Motley Fool Hidden Gems Investing - One of these Clouds Is Not Like the Other

Episode Date: October 25, 2023

Alphabet shed $100 billion in market value as it ceded some ground in the cloud competition.  (00:21) Ricky Mulvey and Nick Sciple discuss: - Microsoft’s quarter and focus on Copilot. - If Bing can become more of a competitor to Google search. - Alphabet’s investments in self-driving technology. - The anti-trust suit hanging over Alphabet. Plus, (14:58) Deidre Woollard interviews Vincent Stanley, Patagonia’s Director of Philosophy, about companies that are doing work to help the planet. Companies discussed: MSFT, GOOG, GOOGL, WMT, UL, DANOY, SSU Hosts: Ricky Mulvey, Deidre Woollard Guests: Nick Sciple, Vincent Stanley Producer: Mary Long Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. We've got more than $4 trillion worth of companies to cover, so let's get started. You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by Nick Seipel, live from what appears to be an empty room. Nick, welcome to the show. Great to be here with you, Ricky. As you alluded to, I'm getting ready to move next week. So my whole life is in boxes. There's disarray everywhere, but we'll try to remain clear-headed here for this episode. Yeah, it's a stressful time. Someone who's not having, I would say, a stressful morning, though, is Satya Nadella, the CEO of Microsoft.

Because if it's hard to accelerate a cruise ship, don't tell this tech company. They beat expectations, growing revenue at a 13% clip to $50 billion just in this quarter. Before we dive into the details, what's your big take on it? Just really how remarkable the growth story is for Microsoft. You think about this as a company that's going to turn 50 years old in two years, still delivering the type of growth that it's putting out there into the market. You just laid out there the 13% revenue growth, net income up 27% in the quarter, over $20 billion in free cash flow, buying back a net $4.2 billion in stock, expenses growing at

the slowest rate in seven years. a company that's getting ready to turn 50 years old, you think it would be maturing, you think it might be slowing down a little bit, not the case for Microsoft, and it doesn't look like that's going to be the case really anytime soon. Yeah. The key word I would say of this quarter was co-pilot. We heard about co-pilot applications a little bit more than Activision Blizzard or OpenAI, which is related to co-pilot. But anyway, basically, they're focusing on these applications where they're going to make coding more efficient, they're going to transform productivity. If you've ever sent an e-mail and then seen the rest of the sentence written for

you, that's the co-pilot at work. Also looking to redefine search with Bing, offering more contextual value when you make a search on that platform, if you make a search on that platform. Why is this such a big focus for Microsoft at this moment? Do you think this push is going to be meaningful for its investors? I do think the push is going to be meaningful for investors. Why is Microsoft excited about it really. Microsoft is a technology company and AI is positioned as the next revolution in technology. For that reason alone, it's something that Microsoft should be excited about and getting behind. But more importantly, if you think about Microsoft's core franchise, going all the way back to its founding, it's really been built on technology that enhances

worker productivity. You think about things like Word, Excel, how they've really enhanced what workers are able to get done. Microsoft has been a leader in that space forever and co-pilots really are the next wave of that type of productivity-enhancing software. Just to throw out a couple of stats for you, GitHub Copilot, which helps software developers write code. Microsoft threw out that that has increased developer productivity by 55%. Technology investments like this have led the number of developers on GitHub to increase by 4X since Microsoft acquired the company five years ago. If you remember Steve Ballmer's famous quote from, I don't know, eight, 10 years ago at this point, developers, developers, developers, really the key

to winning for a business like this. On top of that, the productivity gains that Microsoft can deliver to its customers arguably are going to give the company some more pricing power, which is great for any business out there. Starting November 1st, they're going to offer 365 Copilot AI as an add-on for its existing productivity software subscriptions, which is going to become available to large companies. That's going to be charging $30 per month per seat, which that can add up to a really big number if you think about the full scope of Microsoft's customer base. So, really, a new technology offering, which is going to win a really key constituency when you think about developers and also offer the company the

ability to increase price over time, all those things good for investors. Yeah, I think one of the big questions, though, is if this really makes Bing more competitive with the Google search engine. Right now, I'm in the maybe camp, because I think it would be enormously difficult to break the stickiness factor. But in preparing for this segment, I made a couple of the same searches on Google and Bing. And it's essentially, if you're looking for where something is, Google, I think, still has an advantage. If you're looking for how to do something, right now, Bing might have some advantages because it can add that context with the chat GPT. Yeah. We'll talk about the Google

antitrust case maybe a little bit later. When you're getting sued for antitrust, it certainly says that going after that market is challenging for new competitors. I think for me as an investor, more excited about the enterprise-facing offerings here for Microsoft AI than the consumer-facing areas, but never say never when it comes to these new technology innovations, what they can do when it comes to shaking up the current competitive landscape. Well, the real thing investors are excited about at Microsoft is the Cloud, which produced about $32 billion in revenue. This includes Azure and GitHub, as you mentioned. Nick, I really don't have anything smart to say about this other than it seems like

really big companies like using Microsoft Cloud platforms, but anything stand out to you about the Cloud performance here? Well, the thing that's really jumping out to the market this morning is that it appears Microsoft is taking share in the cloud market. The intelligent cloud business as a whole grew 19% in the quarter and Azure itself grew 28% in constant currency, which was an acceleration from the previous quarter. Management expects the company to maintain that same level of growth, 26% to 27% growth for the remainder of the year, with increasing contributions from AI. AI contributed 3% to Azure growth in the quarter versus 2% expected. Think about those big investments Microsoft has made in OpenAI,

that's really leading to increased spending at the cloud business. Those numbers are great, but really even better is when you put it in context with competitors. We'll talk about Google a little bit later. They reported their cloud business grew only 22% off a smaller base than Microsoft's cloud business, really suggests Microsoft is taking share in the cloud market. If you think about the nature of this business, companies have to spend a lot of money, manpower resources in order to move over to the Cloud. Once that happens, it tends to be pretty sticky. The share that Microsoft is taking today, likely to still be there three, five years down the line. One thing we haven't discussed that

Nadella made a quick note of at the end, I think this was a great mic drop, was the Activision deal. That deal is done and Microsoft now has 13 franchises worth a billion dollars or more. Their library includes Call of Duty, Candy Crush, Gears of War, World of Warcraft. I'm not a big video game guy, Nick, but even I know that those are huge. I want to position this with Google, though. Let's say you're starting Nick Seipel's Megacorp over there in Tennessee, and you've got some money to work with. You can either take Microsoft's gaming division or YouTube. Which one are you taking? Well, while the Microsoft gaming division certainly has lots of attractive properties. It's a great business. I think I would take YouTube as

between the two of them. If you think about Microsoft Gaming, well-positioned, but still as a distant second to Sony in console gaming. Also, if you think about the business structure of game development, like lots of other forms of entertainment media, you have to create the entertainment content upfront, spend all that money upfront with an uncertain payout there at the end, depending on how many people end up buying the final product. You contrast that with YouTube, which is by far the leader in its subsegment of user-generated video content. There's really not a Sony to YouTube in their space. And also, they pay nothing upfront for content costs by utilizing user-generated content. You only pay folks on the back end based on how big of a hit

takes place. So, a lot less risk there on the content generation side. And if you look at the two businesses, similar growth profile, Microsoft Gaming in the quarter, which does not include Activision today, because that Activision transaction closed during the quarter, put up about 12% growth. You're looking at a similar growth profile for YouTube. With a better market structure and a similar growth profile, I would prefer to have YouTube. Let's take a deeper dive into Google, though, because YouTube, unfortunately, isn't the big story for this tech giant this quarter. The business shed $100 billion in market value off what seems to be losing a little bit of ground to Microsoft in this cloud division,

still growing that business at a 22% clip. Nick, if you look at that in isolation, that's still pretty good, but we don't look at things in isolation. Is this just a cloud battle story, an expectation story? What am I missing with this? It seems to be mainly being driven by that gap between expectations and reality when it comes to the cloud business. I mentioned those numbers earlier. For Microsoft, you compare those with the 22% growth rate from Google, suggest that Google is losing ground. They are the third place competitor behind Microsoft and Amazon, and it appears that are going to continue to remain in third place. But if you look outside of that cloud business,

overall results came in better than expectations. Revenue was up 11% driven by strong performance in the ad business. The core Google ad business was up 11%. YouTube ads were up 12%, as I mentioned earlier. Operating income up 28% driven by reduced cost. Most notably, employee headcount down over 2% versus the prior year driven by layoffs. If you look at the top line and the earnings numbers really beat expectations, but it's really concerned about the long-term growth trajectory for the Google Cloud business, whether they're going to be able to compete effectively with Microsoft and Amazon. There's a few more developments though outside of this cloud battle, which is that

they took a little bit of a spotlight on, and you take a pick from this menu of what Google talked about. Waymo has 100,000 people on its self-drive waiting list. It's partnering with Walmart for drone deliveries in Dallas. The Cloud AI platform, Duet AI, is partnering with retailers, including Aritzia and Gymshark, to help them gain new insights for better and faster business results. It's also got a new Pixel smartphone that is, quote, the fastest-growing smartphone brand in our top markets. There's your menu. Take your pick. What stands out to you? I'm excited to see what happens with Waymo. They're letting new riders onto the platform in San Francisco, preparing to launch in Austin

as their next market. We've been waiting for self-driving to become an actual market driving real revenue for the longest time, and maybe that's finally getting ready to take place. Other bets still losing, which is the segment that includes Waymo, still reporting a loss of almost $1.2 billion in the quarter. At some point, you'd like to see those other bets actually make money. If Waymo reaches commercialization, perhaps, that's one of the areas where you'll see that. One of their big competitors stubbed their toe this week. Cruise lost their approval from California's autonomous driving regulators in order to operate their vehicles without a driver in the car. One of the big potential competitors

in self-driving having a tough time. Well, it appears Waymo is continuing to expand its offering. It would be nice to see, as I said, some real results from Waymo, and that's an area I'll be watching. Are you getting in a self-driving car? Let's say you're in San Francisco. You can either get an Uber or you can get a Waymo self-driving car. Price is the same. Which one are you getting into? Whichever one gets there picks me up faster. If you think about the safety standard that a self-driving car company would have to have to have this thing operating on the road, I would argue that you're going to have to meet a little bit higher safety standard than maybe your average Uber driver out there on the road. Again, that's not necessarily true. Again,

we just saw what happened with Cruise in California. You can look up the incident there. I think I would be willing to ride in the self-driving car, but I understand why other people might feel differently. Oh, yeah. I mean, you can show me the data, but it still gives me a little bit of the spooks. I want to try it, though. Anyway, there is a cloud hanging over these clouds, Nick, and that is the antitrust suit hanging over Alphabet. The Justice Department says that Google illegally crushed competition by paying companies like Apple to make its search engine the default, making it tough for consumers to switch. Even though you can, you're probably not going to do it. Google says these deals weren't exclusive and users could always change

to their settings. Do you think this argument is enough to break up an alleged monopoly? Well, that's for the courts to decide. We'll see how it plays out. I will hold judgment on whether or not we've got monopolization here, but I think it is worth noting for the less legal savvy folks out here that having a monopoly isn't illegal. It's that practice of monopolization that is. And to prove monopolization, you really have to prove two elements. One, the presence of monopoly power in your relevant market. And then two, is you have to have the willful acquisition or maintenance of that power as distinguished from growth based on having a superior product, business acumen, or a historic accident, right? Think about your natural monopoly. You can say

pretty definitively that the market power, monopoly power element is there. Google has well over 70% market share, which is what many courts have looked at as your prima facie evidence of market power. However, the second element, a lot harder to prove. Courts are alleging that some of these default agreements, particularly with Apple, are anti-competitive. But you can make an argument that there are legitimate business reasons why Apple might choose Google and why Google might seek these agreements that are outside of anti-competitive behavior. It may come down to what prosecutors find in discovery that goes to Google's intent behind reaching those agreements. You mentioned breaking up the monopoly. Even if prosecutors win here,

one question I have is, how do you remedy this? You could pay some damages out to your bings of the world and things like that, but this is a fundamental business service that I don't know how you divide it. This is not an AT&T company where you can divide the Northeast and the Northwest from one another. It's really kind of an individualized service. So I'm not sure how you could break it up to improve the market structure. You could say that maybe this calls for more regulation in the market, but that would entrench the monopoly even deeper. I'm not sure the remedy that the court could create to change the way the market is structured today, but that's not for me to decide. That's for those people in D.C. to figure out. Certainly going to be an

interesting case. One trillion dollar company paying money to another trillion dollar company Sounds like fun. Anyway, glad you don't have to decide this case, but you got to focus on your move. I'll let you get back to it. Nick Seipel, thank you for your time and your insight. Great to be here with you, as always, Rick. In September of 2022, Patagonia made the earth its only shareholder. Deidre Willard talks with Vincent Stanley, Patagonia's Director of Philosophy, about that process, what corporate responsibility looks like today, and some surprising companies doing good work for the planet. You just found out that your sales team is at risk of missing quota.

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Ready to rule your business? Head to rippling.ai slash fool to get the only AI built to give you full visibility and take complex actions across your entire organization. That's r-i-p-p-l-i-n-g dot a-i slash f-o-o-l. Sign up for exclusive access today, rippling.ai slash fool. I wanted to talk a little bit about the big news you had coming out last year where you transferred ownership to the Patagonia Purpose Trust and the Hold Fast Collective. Now that that's been in place for a while, how has the company adjusted? What has it meant for the company so far? And have you seen interest from other companies about this type of structure?

I think it's made surprisingly little difference within the company, except to make life less anxious. You know, we have the owners of the company are older, and so a transition was likely to be in the works. the younger Schoenards were going to inherit the company. And very much, they grew up inside the company. They both work in the company. And they're in accord with its values. So that would have been fine. We're a B Corp. That part of the transition would be fine. But I think just the symbolic power, I mean, we adopted in 2018 a new purpose statement saying we're in business to save

our home planet. I think that was transformative. It interested me that I watched all the team leaders and people on the teams go, what does this mean for me? What does this mean for our work? How do we change the way we make products? How do we change our approach to the customer? I think that that was a natural transition to saying, okay, now the only shareholder is the I mean, we're giving the company stock to a nonprofit, and all of the profits that would have gone to shareholders beyond reinvestment or beyond bonuses to employees is now going to go to environmental causes. So I think that put the structure of the company pretty much in line with its purpose, and

I think that's been successful. So, it hasn't affected the day-to-day work, because Patagonia as a company hasn't changed much. And the governance, it's the same board that we had at Patagonia is now the board at the Purpose Trust. So, the internal changes are not remarkable. So, one of the things Patagonia is known for is repairing garments. and you have repair on your checklist for responsible company behavior. And we're seeing this right to repair movement when it comes to everything from tractors to electronics. Why is the ability to repair things so important? I think when you talk about

sustainability, durability is so key that you want a product for all of the energy that goes into it, All of the resources and all of the waste generated from the creation of a product, you want that product to last as long as possible. And that reduces its negative impact over the life of your product. If something lasts, you know, with fast fashion clothes that are not made very well because they're going to be thrown away after five uses versus a jacket or a sweater that's going to last 10 years, you're prorating that environmental cost over time but if it's not repairable

then you can't use it so for our business particularly for outerwear the biggest repair item is a zipper that will fail before the fabric does so if you make something with a if you make a jacket with a zipper that can't be replaced your the durability goes way down so repairability is key for that reason. And we didn't even have repairability as a major design principle until we started to really work on this idea of the four R's of making things reusable and repairable as well as recyclable at the end of their life. So, you have the updated book, The Future of a Responsible Company. Has your idea of what it means to be responsible changed over time?

No, I do think it has become more concentrated. And I think there's a big difference between doing business now and a decade ago. And that is that the environmental crisis in two ways, one in terms of climate change and also the loss of biodiversity, kind of thinning of the web of life. And also the water crisis, and we're just beginning to grapple with that. The New York Times ran a piece a couple of weeks ago on water withdrawals. So this is really serious. We're losing water in the aquifers, and then a lot of rivers are becoming polluted. So what we have is an environmental crisis that's also creating social disruption and uncertainty. farmers are throwing their hands up in the air because everything they know about when to plant and when to harvest is challenged and has to change not necessarily related to climate change

but certainly business has been through covid and we were just talking about the kinds of readjustments businesses made in the last couple of years so i think the climate for business and the demands on business are very different than they were 10 years ago. And I think at this point, it's really incumbent on us as a sector in society to actually make things that are useful and that help solve the real problems that we have, both environmental and social. And at the very minimum, I think businesses have an obligation to clean up after ourselves, you know, if we're polluting in a certain way or we're generating a certain kind of waste, to not wait for the regulators to come after us, but to change our processes so that we

no longer do those things. So that's the big change, that the urgency of making business a good actor, not just a value-free, profit-producing sector of society or a job-providing sector of society, that we actually have to be good players. Yeah. Sort of building off of that, one of the things on your checklist was that every company needs to consider the earth as a stakeholder. So, you're seeing, it sounds to me like you're seeing some companies do that. What are some examples that you see that are promising or optimistic and hopeful? I think a lot of companies have responded in different ways. Walmart, for the last 15 years, Walmart, I think, is the largest supplier of organic

food in the country. They have done things like figure out how to feed the dairy cows in order to reduce the methane produced. unilever is an interesting example during paul polman's administration of refusing to report quarterly and of i think they did they determined that uh of their 400 brands the 40 40 of them produced half the profits and also a lot of the innovations that would create the business of the future. Danone made its U.S. subsidiary of B Corp, which is one of the largest B Corps in the world. Nike has been an expert at reducing its resource impacts, really making

products with minimal amount of materials. So there are a lot of companies. Not all of them are all considered great players in all ways. But all of those are seriously doing things to reduce their environmental impact. You mentioned B Corp a couple of times. What do you think in general of the B Corp status for publicly traded companies? There aren't too many B Corps that have gone public. Do you expect that this is going to grow over time? I know the the rules for becoming a B Corp and remaining a B Corp, they're strict. And do you think that's a concern? Yes, but what I've seen is more and more large companies are interested in becoming B Corps, particularly internationally. This was a small company movement as little as five years

ago. And I think that's changing. What we found, we became a B Corp and also a California benefit corporation, which is legal status. I think the advantages for us have been the impact assessment, which we borrowed from in the checklist on the future of a responsible company. That impact assessment gives us a holistic look at our practices that we really can't get anywhere else. And also, I think for companies that are trying to do the right thing, it gives them colleagues. It gives them people to call up on the phone and say, hey, we're grappling with this plastics problem, for instance, and what have you found? So I think it's an important movement. Yeah. And it also gives more benchmarks, which I think we need. Yeah. You mentioned plastics.

That is a huge problem that I think so many companies are wrestling with. What is your take on some of the ways the plastics problem can be eased a little bit? I think there are going to be multiple approaches to this. Our biggest plastic problem comes from microfiber pollution. So particularly all fabrics shed microfibers in the laundry. but the problem with nylon and polyester is because they're oil-based they persist in the water so if they get out of your washing machine and into the municipal water system and then flow into the ocean they end up in the stomachs of seabirds and animals we all have like a credit

card's worth of plastic in our bloodstream from all of the plastic waste generated we had an interesting collaboration. I was talking to a group of Samsung executives and mentioned to them this problem. I said, we're considered a great environmental player, but we have our problems too. And this is one of them. And we said, we can't get any washing machine manufacturer to work with us. And they rose to that. And they actually developed a filter that filters out 98% of microfibers. And now their competitors are also trying to come up with the same kind of filter. So that's one approach. We're also working with an NGO in Vancouver on how can municipal water systems also work on the problem. The big issue probably is how do you reduce the

amount of plastic that's generated, and just a tremendous amount of waste from packaging and then from the products themselves. 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 Ricky Mulvey, thanks for listening. We'll be back tomorrow.