Motley Fool Hidden Gems Investing - Tesla Learns To Surf

Episode Date: January 25, 2024

(00:21) Asit Sharma and Deidre Woollard discuss: - The promise of Tesla’s next-generation vehicles. - If Tesla’s energy business is finally ready for prime time. - How ServiceNow’s AI push is paying off. (18:51) Tom King and Mary Long talk about Constellation Software’s history of acquisitions. Companies discussed: TSLA, BYD, NOW, CNSWF Claim your Epic Bundle discount here: www.fool.com/epic198 Host: Deidre Woollard Guests: Asit Sharma, Mary Long, Tom King Producers: Mary Long, Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. Is Tesla learning to surf? Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst,

Asit Sharma. Asit, how are you today? Deidre, I'm doing really well. Thank you. I booked you a week in advance because I was so excited to talk to you about Tesla. Whenever I see the Tesla earnings on my calendar, I'm like, oh, here it comes. It was spicy. The thing that I'm sort of hung up on, and I think the headline has been, the Tesla says it's in between two growth phases. So it's spending so much right now on building factories, on R&D, highest capital expenditures in company history.

I mean, they've still got plenty of cash, but tell me about these two waves and how much patience we should have as we sit here in the trough. Deidre, before I do that, I have to say, shame on you for revealing how we operate to say that you booked me a week in advance. Now everyone knows one of the dirty little secrets of Motley Fool money. At any rate, I think shareholders should be pretty patient here. You point out that $4 billion in free cash flow in the last four quarters, it's a cumulative number. But remember, for those of you who are a little bit dusty on that, that means that after all the investment that Tesla has made over the past year in all this

new production capability, it still has $4 billion in cash that it generated. It's a company that is seeing some margin compression, but it's still churning out very nice cash flow. I think maybe the elephant in the room, which got addressed briefly, is the impact of Chinese car manufacturers, EV manufacturers. This industry is maybe one of two or three bright spots that the Chinese government has right now in an economy that's failing. They're doubling down in putting resources towards the production of electric vehicles at scale. Now, they have pulled back as a government on some of the incentives, both to manufacturers and customers. But what Elon Musk was referring to in the conference call yesterday when he said that, look, Chinese

vehicles, they're formidable competitors and they're going to take market share all over the world. I'm paraphrasing here. What he's really saying is that they have already gone through their manufacturing curve, their development curve, to, on their own, be able to churn out really great vehicles at a low cost and provide a barrier to entry from any auto manufacturers who are behind in the game. He sees this as a legitimate threat around the world. I also agree this is something for Tesla shareholders to watch. Now, the story won't be quite the same time as last time with industries like the solar industry. Many governments around world are a little worried about China's reach in manufacturing and how it can subsidize,

fairly or unfairly, its priorities and then knock out local competition. While I don't think the Chinese wave here of EVs has a free pass into Western markets, it is a competitive threat. Overall though, just to round this out, I do think that the investments that Tesla has made in its production capacity, in its supercomputing capacity with the Dojo supercomputer over the past few years. There's a track record there investors should pay attention to. I think patience in this trough is warranted. I know the stock is down today, and investors are disappointed with a little bit slower growth outlook. But the longer-term story is still intact. Well, I'm thinking about that longer-term

story, because on the call, Musk made it very clear, this isn't a product announcement call. this is an earnings call. And yet he definitely wanted to tease out the next generation of vehicles. Didn't give us too many details, poked fun at himself for tending to over promise on timelines, which I'm sure his employees are well aware of. Given that we don't know much here, is he overselling what this next generation could be? I mean, it seems like it's more about the computer aspect, the dojo aspect, and less about maybe any eye-catching new design. I think what he's telegraphing is that the next generation is going to be a lot more competitive price-wise. There was some other caller in the call where he was talking about

the average selling prices of more conventional automobiles among other auto manufacturers. So what Musk is saying here is that, yeah, I'm not going to give you any timelines. lines. In fact, I'm pretty bad at that, but it'll be a more cost-effective car from the consumer's perspective and it'll be loaded with great Tesla features. I think that's enough for shareholders to get a sense of where the company will head next in terms of that wave that you're referring to. I also like that he was humble. I like the self-deprecating Elon Musk. I hate it when he's on a high horse and is dissing the analyst at the table and cursing and walking in with a huge amount of swagger. I think as a shareholder, you want him to be

humbled and focused on Chinese competition, on where Tesla can go to find its growth, and to make those comments about his own foibles that signal to us he's much more focused on getting back comfortably ahead of the competition. Yeah, I've heard some rumors about that, the $25,000 car and things like that. Tesla hasn't said anything about it. But one of the things that Elon has continually stressed is the idea that the most valuable part of the car is going to be the software going forward, and that this is just like a conveyance device. But I got to take issue when you say he was humble, because I think I'd never find him particularly humble. And I think my favorite moment might have been when he was asked about

his most recent demand for 25% of voting control. And he was saying he just wants to be an effective steward of the AI technology. It's not about the money. It's not, like he said, it's not about if I have power and I'm going to go bonkers or something like that. What do you think? What was your take on that and his most recent demands about that? Not surprised. He did actually say, look, it's not about the money. Again, this is the Musk that I sort of like. And you're correct. I mean, there probably is no true version of humble Elon Musk, but humbler than usual, maybe is what I was trying to communicate. When you're asking for voting control so that you can realize your vision, that's more the

enfant terrible, the spoiled child genius, who's like, just give me the marbles and let me play with them. I want to be like Mark Zuckerberg over here. I think he's just jealous of companies like Meta, which have already established that kind of voting control. This is another way just to get attention and to point the finger at his greatness, how much AI has been part of Tesla's DNA. We see that a lot in these calls where he's talking about generative AI and AI in general. He doesn't like that after walking away from OpenAI, Tesla today is no longer seen as at the very forefront of artificial intelligence. Rather, it's companies like Microsoft, like OpenAI, which is private and some bigger competitors. Part of what we're seeing here is Elon Musk's

theater, and so many references to AI ambitions. Again, you have to take this, if you're a Tesla shareholder, with the rest of what you get with Elon Musk, which is a lot of capability in terms of manufacturing, production, and investment in future technologies. One of the things I look at every quarter is the energy storage business. It's not a big part of the business, and it hasn't necessarily worked out the way he wanted. I was remembering recently in 2016 when he made that big announcement about the solar roofs and those beautiful glass tiles. He was on the set of Desperate Housewives. It was this whole moment. And well, energy storage didn't quite go that fast, but deployments were more than double compared to the previous year.

the profits are growing. I mean, small part of the business, but growing pretty quickly. And he said, you know, the energy business is going to grow faster than the car business. Maybe, I don't know. But one fact that they said is they're going to start releasing those production numbers along with the car numbers. That seems to me to be a positive sign. I think so. And I think this is something we can start paying attention to with a little more time. Deidre, you're right. Total deployments of gigawatts in 2023 increased 125% versus 2022. This is a business that's growing faster than that vaunted 50% rate, which is really the stretch goal for automotive production and all kinds of signals on the ground that that

automotive production is going to slow next year. When you add the energy business to the other services business, sale of used Tesla cars, the supercharging revenue, that now has become about 15% of the total top line. When you have higher margin businesses that start to approach 15% to 20% of total revenue, that can be a bottom line boost in any business. Here's right about the time investors should start monitoring that. I think you're right to call it out, and I think good on them if they start giving those production numbers every quarter. This could be a neglected aspect of Tesla's total story that will be more meaningful with each quarter as we get into the rest of this year, 2025, 2026. Yeah, absolutely. I could talk to

you about Tesla all day, but I want to hit another one that reported yesterday. It isn't a household name, but man, it's a great story. And that's ServiceNow. I'd love for you to explain a little bit of what this company does and why it had such a spectacular quarter. Sure. ServiceNow is a company that makes it super simple for workers at an enterprise business to spin out apps to do things. So, for example, if I wanted to have some way to communicate with you about scheduling on Motley Fool Money, I might be able to use ServiceNow to make that very easy. Rather than the way we probably go about it now, some Slack, some emails, etc., there's a way that I could use their technology. Because my company would subscribe to their

software as a service platform, just pull down some tools to make that happen. While I'm not a software engineer by any means. I have the technology at my fingertips, and they do this really well. They don't like to acquire other companies. They build almost everything on what they call the ServiceNow platform in-house. They have a bunch of big businesses that pay them good money to make the technology available across their total global businesses. This is really where they excel is in increasing businesses with these Fortune 1000 customers all the way up to the biggest companies on the planet. The amount of customers they have in the Fortune 500 was something like 85%. They work with everybody. The growth is really impressive.

Part of that is that their AI platform, Now Assist, they said it's their most successful launch ever. One of the things I like about them, too, is that they break out their customer cohorts. They use their data in a way to really tell the story. And the customers that have big spend, so over a million in contract value, is just really impressive, keeps growing. And on the call, CEO Bill McDermott, he talked about having 186 CEO meetings in the last six months. So he's been moving around. And he said that CEOs really want to get involved with AI directly. So it sounds like this is big now, but also bigger for the future, right? Very much so. Two parts of this I think shareholders should focus on, or prospective

shareholders, if you're looking at service now. Bill McDermott started his career in sales. He's a great manager. He's run some pretty big divisions of companies like SAP. He comes with a lot of executive experience, but at his heart, he's still the teenager who started a store on the corner near his house and was selling merchandise. For him, it's really important to go one-on-one, even if that means meeting a CEO a day or whatever the cadence is, to persuade them that now technology is the best, so that his sales teams can come in afterwards and do the hard negotiations. They're very crisp negotiators, by the way, to lock in these lucrative contracts. But part of the story he's telling makes sense

because CEOs now are caught in this uncomfortable position. They have to show shareholders that they are investing in AI like everyone else, but they have to see return on it so they're not losing money because then they'll just be blamed next year or down the line. It's a tough spot to be in for the companies that don't have an immediate clear line of sight to how AI can help them. ServiceNow is making that easy by not trying to be really fancy. You mentioned Now Assist, which is a pretty interesting modular part of their business. It helps a company get a virtual agent really quickly to interface with customers, or it helps a business identify a process and let the Gen AI figure out how it can be done more

efficiently. As a manager, you can monitor the progress, you can see who's using it, how they're using it. It itself provides a really great and easy use case to C-level executives and the managers below them that they will be able to see a return on all the money they're spending. That is an edge versus some competitors who are still fumbling around and trying to wave a banner of generative AI and motion people over to their software. I think they've got specific use cases that give them an edge. I love the way that they're adding modules on. It reminds me of some of the cybersecurity companies where you've just got that potential

for expansion. I love what you said about McDermott and his enthusiasm. I listened to these two calls back-to-back, and they were very different experiences. Musk, he's got the swagger, he's the household name. maybe he's a little, he's, I'd call it in Susie and he's a little, you know, he's, he's, he's kind of, he's laid back about it and, and he, you know, he wants people to trust him, but he doesn't really feel like he has to earn it. McDermott, he's more like, I, the way I had it in my notes is sort of like football coach in the locker room, even after the team has like, is blowing

away the competition. And he's like, yeah, we're going to go even farther and faster. So what do you think about the tenor of the CEO when you're looking at the earnings and you're also hearing their voices and what you're hearing in the voice. How do you balance the two? One, I really commend you, Deidre, for actually listening to calls. Many an investor gets caught up because of lack of time in scanning transcripts. You get so much data out of hearing the voices, the reactions to questions, instead of reading what's on the paper or on your screen, to actually hear that tone of voice. I think with Musk, we get what you probably want. Given everything we've already said, all the dressing down of Elon Musk that we've presented, you

actually want someone like that who's trying to spearhead an entire industry, actually three of them, if we count the energy business and AI, to have the swagger to be a little cocky to show that he or she is going to attract the capital and invest it wisely, and they're not afraid to do so. With a company like ServiceNow, which is just so dominant in its industry and has the next step, which is to get bigger, you need a great football coach who can inspire the team to do just that, because it's no easy task. Where is ServiceNow going now? They're starting to work with sovereign governments, because when you get that big, we talked about the statistic you cited, 85% of the Fortune 500, okay, what's left? Another 15%. You have to now go to governments and sell

your wares there. You need a coach who's proven, who can inspire the troops, who doesn't get tired, who needs to rest his or her voice at night, maybe with a cold soft drink or something, just because they're hoarse from all the exhortation. I think in Bill McDermott, you get that. As I said before, he's a special blend of a great manager, someone with really fine executive skills, but also the ability to inspire. He's got that salesperson talent. He's always selling, always selling, and you want that in the CEO of a growing company. I think out of both of those calls, if you own shares, you probably heard something that made you feel fairly comfortable about the people in charge. Yeah, absolutely. Leadership matters.

Thanks for the time today, Asit. Thank you so much, Deidre. This was so much fun as always. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data,

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fool.com slash epic198. We'll also include a link in the show notes for you. Most CEOs are happy when an analyst upgrades their stock. Not this one. Mary Long cut up with Motley Fool analyst Tom King to learn about a software holding company with a disciplined allocation strategy. Our good investments written in the stars. Joining us now for a medium dive into Canada's Constellation Software is Motley Fool analyst, Tom King. Tom, welcome. Good to have you here. Thank you for having me, Mary. So Constellation Software is a conglomerate of over 500 software businesses. The general theme to this family is that they're all, at least right now, well-run vertical market software,

aka VMS companies. What is VMS, and why are these companies such appealing acquisition targets? So, vertical market software is software that is designed for a very specific application or for a particular industry. So, the easiest way to understand it is by contrasting it to horizontal market software, like Microsoft Word, for example, or Google Sheets is classified as horizontal market software because it's used in a variety of industries and for a variety of applications. So, vertical market software has a very specific purpose in a very specific industry. And the reason they're not necessarily more appealing acquisition targets than any particular kind than any other kind of business. It was just that this was an industry that,

when the company was founded back in 1995, the founder felt that this industry was being overlooked and that there were opportunities there. So, that founder, his name is Mark Leonard, and he's a pretty central part of the story of Constellation. He's been called the Warren Buffett of software. What's the deal with that nickname? Where did that come from? I suppose it would be that he has established a very disciplined set of acquisition criteria. And they are criteria that they are not willing to deviate from. So no matter what the rest of the business environment is like, they stick to their criteria. And that can be hard to do because often they're being encouraged to get on the train with

everybody else, but they're not willing to do that. Do we have a sense of what those criteria are? Today, they focus on vertical market software companies. And the specific criteria that they look for in those companies are that they are small, so typically fewer than 100 employees, but they can get bigger, but they prefer small. They also prefer companies that are first or second in terms of market share in their industry. They like them to be mission critical to the service they provide to be mission critical. And they also want them owner managed.

So the owner who is selling to Constellation should ideally be willing to stick around and continue to manage the business. And the last criteria is that they expect the business to run autonomously after acquisition. So, this is a company that has compounded shareholder value at a rate of 34% over the course of its history as a public company. So, clearly, this formula that you've laid out, it's worked pretty well for Constellation. If you can articulate what they're looking for in businesses. What is stopping someone else from copying and pasting and doing the exact same thing? What's like the moat here? The moat is that they set themselves up as an attractive person to sell to. So the other, if you were the owner and manager of a small

software business and you're getting to the point where you're thinking you want to sell this business, you can sell to, your options are Constellation on one hand, and a variety of other businesses such as private equity investors on the other hand. And typically, those kind of businesses, those private equity investors have an exit date, so they're not going to hold this business forever. They're probably going to come in, they may make some changes, they'll try to, in inverted commas, optimize the business, they might borrow a lot of money against the business's assets. That is how private equity investors typically work. And they look to get out in five years' time or 10 years' time or some time frame. So, Constellation sets itself up as,

if you don't want to go that route, come to us. We'll offer you a decent price. We'll give you opportunity to cash out. We're not going to tell you how to run your business and we'll hold you forever. So it's a, it's a comfortable, it's a comfortable, if you, if you care about the business that you own and the people who work for you, when you, when you get into the point where you want to sell, Constellation is, is a good candidate to consider. Yeah. So it seems like culture is really a selling point here. And again, we've talked about Mark Leonard a bit, but he's a really central point of that culture mentioned. He's an interesting guy. He doesn't do many, really any interviews. There are maybe only one or two

pictures of him on the internet, but investors can kind of get a sense for what he's about through reading his president's letters. They're not annual. In 2017, Leonard said he would only write to shareholders when I think I have something new and important to communicate. I'm sure you've read a lot of these letters. Do you have a favorite nugget or takeaway from his writings to shareholders? Yes. I think one of my favorites is from a letter he wrote in 2018. This was one of his last before he decided, I'm not going to continue writing these unless there's something useful to say. And he said, one of the analysts who covers Constellation recently changed his perennial sell recommendation to a buy. We lost one of our few critics.

analysts who worry about the quality of earnings and reversion to the mean and the impossibility of trees growing to the sky are valuable. And that really stuck out to me because I don't know too many CEOs who would celebrate losing a critic. Sticking to this culture point, Constellation Software does not do stock-based compensation. So if not for that, how does the incentive structure work within the company? So, everybody is paid a salary, a cash salary and a cash bonus. The cash bonus is dependent on two performance metrics. Those are return on invested capital and net revenue growth. The return on invested capital has to exceed what they call the risk-free rate, and that was set to 5% in 2022. So, the reason this is important

is that they only get paid their bonus if they add business value. So they can't simply tread water or lose value and expect to be paid a bonus. And they don't pay any stock-based compensation at all. It's all cash. Now, executives, managers above a certain level, as well as the directors, are all expected to use their cash bonuses, most of it, to buy Constellation stock and to hold that for several years. There are restrictions on selling it. So, what this does is that it creates significant alignment between the managers and outside shareholders. Now, we often, if you read the proxy statement of any public company, they will talk a lot about alignment, but it's not true alignment because they typically give

the stock to their employees and then say that this creates alignment. But I think there's a very big difference between how people feel about something that they've been given and how they feel about something that they've earned. In the case of Constellation Software, the managers and senior directors are all buying stock with money that they've earned. They are not given it. So that aligns them with shareholders to a degree that doesn't happen in any other public company that I have encountered. We mentioned before the really impressive returns that this company has seen since it IPO'd. Even just as we're talking and as I'm researching this company, from a foolish investing perspective, you talk about Mark

Leonard, you talk about these aligned shareholder incentives, the focus on the long-term letting the companies that are acquired run themselves even after they're bought. As I look at all that, I think, okay, well, wait, what's the downside here? So there've got to be some risks that you're thinking about as you look to the future for this company. What might they be? I think the primary risk is price, like what we pay as outside investors to buy a share of Constellation. It's a lot better known today than it was in the past. And we faced the risk that Mark Leonard avoided back in the early days, the risk of other buyers going after the same thing. So, other buyers are also interested in Constellation stock, and we just need to be

careful that we don't overpay for the stock. So, before you buy the stock, if you're considering and buying it, definitely put some attention into the price you're willing to pay. Awesome. Well, thanks, Tom, so much for sitting down and kind of giving us a closer eye into what is a really interesting and impressive company. Thank you, Mary. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Deidre Wood. Thank you for listening. We'll see you tomorrow.