Motley Fool Hidden Gems Investing - Live from Denver: The State of Tech Investing

Episode Date: December 16, 2023

The money ain’t flowing like it used to. What’s a tech investor to do?  Earlier this month, Motley Fool Money hosted a live podcast recording and meetup for Fool members. There, Mary Long caught up with Alicia Alfiere, Tim Beyers, and Tim White to discuss: Differences between public markets and the venture scene,  How money can ruin companies, And Tesla’s AI ambitions.  Companies discussed: WMT, AAPL, CRM, CPNG, SNOW, TWLO, DDOG, TSLA Host: Mary Long Guest: Alicia Alfiere, Tim Beyers, Tim White Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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that, which is a weird thing to say, because they used to be the ultimate disrespector of that. But now that they are getting respectful of that, they're in a much better position. And those are the companies that I think will continue to be. I'm Mary Long, and that's Tim Byers, a lead advisor here at The Fool. I caught up with Tim and fellow Fools, Tim White and Alicia Alfieri, in Denver earlier this month for a live member event. At that event, we hosted a roundtable conversation about the state of tech investing. Today, we're sharing with you some snippets from that discussion.

Hope you enjoy, Fools. We've posed this question about whether tech investing is dead. And then last month, all three major stock indexes were up, and the Nasdaq kind of led that charge. It was up 10.7%. Tim White, maybe we start with you. Why are we even asking this question of whether tech investing is dead at all? Sure. In the last couple of years, a lot of the recommendations that we had at The Fool and certainly a lot of the biggest stocks were tech companies. That was because there was this explosion of tech companies trying to be disruptors. I'm doing air quotes for those on the podcast. What those disruptors were trying to do

was completely change a market with technology. And that led to an enormous amount of money flooding into tech companies from both private investors, but also big funds and companies like SoftBank, Tamaha Yoshisan, just dumping money into WeWork and Uber and companies like that. And so valuations skyrocketed. A lot of us put a lot of money in those. That money is not as much as it was back in 2021, for example. So a lot of people have been asking us, is tech investing debt? Should we be putting all of our money back into Exxon and Shell instead of tech companies? And so we wanted to really talk about why it's tough to be a tech company right now and whether we should keep putting our money into tech companies or not.

So the question, the answer to this might be obvious, but Tim and Alicia, let's kick it to you next. Should we keep putting our, is tech investing dead? Should we keep putting our money into those companies? I mean, certainly, but you want to be discerning. But I think one of the features to build on what Tim said. And it's something I heard from a Sequoia Capital managing partner 20 years ago. And Doug Leone, he was the guy at Sequoia for a little while. He's retired now. But he told me straight to my face, he said, money makes companies stupid, And it also makes people stupid. And I think he's right. I think he's exactly right. And so you've had a period for the last, let's say, 20 years before March, was it March 2022 when interest

rates started going up? So right up until that point, you had a period of excess whereby there were a lot of dumb companies. And I frankly should have been a lot more discerning with some of these companies throughout 2020 and early 2021. I frankly just did not internalize that lesson and use it to sort of have a more focused lens in 2021. So it's not dead, but I do think it is important, maybe more important than it's been in a while to be discerning with the kinds of tech companies. And also for that matter, and kick it to you here, what are we talking about when we're talking about a tech company? You could be talking about a company that is a really smart user of technology and is changing their operations fundamentally. So a good example of

out that we could maybe talk a little bit more about later would be Walmart. Walmart's an outstanding user of technology, but would you classify Walmart as a tech company? I wouldn't, and it certainly doesn't get a tech company valuation, but boy, is that a smart user of enterprising software engineering. Yeah. So I'll just add, Tim, I really love your comment that money can make companies stupid. I think we have seen examples of that in the past. I think the benefit of going through this bear market, this difficult time has been that companies have really shifted their focus from growth at any cost to really looking at things that we get excited about, like gaining operational efficiencies, free cash flow, being able to

sustain the business yourself instead of, you know, going after dead. And these are things that are important and will set the companies up for the long term. And I think we've really seen that happen. So. Tim, you mentioned like looking back and feeling as though you weren't as discerning as you would like. Are there companies that any of you have watched over this period of, let's say, the last maybe four years and get a bit of variety in there that have been discerning even when all others were not. And that did a really good job of managing their cash and kind of were able to read the moment for what it was. Sure. I'll go first and I'll say Apple, 100%. Apple just did not go crazy. They just kept doing

what they were doing. Pretty much, if you looked back at what they did, you'd had no idea what was happening in the world based on what Apple was doing. I mean, I would say there are companies of the ones that I followed, there are companies that have learned the lesson and maybe some that have learned the lesson a little earlier. I wish that Salesforce had learned the lesson a little bit earlier, but I will say they did it in two stages. The first thing they stopped was acquisitions at scale. And then once they stopped that and really started focusing, they have for, I would say the last year have been the poster company for 2023 is the year of operational efficiency. They have crushed it. It's really been impressive to see the transformation.

Because usually that does not happen. It usually requires, it's a little bit like, I mean, I don't want to get too sports ball here, but usually what ends up happening is you switch the coach. And then once you switch the coach, you get a new style of play and that new style play leads you into something new and different. So, you would expect that what ends up happening is, well, Mark Benioff's got to go and we need somebody else to come in and do that. But that's not been the case. Being able to internalize that and then turn it around has been impressive to watch. Well, and sometimes I think you need almost like an inciting incident to get some companies to change their strategy, right?

We saw recently with Coupang, so previously burning cash, they had some difficulties with the bear market, their share price went down, and they started really refocusing, shifting their strategy, and for the last, I think it was four quarters, they actually generated cash for the first time, which was pretty exciting. But sometimes they need that inciting incident to get them started. So the second half of that lengthy, detailed title that I listed off is Until Interest Rates Drop. And so the Fed still meets again this year. There's a number of expectations about what will happen then.

How do you view this moment going forward? I'm not asking you to say whether the Fed is going to cut rates or whether they're going to stay. We can kind of stay away from that. But assuming that this is like peak of the interest rate hike period, what are your expectations moving forward? Is there really a question of or a worry of potential death down the road for certain companies, for certain industries, what have you? Or is this actually more of a buying opportunity where we're going to know which companies are able to handle their cash and in an environment where money is not as free flowing and it's harder to come by? I'm going to give you an answer you're going to hate. Yay.

But it's true because two things can be true at the same time. So the answer is yes. Will you see deaths? Yep. Will you see opportunities? Yep. Both things can be true. And here's the problem is that, and we were talking about this yesterday, the cost of capital has gone up. It's gone up significantly. And that is important. So let's talk about what we mean when we talk about the cost of capital. The cost of capital is you have the cost of debt and you have the cost of equity. And a lot of companies, particularly in the tech sector, use a lot of equity. I mean, you've probably heard us talk about it. If you listen to Motley Fool Live, you've probably had... I hate to do this in an audio program, Mary, so I'm sorry. Oh, no.

But we're going to get a show of hands. How many times have you heard us talking about, you know the phrase I'm going to use, right? Stock-based compensation. How many times have you heard us talking about this? How many hands? Basically, everyone. Yeah, let the record show there are a number of hands. A number of hands in the air.

And so, when you're doing that, right? So, if you are a company, if you're a tech company that is using the most expensive capital that you can use to grow, which is equity. Equity is far more expensive than debt. Then the pressure on those companies to grow and grow quickly in order to outperform the cost of the expensive capital they're using is extreme. And that puts a lot of pressure on these companies. So what do you do in that situation? Well, there's a couple of things you could do. One of them is you could ratchet down your growth plans a little bit. And that is something we've seen. We've seen reductions in forecasts. We've seen that. We've also seen some real focus on levering down your costs. We've seen that too,

lowering your debt exposure. So there's lots of things you could do. But in an environment, even if interest rates freeze where they are right now, the cost of capital is still elevated. So the pressure is still on. It hasn't gone away. It's just a little bit less than it used to be. Ultimately, though, I feel like I'm ranting. I'm not trying to rant. What I'm saying is that the cost of capital is elevated. It's going to stay elevated. So companies that are respectful of that. So I just gave you Salesforce as an example of a company that is respectful of that, which is a weird thing to say because they used to be the ultimate disrespector of that. But now that they are getting respectful of that, they're in a much better position. And those are the companies that I think will continue to be in a good position.

And I think the thing to think about is that not only is the cost of capital high, but As an investor, you can put your money in things that give you 5% to 7% interest right now with no risk, right? Whereas equity investing has risk. So as soon as those interest rates go down, people are looking for a place to put their money that's getting that type of return, even if it has a little more risk. Right now, part of the reason money gets sucked out of the market is there's safer places to put it than equities.

And so part of the reason you've seen a raise recently is people are predicting if interest rates go down, they're going to need to get in now while prices are low on these equities before they start skyrocketing. Money starts flowing into the equity market. When money flows in, that's when equity prices start to rise, right? Yeah. Yeah. Well, and I would say, too, that as we've had this difficult time in the tech market, you have had valuations go down. And if you do have a company that's shifting their focus, doing the things that they should be doing with the valuation being down, it could be an opportunity. It really depends on the company, though. You always have to exercise caution. You just found out that your sales team is at

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but there's been a number of private companies that have filed for bankruptcy that previously were just flush with cash. And so how do the private markets look to whatever eye you have into that? How do private markets, venture markets look right now compared to what we're seeing play out publicly? It's terrifying. I really would not want to be an investor, in particular, in late stage private market tech because the valuations got... So that's an illiquid market, right? That's an illiquid market. And so, the valuations don't reset easily. And usually, I mean, I know I'm oversimplifying here, but in the private market, a private company valuation is essentially a handshake agreement. What do you want to sell me your

equity at? I would like a pre-money valuation of $150 million. Will you take that? No. How about 125. And it ends up being a handshake agreement. And then you have investors who pile in around that pre-money and post-money valuation. And so resetting is like new rounds of money. And nobody wants to go through what's called a down round. In other words, I have to raise more money because I burned a bunch of cash, but I can't raise it. So let's say I had a $10 billion private market valuation. I need to raise more money. And in order to raise more money to attract venture capitalists, they're not going to give me a $10 billion valuation. At most, they're going to pay $7 billion. That's what they're going to value me at. And if I want money, I'm going to

have to mark my equity down. Guess who hates that? The existing investors. Everybody who's already in. So I think because those valuations and it's in a liquid market is so extreme that it means that, man, see, it led me into a downer. But I think the positive side of this is the IPO market for 2024 in tech is probably not going to thaw very much. Probably not. Having said that, I do think there's going to be a real opportunity in public market tech. Right. For companies that haven't been saddled with all this expensive private money where You've got multiple VC firms competing to see who can give you the most money. And then they end up valuing it, a company that is way more than it actually is worth.

And it can't go public because there's not an appetite for very expensive IPOs anymore. So that environment means that you're going to have to have companies that are wait for an appetite for expensive IPOs again, which will probably happen. It happened. It happened in 2000. It happened in 2020. Right. So that could happen or they have to figure out some way to get those investors to let go before they go public. Yeah. And it'll it'll it'll probably to your to your question, Mary, you'll probably that's where you're going to see some companies heartbreakingly are going to go away because venture the way venture investors tend not to just kill companies. what they do is they tend to neglect companies. Those companies tend to raise more money. They need more capital. The VCs say, sorry, you're on your own. Then that ends into a slow descent into the ditch. Like I said, the good news here is that vertical software companies, we've talked

about vertical software companies, for example, small cap tech where it's not saddled with the same anchor, that is probably a pretty decent opportunity, honestly. And it probably outperforms private market tech for the next three to five years. And that's not me saying that. That was a partner at Benchmark that said that on Patrick O'Shaughnessy's podcast, Invest Like the Best, which is a really good one. Well, and two, I think just to add some context, There is still venture capital activity happening. No question. It's just a lot lighter than it has been in the past.

And there still has been a fair amount of money being filtered to healthcare, for example, and also what we're going to talk about, I think, later, AI. So, a fair amount of money there. Yeah. And to be clear, early stage venture investing is still as robust as it ever has been. But that late stage, because there were a lot of people. It was basically arbitrage. Late stage, lots of venture investors, angel investors piling in saying, so let me give you an example. I want to get in on Snowflake before it goes public and get

the best deal possible. So people just piling in at a valuation that was just extreme, knowing that when it came out, it would come out at an even more extreme valuation. And that's just not true anymore. But at the seed stage, yes, it's still very vibrant, and there's a lot of money flowing in. After talking about artificial intelligence and making some reckless predictions about the future of tech in Colorado, we handed the mic to audience members so that the Tims and Alicia could answer questions about Twilio, Datadog, and Tesla. Yeah, hi, my name's Carl Kolesnikoff, and I wanted to ask you specifically about Twilio, and does Twilio fit into that same situation that sales force was in with regards to how they've managed their money over time

we wish that was the case yeah we really do i mean i'll start here and then either either of you kick in here so thanks carl um they just did a a five percent layoff and i think that the lousy thing is it's been a bit of a drip, drip, drip. And I've been waiting for them to get past the point where they have stabilized the business such that there's no more drip, drip, drip. And yet here we are just again this week with another 5% layoff. And if you can, And I would encourage you, the SEC has all of the filings and there's an 8K, I think from Thursday. And in that 8K is Jeff Lawson, who's a CEO and co-founder, his letter to employees about

this layoff. And in it, what it says is that they couldn't figure out, go to market for the new product, the segment product. They just weren't getting enough uptake on it. And so they've gone back to selling the newer products by bundling it with the old product, the communications product, which makes sense. So it means that there are salespeople that they hired in order to sell Segment, the new product. Those people are getting laid off.

They had engineers and support staff to support Segment. Those people are getting laid off. So, I want so badly, because I own so much Twilio, I want them so badly to figure this out, but I just can't tell you that they have figured this out yet, but I'm hoping, because the core technology is still very good, and I mean, tons of people still use it. So anything you want to add? I will say that they did have a similar story where they did a lot of acquisitions, right? Denver-based SendGrid, Denver-located Segment, right?

A lot of businesses they bought, they've paused all that, and they're still trying to figure out how to integrate it now, which is good news. But integrating acquisitions is extremely difficult. It's very hard. And so it's something they've really struggled with. So, I think maybe next year, ask us again, Carl, where we're at with that. And hopefully, it'll be a better answer. Yeah. Every quarter, here's what I'm looking for.

Like, if we could get through two quarters of stabilized no layoffs and then some improvements that show up in rising operating margins. And so, you actually don't have to scale up your sales and marketing spend in order to grow your revenue number. and that shows up as improved operating margins, that'd be a great sign. That would really be something I'd love to see. And I think the stock would respond if they did that. Now it's on the record, so we can't have someone check back in a year from now. Well, we make predictions every single week, and we regularly revisit them and go, ha-ha, we had it.

But most of the time, we're like, what were we thinking? Yeah, right. But the advantage of making predictions every week is it keeps you thinking about the future, and that is important. Even though Datadog is not headquartered here in Colorado, they have an office just around the corner. So, you know, it seems like, and I have a daughter that has worked there, and I'm just curious, you know, are they the type of company, they keep adding more of these modules, and is their future bright? Do you want to start? So, I'm just going to say what I talked about, proceed license cost optimization applies to Datadog.

I do believe that they will be subject to some headwinds there because it is a very expensive product. And as you said, they're always adding modules, which makes the product more expensive for companies. And open source tech, which Tim and I talk about a lot about competing with this in the case of open telemetry and some other open source bits, are competing with Datadog in a way they weren't three years ago. So I do think that there are some headwinds there. On the other hand, Datadog has a lot of very happy customers. and I use it literally every day in my job to try to figure out what's going on with our tech. So I think it's a great product.

I think that they've got a good strategy. I think they've kept their costs reasonable and there's still a lot of SBC, but generally kept things reasonable. So I think their future is bright, but there may be some pivots in order to deal with some of this SaaS headwinds. I think that's exactly right.

And they've been open about this, Tim. I mean, they have said that we have a lot of customers that are coming to us and they are quite literally, they use the term cost optimization in the earnings calls. So they have customers who are coming and saying like, this bill is too big, we need to find ways to cut it. And so that is cutting into the growth a little bit. So I think that is fair and expected. And it would be weird if that wasn't happening, especially with the assault of open source on this, like open telemetry is a pretty darn good product. So now having said that, man, they are delivering, like they are growing their customer

base. And for the existing customers that have actually committed to Datadog, they're growing their usage slower than they used to, certainly, but they're still growing their usage over time, which is great to see. You don't mind, at least if you're me, I don't mind when a company that comes under increased competitive pressure or you run into economic headwinds and the CIO says, hey, you know what, Tim, I see this bill. This bill is 800 grand. I need you to get it down to 600 grand. And then Tim says, well, there's no, here's the good thing that I take from it. It says, there's zero chance that I am unplugging this, so I'll get it to 600 grand. That's a good sign. Right. It's still solving a migraine level problem. It just may be that I don't want to pay

that much for the aspirin. Exactly. Exactly. So that's why I still own it and still really like it. My name is Vinay Bhawalkar. Hi, Vinay. We talked so much about AI, but we didn't talk about Tesla. That's true. So can you complete the story? Do you want us to talk about Tesla's AI ambitions specifically? Sure. So again, Elon, a big investor in OpenAI in the beginning and wanted to run it himself as he does all things and really wanted to push for it. And he could never convince the OpenAI board and Sam to build the AI that he wanted. And in the same way that he wants to make Twitter the way he wants to make it, right? So he's built his own. He's got a lot of money raised for it. He'll probably raise a lot more to build an alternative AI. And I think

this plays exactly into what Tim was saying about when you have a big free tier, you're competing zero dollars for everybody. There's no switching costs. I can try one today, a different one tomorrow, another one the third day, and I can use all of them. And what you often see software developers do is play this game of, I will use until I hit the free tier so they don't have to pay again. And they just keep going sideways and using as many as possible. So are there going to be people who love Tesla's AI and use it? I'm sure. On the other hand, it's an incredibly competitive landscape. So I don't expect them to be a crusher right away out the gate. Having said that, I'll take a sidestep of that, a different version of what Tim just said,

because I agree with all of that. The other piece of it though, is that if you were to think about the best datasets for AI that exist in the world today, it would be very difficult to think of a better dataset than is in possession at Tesla. It's an astounding dataset because of all of the miles driven by Teslas and all of the monitoring that they have done. Now, I need to qualify that and say, they haven't used that data set yet to get to full self-driving. And I think that is a problem of... I don't know exactly what the problem is there. But in terms of software engineering, I think one of the things we know, and Tim knows this better than I do, it is very difficult to create a perfect product.

you still end up with errors that appear out of absolutely nowhere. And the consequences of an unknown error in full self-driving are just unthinkable. You just can't have them. And so, because of that, even though the data set is absolutely astounding, and I think the AI that's built around that data set is incredible and probably is going to deliver lots of really amazing things, it's not clear to me, Vinay, that it can deliver full self-driving in the way that I know Tesla is promising it will. That said, a lot of extremely talented engineers between Tesla and SpaceX. 100%. Yeah. 100%. I mean, we kind of touched on this before. I think autonomous driving, full self-driving is a lot more complex than people realized,

right? Not only do you have all of these different kinds of roads to worry about, you have something that I think a computer would have a hard time figuring out. That is, you know, human drivers to have to interact with, right? Like that's the most dangerous part of getting to autonomous driving is the part where it's humans and computers on the road. Yeah. And when you have to deal with multiple variables like that, you're dealing with a computing problem that may in fact be ideal for quantum computing. At our Denver meetup, we collected stock pitch ideas from members, some of which we're planning to play on future shows. But we want to hear your ideas too. If you've got a stock you think

we should look at, tell us why. Give us a call at 703-254-1445 and leave us a voicemail to pitch us on the companies you're eyeing or would just like to hear more about on the show. 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 Mary Long. Thanks for listening. We'll see you tomorrow.