposits are not risk assets for you, right? That is cash mainly. You have to ask

yourself, what is the benefit of holding out and seeing if everything is okay, right? And so, there is very much a psychological phenomenon around bank runs that it can't really be anticipated, right? Again, like I said earlier, we've known for a long while that plenty of banks were functionally insolvent. And that sounds bad, and it kind of is, but it's not necessarily determinative for what's going to happen to the bank. But when you have a bank run, that is determinative. That's going to take the bank down because those assets are what are backing the loans that the bank is making and is capable of making. I said on yesterday's show, the big banks sure have been quiet lately.

You know who else has been quiet lately? Warren Buffett. Warren Buffett's been very quiet lately, and I'm not asking you to read his mind, but I am wondering what you think he thinks. Look, there have been times in the past where everything that has happened in the last, let's just call it six days, has been prelude to Warren Buffett stepping in and saying, hey, I've got an announcement. This looks like a great house fire. Yeah. What a coincidence. I've got this big old hose and a lot of water. That's exactly right. Well, the big banks have been quiet, at least in the main,

because they were the ones that stood to benefit the most. If you have to worry about the security of your deposits, what are you going to do? You're going to put them with J.P. Morgan. I mean, that's just logical. As for Warren Buffett, I think, and let's be frank, there's a cottage industry trying to figure out what Warren Buffett is buying and selling, and they're almost always wrong. And yet I'm going to play a little bit, right? I think that Warren Buffett is going after some of the very stable, great franchise mid-level banks. And if I had to name one that he would be buying, it would be PNC because it is a big enough bank at a $54 billion market cap that he is able to get some exposure to it. And it was one of the largest of the banks that were kind of thrown into

that trough of, well, this one might not be safe. And look, I don't know that PNC in a Wild West environment was safe, but I'm pretty sure that it was at the top of the list of institutions that the Federal Reserve was looking to protect at the point in time in which it made the decisions that it did to backstop the deposits for these banks. We're going to go completely away from banks to meta-platforms. There's some whiplash. For the second time this calendar year, I think I have that right, or maybe it was late last year, but for the second time in the recent past, Mark Zuckerberg announced layoffs at meta platforms, 10,000 employees, shares of meta are up 6% today. And year to date, the stock is up just over 50%. And this seems to be, at least

among some on Wall Street, a recognition that Mark Zuckerberg appears to be very serious about the underlying profitability of the business coming on the heels of a year or two when he was looking to spend money on the metaverse. But I'm wondering what you think about that and what you think about the fact that he's taking this approach as opposed to the approach that some leaders like to take, which is, if we're going to have layoffs, we just want to do it once. Yeah, I think that obviously that is a principle, particularly with smaller companies that you would want to embrace. Meta is a bellwether company, so I don't know that they have the same downside as a company that smaller companies do. I think Mark Zuckerberg, and by the way, there is always a little bit of a tension in between shareholders and employees in this situation.

So, when you're talking about shareholders saying this is a good idea, let's put a pin in the fact that there are 10,000 people who are losing their jobs, and that is not awesome for them. So, I don't want to belittle that experience at all. Not at all. Layoffs are horrible. They're absolutely horrible to the people who participate in them. They're horrible at the companies. So, the principle of laying off once matters. But Mark Zuckerberg does deserve credit for being early in recognizing that capital efficiency

matters and that we have moved from an age of excess, and that's what zero interest rate debt basically is. Just throw stuff at the wall. We are no longer at a throw stuff at the wall stage. And Meta, as big of a company as it is, doesn't really get credit for just trying things in this kind of environment. It's too expensive. And so I really do give him credit for saying leaner is better, that we are being very data-driven about what it is we're doing and who is doing it, and how they are doing it to get to the point where we are a better company for all of the constituencies, including our remaining employees. Bill Mann, thanks for being here. Hey, thanks, Chris.

The quarterfinals of our March Madness continues this week. If you missed yesterday's show, we've got analysts facing off against one another, pitching a stock that they believe is a better buy than the other analyst stock. In a segment that originally aired on the morning show of our live stream for Motley Fool members, Sanmideo has a fast-rising fitness stock going up against Tim Byers Rule Breaker. Our second match of the first round of March Madness gets started. We have Tim Byers and Sandmeet Deo, one stock each that they're pitching. Tim Byers, six minutes is yours to get started. Six minutes, six signs.

Monday.com is a rule breaker. So let's go through the, if you don't know the six signs of a rule breaker, we're going to go through it right now. The ticker is M-N-D-Y, Monday.com. Monday.com is the top dog. So top dog or first mover. that's the first sign of a rule breaker. Top dog and first mover, sustainable advantage, past price appreciation, good management, strong consumer appeal, overvalued according to the

media. So, top dog. Monday.com is the top dog in low-code productivity software. The number two, I would argue here, is either Atlassian, Asana, or arguably Airtable. I would say Airtable is the closest comparable here. Airtable was founded in 2013. Monday.com founded in 2012. So Monday was the innovator here. But there are some differences between all of these. And Monday, just to be very brief about this, we can move on to the next sign. This is the one that's not laying people off. This is the one that's getting more operationally efficient. This is the one that has serious insider ownership, sustainable advantage. that's number two second sign of a rule breaker sustainable advantage here

is what monday.com calls big brain and big brain is if you can imagine this every employee at monday.com has a tv like the average tvs in the monday.com headquarters this blew my hair back it's like 1.1 per employee and the reason for that is all of the data all of the statistics that matter to driving the business is available to every single employee at their fingertips, right up on the screen, right where they work. They developed BigBrain internally. It's a BI system. I'm not going to go too far in the details because I don't have time, but there's an obsession with numbers and it shows up in the numbers. So let's keep going. Past price appreciation over the past six months, this company has done very well. So

is it beating the market for right now? Over the past six months, the stock is up 15.6%. I'm going to say, going back to November 2022, I wish you could get the price that we got in cloud disruptors back in November 2022, when everybody had left this thing for dead. You can't, but it's up 77% this then. It's throttling the market because it's performing. So, that's sign number three of a rule breaker. Number four, good management. Roy Mann and Aaron Zinnen are the co-CEOs and co-founders, and combined, they own roughly 18%, actually, let's call it 17% of the shares outstanding.

Companies based in Israel, they still operate out of Israel, but they're co-CEOs, and they've been brilliant as co-CEOs, and they have a huge stake in the business. So good management. Another sign that goes with this is smart backing. So just going to Crunchbase and giving you some backup here. Here are some backers of the company early on. Salesforce Ventures, Sapphire Ventures, Hamilton Lane, Ion Crossover Partners, Harbor Vest, Insight Partners, Entree Capital. Zoom was a buyer of shares at one point, their venture capital arm. They don't have premier like Sequoia Capital names, but they have some serious backers at this company. Let's keep going so I don't run out of time here. Good, strong consumer appeal. Consumer, I'd say maybe, but there's

certainly strong brand appeal here. If you look at the brands that are known in low-code productivity software, there's really two that people know. They know Airtable because Airtable has been around for a while. And they know monday.com because you can admit it, you have seen the annoying commercials. You've seen them many, many, many times. But here's the thing that's interesting. You know what you don't see? You don't see them anymore because they built that, they seeded that ground, and they've since pulled back on that. And I'm going to move to the last one here, which is overvalued, according to the media, could face slower growth, stay away. When was this? November of 2022. What has happened since? The stock is up 77%,

roughly 77% since then. And here's the reason why, friends. I'm going to show you this. I don't want to give you just a data dump on numbers, because that would be silly. But I do want to show you just here is some key metrics, some key data. The thing I only want you to focus on is take a look at this. This is operating income per employee. Look at how that has improved. We've gone from negative 52,000 to negative 6,500. The employee headcount has gone up. The competitors are firing people. 130% in net dollar retention with their core customers, especially the ones that spend the most that's those are really good signs a rule of 40 just very quickly and then i'm going to pause i don't know how much time i've got left i'm out you know what i'm out those are the statistics

we're done out of time you don't get the last statistics i already did the statistics i already did the statistics they're they're done all right you can ask me about rule of 40 later possibly San Mateo, you've got a more health and fitness-related stock for your pitch. Six minutes is yours. All right. Well, hey, Fools. So, I am bringing to you a potential rule breaker, a potential new entrant to the Motley Fool universe, because it's not in it, and a diversified way to invest in the omni-channel

fitness industry. Exponential Fitness is the name of the company, ticker XPOF. This is a diversified way to invest in the fitness industry. It operates in a very large and growing U.S. boutique fitness industry. Its estimated size of 2023 is $24 billion, projected to grow about 5.3% from 2023 to 2025. Basically, their small retail studio is about 1,500 to 2,000 square feet in size, with small class-based fitness providing community in an energetic and engaging format. Some of the highlights of the company.

It's 10 brands spanning different fitness modalities from Pilates, yoga, cycling, rowing, bar, boxing. You may have heard of some of the names, Club Pilates, Pure Bar, Rumble Boxing, and so forth. They have about 2,600-plus global studios, and they've grown that 26% over the past five years. They have 5,400% global licenses sold. They're franchisors, so they're selling licenses to potential franchisees that will open. These are contracted licenses to open their studios. They have about 590,000 members as of the end of 2021. As of about January, they've grown that to even above 600,000. They have over a billion in system-wide sales. That is sales across the whole franchise unit. They're much larger than all the competing brands in the

boutique fitness space. They have a very experienced management team that has been together for a very long time. Another thing, when you're looking at a franchisor, you want to know, is it compelling to the franchisees? This concept has great unit economics. You put in about $350,000 for initial investment. It takes about six to 12 months to ramp. By year two, you can average about $500,000 in sales at 25% to 30% operating margins for the franchisee. This gives you about a 40% cash-on-cash return. How is it going to grow? Well, they're going to grow franchise studios across North America. They think they have the potential for 8,000 in the U.S. alone. They're going to grow internationally. They have the potential to 3.5X their current size. They have 16 countries in

contract in place. They're growing through master franchise agreements, meaning they license to one big entity that will open up multiple studios. This provides them high margin flow through to the company because they're not opening up the studios and taking on the cost. They're going to drive average unit volume, meaning the sales of each store, through customer acquisitions, partnerships. They have a program called XPAS, which is similar to ClassPass, but just for their brands. X+, which is their digital offering. They're going to have margin expansion opportunities through higher royalties off of their average unit volume sales growth, increasing the royalty rates. They're currently at 7%. Their popular, more mature brand, Club Pilates, is at 8%.

That's something that they could potentially grow to for future studios, future brands. Higher-margin international growth will drive margin expansion. Their partnership revenue is very unique because they actually get paid for partnerships that they're doing, for example, with LG having their X Plus digital offering in TVs, Princess Cruises having studios and classes for cruise members, and then signing them up as they leave the cruise. lots of cool partnerships that they're doing to drive customer traffic that's unique from just doing Facebook ads and Google ads. They're going to expand into more fitness, maybe more wellness-type modalities. They have a brand called Stretch Lab, which is essentially just

helping you stretch. Sounds silly, but it works and it's growing very quickly. That's a concept in wellness, which is an area that they can expand into. Really quickly, taking a look at the valuation, as I modeled it with relatively conservative estimates of about, over the next five years, 14% revenue growth, about 21% average EBITDA growth, which is in line with the management's estimates of 20% to 25%, and about 40% adjusted EBITDA margins, which they think they can reasonably achieve through some of the things I told you about. They're currently trading about 11X enterprise value to EBITDA for the 2025 year. If you look at Planet Fitness, currently, they're about 16 times. Similar

fitness franchisors, growing quite large, similar margins, they're about 40%. But their revenue EBITDA growth is not as fast as exponential. I think this is a very interesting concept. It's a franchisor, asset-light, high potential for margin expansion, strong growth, trading a pretty reasonable valuation, given other fitness concepts. 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 Chris Hill. Thanks for listening! We'll see you tomorrow! Thank you.