Motley Fool Hidden Gems Investing - Owning the Operating System

Starting point is 00:00:00 Emily Flippen The edge in the stock market may be increasingly going to the companies that own the operating layer, not the brand. We're reflecting on three examples of this today on Motley Fool Money. Today is Tuesday, January 27th. Welcome to Motley Fool Money. I'm your host, Emily Flippen, and today I'm joined by Fool analyst Jason Hall and Asit Sharma to discuss the power of owning the operating system underlying our everyday lives. Today, we'll be discussing how restaurants are integrating tech improvements to improve throughput, as well as a unique deal between USA Rare Earth and the government, and how that shows the strategic importance of resources.

Starting point is 00:00:44 But first, we have to start with the recent, but arguably not surprising news out yesterday, that CoreWeave is getting yet even more support from NVIDIA via a $2 billion infrastructure investment. Now, CoreWeave shares were up more than 10% yesterday after NVIDIA bought $2 billion worth of stock at a share price of around $87, a discount of around 6.5% compared to Friday's clothing price. Now, this isn't really a big surprise. I mean, NVIDIA's already been backing CoreWeave because CoreWeave does build and rent the data centers for AI usage that obviously uses NVIDIA chips to run. And NVIDIA does have agreements with CoreWeave to buy unsold data center capacity over the course of the next six or so years. But Jason, when you look at this deal,

Starting point is 00:01:25 is NVIDIA justified by the investment? I mean, they said they're working with CoreWeave to, quote, meet extraordinary demand for NVIDIA AI factories and that the investment will help accelerate its build-out of five gigawatts of AI factories by 2030. But critics obviously were concerned. Some noted that it felt like NVIDIA was bailing out CoreWeave because they're arguably running out of cash and, you know, saddled with debt. So, what's your read of this deal? So, I mean, this can be both investing in the company and propping it up. And I think it probably is. And I'll talk about that why, but before I get to it, I just want to point out that it's important as individual investors, we shouldn't conflate our goals and incentives

Starting point is 00:02:11 with NVIDIA's incentive to either invest in or prop up CoreWeave, whichever it proves to be down the road. Two things can be true. If AI expansion and proliferation does continue to happen, there's going to be a need for this infrastructure, right? And the build-out is going to need to continue. And companies like CoreWeave are really facing serious liquidity crises in the meantime. I've spent 15 years following big trends in energy and housing. And if there's an important phrase that I think investors should just absolutely sear into their psyches, it's this, secular trend, cyclical demand. A company has to survive weakening near-term stuff to profit from a decade of massive growth.

Starting point is 00:03:00 And we're going to see ups and downs for demand across the AI cycle. It is a reality. Now, does that mean NVIDIA is putting good money after bad with CoreWeave right now? I think that almost doesn't matter to a large degree, because NVIDIA is so critical. It's the hub, and there's all these spokes coming off of it on the wheel of the AI build out that's happening right now. And it is a provider of capital in this current space. whether it turns out to be a profitable deal has a lot less to do with CoreWeave and its execution

Starting point is 00:03:41 with some really big things that are happening more broadly. And CoreWeave just has to kind of survive. And maybe it has to stay on the NVIDIA purse strings for a little bit longer to get there. I think that's a fair point. I don't know if I fully agree with the concept, though, that they can't invest too much in this space. I mean, I look at a business, a stock advisor recommendation, Ferrari, the ticker is race. It's a lovely ticker. I always loved that. And one of the things I always admired, despite the fact that the stock has been challenged recently, is that the management team at Ferrari invested pretty heavily into electric vehicles, but recently actually kind of pulled back on a lot of their loftier goals.

Starting point is 00:04:19 And it's not that they don't believe in the future of electric vehicles, but they said all these targets that we set out initially, we just don't think they're as achievable in the near term as we set them out to be. We're still going to be investing, but we're not going to be investing as heavily. And to your point, they don't want to throw good money after bad, so to speak. So they see the future in electric vehicles, but they're not going to overinvest in this space. And I think the question becomes, in the case of NVIDIA, can NVIDIA overinvest in AI? And I think a lot of listeners probably say, no, I don't think that's possible. I actually think that it is possible for NVIDIA to overinvest in AI. We've seen the cycles happen to NVIDIA in the past,

Starting point is 00:04:56 whether that be cryptocurrency or gaming. The demand for chips is cyclical in nature. And I worry a little bit about NVIDIA getting a little too caught up in its own narrative and investing so much money into something that ultimately ends up being a slower cycle than they initially maybe expected it to be. But Asit, I guess I want to, I've been talking too much. I want to pass that question off to you. Nobody wants to hear my opinion here. What's your take on the investment? Do you think it's a proactive or maybe a reactive move? Well, first, I want to say, listening to Jason, it occurs to me the difference between Jason and myself, which I rue, is that Jason can do something for 15 years. I've not in my life

Starting point is 00:05:36 been able to do something, anything for the course of more than a couple of years. Austin, I didn't say I did it well for 15 years. I didn't say that either, buddy. No, all jokes aside, really respect Jason's long experience looking at markets and how long they can persist. And I'm going to come back to your point, Emily, because I think I slightly disagree with you. But let's start with NVIDIA. Because I understand the NVIDIA side of it much more than the CoreWeave side. I have trouble understanding still CoreWeave as a business. I'll get to that in a moment. NVIDIA is a business that is going to soon be the biggest free cash flow generator on the planet. I think by 2029, 2030, it will be

Starting point is 00:06:20 way ahead of anyone else who produces appreciable operating and free cash flow. We're using very rough numbers here. This year, NVIDIA should generate in free cash flow. By 2030, it will be close to $300 billion in free cash flow. Putting a $2 billion investment into CoreWeave in that context places me on the side of the question, Emily, that, well, at least in this instance, it's not over-investing. It's not even material. If you take the scale of going from $100 billion to $300 billion, just add that progression up, it's several hundred billion dollars worth of free cash flow that's coming down the pike. But what is it doing here? It is, I think, investing in its ecosystem. I'm more a believer in this. Jensen Huang used this term AI factories

Starting point is 00:07:12 way back when ChatGPT first exploded onto the scene. He had a very clear vision. He thought that these AI factories would have to be replenished every five years. They would have to be equipped with the latest technology, not just GPUs, but networking equipment, all types of storage. And so, looking over the press release, look, part of this is that CoreEVE has to adopt the Rubin platform, Vera CPUs, Bluefield memory. So, NVIDIA needs proof points for other hyperscalers, for sovereign governments, for academic research institutions, that its AI factories are the one-stop shop for AI. And that has to happen over the next five years. So this is why it's important for NVIDIA. I think that otherwise, if that wasn't in the

Starting point is 00:08:03 offing, I would agree with you, Emily, that maybe they're over-investing here. I do believe though, to circle around to your question, there is a point where NVIDIA could become too diffuse in its investments. We got to keep our eye on that because a couple of billion here could turn into 10 billion to 20 billion there. And then you start getting into a true question of, is this all circular? Right now, I believe that investors misunderstand the scale that NVIDIA operates on, but we should watch the numbers. If they start to mushroom, yes, it could be at the beginning of a circular type of revenue demand cycle. And that won't be good for anybody. And that could also disincentivize innovation down the road too. And you end up with the Intel

Starting point is 00:08:49 problem. I'm extrapolating very far into the future, but it is a reality. It's also Jensen's biggest fear, right? Is that they could become Intel at some point. Well, if one thing's clear to me, it's at least that NVIDIA has a lot of leniency here given to by its cash generation. If it is a mistake, it can make a fair bit of mistakes here. And it rather make an errant investment as opposed to find itself down the road, an Intel-like position. Up next, we're going to be turning to restaurant tech and how it is pushing the limits. Stick with us. Where some see heroes and others see egos, Bloomberg sees the era of billionaire athletes. While others follow the noise, we follow the money. Learn more at Bloomberg.com.

Starting point is 00:09:34 Welcome back to Motley Fool Money. For those of you who joined us last week on the Tuesday podcast, we spent some time digging into the downfall and potential re-emergence of fast casual stocks. And one of the trends we discussed was the issue of declining foot traffic and the need for restaurants to invest in order to drive a change in perception and value in their offerings. And one of the ways restaurants have been doing that as traffic has dwindled and costs have risen is actually through tech integration. So these are operating system improvements to make more with less. Things like tech improvements, robotics, analytics, even labor management, asset. There are a lot of companies that are selling products and services that really

Starting point is 00:10:09 seek to make that value proposition easier for restaurants. I kind of want to pick your brain about this. Do any of these companies intrigue you or do you prefer to invest in the restaurants themselves? I actually prefer to invest in the restaurants themselves, Emily. There are a few companies that have become very prominent in the public markets. Toast is a great example, symbol, T-O-S-T. In this space, Toast provides point-of-sale systems, so it has a front end. They take the payment. They also use that as an ordering device, but that's tied to a really good back-end system, which gives restaurants a lot of visibility into the ordering and gives them a lot of other functions they can use that's optimized for the restaurant business. But outside of Toast,

Starting point is 00:10:52 I don't like many other pure players in this space. And then on the automation side, many of those companies that are starting to work with restaurant chains are privately held. So I don't see a lot of great options for investing. Now, Shopify, symbol S-H-O-P, is an interesting side door to this because they actually have a point-of-sale system for restaurants. It's not optimized solely for restaurants, but they have a huge app store. So there are many businesses which have been very successful on the Shopify platform. Now, just quickly getting to businesses that I like, what's the investment case? Look at Kava, symbol C-A-V-A. They have two big distribution kitchens. You can call them giant kitchens,

Starting point is 00:11:33 which are full of tech. They use their own supply chain software that monitors their supply chain of ingredients coming in. And they're tied into the restaurants, which have visibility and automated systems that show where the inventory is, what needs to be ordered. So they've got this amazing system. I think it's pretty amazing. And it helps with Kava's operating margins. If you compare Kava to a Sweetgreen, you'll often hear people ask, well, why does Kava make so much money? Why does Sweetgreen lose money? Because the tech is better, because they're more efficient on the tech side. And then finally, I would look to a company like Wingstop, symbol W-I-N-G, which is optimized for a digital age. They have very small space locations. As you know,

Starting point is 00:12:18 Emily, you're very familiar with this business. We've looked at it together. They are built to absorb these third-party platforms like Uber Eats and Grubhub and DoorDash and play nice with them. They don't need to give up a lot of margin because they're already very efficient. It's not a drag on their P&L to both have their own digital ordering and loyalty programs tied together with the third-party platforms and they invest a lot in their tech. So I like that business as well. Jason, I'm curious, when you think about the tech improvements that Asit is talking about, how can you tell what's vaporware versus true improvement itself? And do you think tech alone is enough to save a business even when it's going through a downturn like we're experiencing now for

Starting point is 00:12:57 fast casual? So, I mean, the restaurant industry is brutal. It's very, very low margins. The ones that do well have great locations, great operations, and they turn their inventory super fast and that's how they thrive. And figuring out which of these tech platforms are value versus vaporware, the obvious first place to start is trying to figure out how sticky a platform is with its existing customers. So you look at the results and you talk to the people. And I could use just as an example, Toast. We looked through some of Toast's results and we see reported locations increased 23% year over year in its most recent quarter, but annualized recurring revenue was up 30%. And gross payment volume was up 24%. So that says, existing customers are using it

Starting point is 00:13:40 more. That's really, really important. Another thing, anecdotally, I've made a point to talk to restaurant managers and staff when I see that they're using Toast or other platforms to find out. And what I get overwhelmingly is they're effusive of Toast. So when the people are telling you that, and the results that Toast is reporting backs that up, you find out what is creating value for these restaurants. Now, to answer the other question, tech can help cut costs and do things more efficiently, but the restaurants that survive when times are bad are the ones that have a good value proposition, are easy to buy from. Having technology that can help them integrate across every possible sales channel, like we've seen Uber Eats and Grubhub

Starting point is 00:14:24 and all of these have exploded, technologies that allows them to easily integrate with those sources of revenue to maximize those sales opportunities. Those are the restaurants that are figuring out how to survive when times are not great. It seems like there's opportunities at every point in the value proposition.

Starting point is 00:14:39 Up next, we're going to be wrapping up the show with some reflections on a new equity investment from the U.S. government into rare earth minerals. Stick with us. Where some see heroes and others see egos, Bloomberg sees the era of billionaire athletes. A fad to some, the future of money to others. We see crypto's trillion dollar swings, the end of jobs or the end of human struggle. We see the endless funds fueling the AI hype

Starting point is 00:15:08 while others follow the noise. We follow the money. Learn more at Bloomberg.com. Welcome back to Motley Fool Money. As we wrap up the show today, we'll have to talk about one of the key aspects of any operating system, which is, unfortunately, the materials that make it up. We do have some new news out today that the U.S. Department of Commerce has used its CHIPS program to invest a non-binding $1.5-ish billion into USA Rare Earth. That's a domestic mining company that has increasingly attracted attention from investors as a business that is increasingly maybe critical to national security. It's clearly an investment aimed at reducing reliance upon foreign materials. Jason, I spent four years living and studying in China. And in my experience,

Starting point is 00:15:51 it was really common for the Chinese government to invest in or even control private companies that they deemed were operating in critical industries whose operations were important for national security reasons. And historically on average, although not always, the U.S. government, I think, has been more reluctant to get involved in private enterprises, even if they are critical for national security. So I'm curious, what do you think is driving this investment? And as an individual investor, does investing alongside the government change your risk assessment at all? When you have a very business-minded individual sitting at the top of the administration, you're going to get more of the business-minded approach. And we've seen that under President

Starting point is 00:16:25 Donald Trump. So I think that that's part of it. But I think the bigger thing for investors to think about is how you think about and try and assess these businesses. This is materials businesses. Remember what I said at the opening, the cyclical risk and the secular trends? companies are still going to live and die based on demand and commodity pricing. If you look at what's happened with lithium over the past three years, it is exemplary of the boom-bust-boom cycle. And at the end of the day, while maybe some of these companies, and in this case, U.S. Rare Earth, may get a little bit higher floor on some of their production with this partnership with the U.S. government, they still have to sell the majority of their production

Starting point is 00:17:06 at a cost that makes sense into a market where they're simply a price taker. They have no competitive advantages in what they can sell for. It's all about their operating and production costs. These are industries you really have to understand and know them really well. When you invest in them, think about buying really when the cycle is negative and the stocks are depressed versus jumping in when every retail investor finds them attractive. You're probably the bag holder for somebody that knows the industry really well that's looking for an exit point, and it's going to take a long time to turn your investment into a gain, and you're probably going to have to ride through a downturn to do it. It's a beautiful segue for the question I had for

Starting point is 00:17:45 you, Asit, which is, it's really easy when individual investors see headlines like this with USAR, that's the USA Rare Earths ticker. They're skyrocketing on the news. They're up over 100% in the past month. It's easy for individual investors to feel FOMO, this fear of missing out whenever they see share prices increase like that. How should investors handle these policy changes or avoid trying to get swept up in the hype when they see this type of news? Well, Emily, one of the ways is to realize that you don't necessarily want to find that company that's going to go 100% in a day. And the reason is, it's a much harder way to make money. In that pursuit, the chances to lose are so much. And FOMO can do this to us. It can push us to corners that

Starting point is 00:18:27 are speculative in the investment world that work against our interests as long-term investors. But if you want to scratch that itch, I think AI has become a great leveler. FOMO used to be accompanied by a big blind spot, which is like, hey, everyone's buying it, but I don't understand it. I don't know what's going on, but I feel like I got to get in. Just spending some time with a good AI model to break down the question you have about a certain rare earth mineral, the demand, what could go wrong if you invest in that trend, is so much better than previous FOMO cycles we've had where you just couldn't understand what was going on, but you felt the compulsion to participate. And it's ironic, I just finished an interview with a company whose business model

Starting point is 00:19:07 is based on exploiting their license for a rare earth material from the U.S. Navy. But to Jason's point, they are doing something more than the sum of the parts with that. So, if there's a strategic bent, if the company has an other way to make money rather than a binary proposition where they've got to make it on this one rare earth or not, I prefer those. The clear picture is there. The holistic picture is there. There's another reason to invest. And at the end of the day, and by the way, I hope we will get that interview up on Motley Fool Money soon on a Sunday. At the end of the day, what you're trying to do is to choose from among many different investment opportunities. The FOMO geopolitical driven opportunities should just be

Starting point is 00:19:56 one that you look at in addition to, hey, restaurant tech, some other trends, the operating layers of today's investment world. And it certainly sounds like there are some operating layers that are much more riper for investments than others. Jason and Azad, I think I generally agree with you that in the case of these rare earth minerals, it's not my favorite aspect of operating layer to invest in. But thank you both so much for your time joining me today on Motley Fool Money. I really appreciate your insights. As always, people in the program may have interest in the stocks they talked about, and The Motley Fool may have formal recommendations for or against, so please don't sell or buy stocks based solely on what you hear.

Starting point is 00:20:32 All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For Jason Hall, Asit Sharma, and the entire Motley Fool Money team. I'm Emily Flippen. We'll see you tomorrow.

Motley Fool Hidden Gems Investing - Owning the Operating System

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