Motley Fool Hidden Gems Investing - “There’s Always Money in the Banana Stand!”

Episode Date: June 28, 2022

It’s not easy being a public company. Zendesk looks to go private, while acquisition battles continue to heat up. (:21) Deidre Woollard and Jason Moser discuss: - Stocks that could be prime acquisition targets. - JetBlue’s offer for Spirit Airlines. - Venture capital drying up, and what that means for technology innovation.   Plus, (14:46) Alison Southwick and Robert Brokamp continue their series on past market declines with Morgan Housel, this time covering the dot-com bubble, and the lessons investors can pull two decades later. Stocks mentioned: ZEN, SAVE,  JBLU, ULCC, CSCO, OTLY, PTON, MSFT, IBM Host: Deidre Woollard Guests: Jason Moser, Alison Southwick, Robert Brokamp, Morgan Housel Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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and I'm joined by Motley Fool senior analyst Jason Moser. Hey, Jason, great to be with you today. Hey, Deidre. Thanks for having me. Well, I'm excited to talk to you because you've seen cycles in the overall market, and wow, we are in this kind of like, let's make a deal environment right now. There are so many acquisitions. There are rumored acquisitions. It's just all spinning. Now, some of it's kind of small, like eBay buying an NFT platform called Known Origin. But then last week, you had that larger deal, like Zendesk going private for $10.2 billion. We've got the frontier battle. We've got rumors coming out like PepsiCo and Celsius Fitness Drinks and FTX and Robinhood. Well, let's start with Zendesk for a minute.

So, we had a flood of IPOs and SPACs in last year, too. That flood turned to a trickle, and some companies are now going private. What does this Zendesk deal signal to you? Well, it signals a couple of things. I think on one hand, it does feel like clearly the market's appetite for those high flyers has been tempered a bit. That promise of profits down the line isn't quite as enticing as maybe it used to be. We saw not all that long ago, so many of these businesses that were just trading at 20, 30, and 40 times sales, which it wasn't normal, but it kept on going on for a really long time. It became normalized. All of a sudden, we became a little bit more immune or just numb to that 20 and 30 times sales multiple. It was really

out there though. As market conditions have deteriorated, as the cost of capital continues to go up, you see the market's appetite for those high flyers has been tempered a little bit. Zendesk going private now around seven times sales. You start asking yourself, maybe some of these companies, whether it's private equity or these larger acquirers, maybe they see where things are headed. They believe in this digital economy and that ultimately where we're headed as tech guides more and more of our lives, particularly on that backend. Maybe these acquirers see that long-term opportunities, these valuations start to come down. I'm not saying they're cheap by any means. Six, seven, eight times sales is still expensive, I think, conventionally speaking,

but it starts to become a little bit more palatable if you can really take that longer view. If you're looking at this as a decade plus long play, then all of a sudden you start seeing these valuations making a little bit more sense. We saw recently private equity firm Toma Bravo just acquired Anaplan for essentially double that multiple just a few months back. It does feel like we're starting to see some of those high flyers come back to somewhat palatable valuations. Well, I think it's interesting because maybe some companies went public really before they should have in that IPO and SPAC frenzy. I think we saw a lot of younger companies get in the mix before they were really seasoned. Do you think that's some of why we're seeing

some of the public companies go private now? I think you're absolutely spot on. It's very difficult. If you're a company, particularly exiting that startup mode and really trying to get your feet underneath you, and you're in that type of market that we've been witnessing over the last several years, I'm not saying it's easy money, but you really do want to go public when you have the opportunity to raise as much capital as possible. The enthusiasm has just been there. Enthusiasm bordering on speculation in some cases, perhaps, yes. But it was an opportunity for a lot of these businesses to raise a lot of capital. I think it's fair to say that a good percentage of them probably weren't necessarily ready to live their lives as publicly traded companies. Perhaps

witness the difficulties that come along with that. When you see an exit strategy, they can maybe let the company get back down to doing what they really want to do, sometimes that's a difficult offer to pass. Yeah. Well, SPAC and SPEC are just a letter apart. I like that. It's true. Well, I'm wondering about other targets. I think the whole market is looking at things. I'm thinking about Peloton. We heard a few months ago there was all that speculation about who might get them. They're Oatly, Upstart. There's a couple of ones that are bubbling around as potential acquisition targets. Any that you're thinking about? Peloton is one that, golly, you wonder what the endgame is for them. It feels like Peloton is

an acquisition waiting to happen. I feel like it's a better company than the press is probably giving it credit for right now. It has been kind of raked over the coals a bit, but they make a very good product. I do feel like there probably is the opportunity for them to become part of a bigger family somewhere. I like that you mentioned Oatly. The main reason why, I feel like with Oatly, I feel like that's a company that probably has a bit of a tricky time on its own as a publicly traded company, but there are a lot of food-related businesses out there with a lot of brands under their umbrella where this move towards plant-based is real. It's got a lot of legs. I was just thinking the other day, we saw news that Kellogg is going to split

off into three different businesses here. While the snacks-related business is probably what gets most of my attention just because I'm a snack head, they're also going to have a plant-based company that spins out from this. Oatly strikes me as a business that could be a perfect complement to something like that. It's been a little bit of a tough time for Oatly as a publicly traded company, but I wouldn't be surprised at all to see some food companies out there really taking a closer look at this. Because again, I do think the plant-based movement is real, it's growing. I think it's difficult to make that journey on your own in that food business. Yeah, I think that one's interesting

two of the three businesses that Kellogg's is spinning off. The plant-based one is the turkey of the bunch, unfortunately. But thinking about fold-in acquisitions and things like that, as an investor, if you're looking at stocks, does it ever make sense to buy a company just because it might be an acquisition target? Well, getting back to speculation, I think if you're buying shares of a company because you thought, well, the crux of your thesis is acquisition, that's certainly a bit more speculative. Now, everybody's got their own way of doing it. I personally would never use acquisition or potential of acquisition as a thesis, but I will say it can be part of the calculus when you're weighing the risk-reward.

That's something to keep in mind because ultimately when we make investments, you're really trying to get an idea of what is the risk versus the reward with this investment. Obviously, want that reward to tilt in your favor as often as possible. When you see a business where you feel like, okay, this is a good business, if they don't execute, then the worst case is maybe the business gets acquired. I could see that as playing into the calculus for the risk-reward. I would never make it the crux of my thesis though. Yeah, that makes sense. Well, we got some news that this JetBlue Spirit and Frontier deal, this just keeps happening. JetBlue keeps raising their offer. What does this fierce competition mean for shareholders and any

ideas on how this is all going to play out? It's been fascinating to watch. It is, and it's not just this market. I think it extends well beyond airlines. Airlines are a bit of a unique market in that the regulatory barriers involved in really sort of the limited, quote-unquote limited, I guess, competition. I mean, it is a market where scale really matters, right? Size really does matter when it comes to building an airline. And that's all fine and well. I mean, I do appreciate that perspective. I think it's always worth keeping in mind, though, with investors. I mean, you see times when these valuations get stretched. You see how bad a company may want another asset. And then you

start to see this bidding war, you have to start asking yourselves, what is a fair value and do we get to the point where maybe they're paying too much? That could be a big problem. Sometimes it's nice to see the company step back and say, hey, you know what? No, we're good. We wanted this, but we don't want it at any cost. I think you have to keep that in mind because for shareholders overpaying for these acquisitions, number one, acquisitions are really hard. hard. Integrating an acquisition into your business, there are a lot of risks that come with that, business model risks, culture risks, all sorts of financial risks. You see for shareholders, this can result in bloated balance sheets, lots of goodwill that eventually needs

to be written off. You start to question management's actual judgment, does this make sense? One thing that came to mind when we were going through these questions, talking about this bit earlier. A good example that comes to mind recently is Teladoc Health. Teladoc Health is a good example of a business that for a long time, part of its strategy was to grow through acquisition. Now, it was smaller acquisitions. It wasn't doing anything crazy. It was just buying a little small bolt-on acquisitions to expand the comprehensive nature of its offering. To a certain point, it had executed very well. You look at BetterHelp, for example, that they acquired, I think, for under $10 million, grew that side of the business up to a $750 million plus revenue

generator. But then they go and they acquire Livongo Health for $500 billion. Of course, that's not how much they paid, but that's how much it feels like they paid, because they sure paid, it seems like, way too much for something like that. What we've seen since that acquisition is the market just has not been on board. Now you're seeing essentially the value of that acquisition has completely been erased from the Teladoc Health side of the business. You start to ask yourself, okay, well, this company, they had a really good track record up to that point. Is that a one-off or is that a sign of poor judgment on management that we may expect to continue? We don't know the answer to that yet, but it really just goes back to show that you do like to see management maybe

draw a line sometimes and say, we want this, but we don't want it at any cost, because there are real cost to shareholders down the line for companies that do just vote to pay anything for an acquisition. Yeah. I think this one is really complicated too, because you have more overlap with JetBlue and Spirit in terms of flights, and you have maybe more regulatory risks. I think it's going to be interesting to watch the next couple of days and see what happens with that one because definitely we're going to see some more news on that. I want to take it to the other end of the money universe, the private side. There was a report that came out from CB Insights showing that venture capital has just really

dropped dramatically, dropped 23% between the first and second quarters of this year, total funding down 27%. I'm watching this at the same time that I'm seeing tech layoffs at startups and publicly traded companies. Startups are a great source of innovation, and as this funding starts to dry up, what does that mean for some of those potential unicorns out there? Well, you would think in theory this means something slows down, or at least there's a lull in some of this investment. But to steal a line from Jurassic Park, tech finds a way. and to steal another line from Arrested Development, there's always money in the banana stand, Deidre. There is always a lot of capital out there to put to work.

I think that what we likely see from this is less waste and more focus, doubling down on the things that work and maybe putting some of those moonshots on hold. That's not to say that we don't see investment in some of those longer-term moonshot-y ideas, but maybe you put those on hold for a little bit and really focus on the things that are working. It's been a material slowdown for sure. For the first quarter of 2022, the global IPO market saw 321 deals that raised just over $54 billion in proceeds. Those numbers are down 37% and 51% year-over-year respectively. It is real that that inflow of capital has slowed down and that definitely plays a role in these businesses weighing where they need to

allocate that capital because it becomes a little bit more difficult to come by. Yeah, absolutely. In the report from CB Insights, it also mentioned that Series D funding rounds are far down. That makes me wonder if more of those companies that are more mature might IPO or maybe even SPAC to try to raise capital instead. It's certainly possible. I mean, going public opens a lot of doors to raise money. That is one of the benefits of being a publicly traded company. You just have a lot of ways that you can raise capital, and so I'm sure that's something they're thinking long and hard about. All right. Well, thanks so much for your time today, Jason. This was fantastic.

Hey, thanks, Deidre. Next up, Alison Southwick and Robert Brokamp continue their conversation on past market declines with Morgan Housel. And in this part of the series, they're going to talk about what was my first scary experience in investing, the dot-com bubble. Alright, so let's get into it. So, for me, the dot-com bubble, I was kind of around, I was kind of alive, not an investor. So, from my outsider perspective, it seems like this perfect storm of exuberance over this new thing, the internet, and not quite understanding it, and these companies coming in. We know it's big. We don't know exactly why.

But then, also, investing in these companies also becomes a lot easier. So, that's my quick take, but you're going to give us the longer take until I'm right. No, I think that's exactly it. And those two points coming together at the same time is really what made it crazy, versus other times in history when there was a new industry that was coming along that was going to change the future. One in the 1960s was plastics, which is almost funny to say. In the 1960s, plastic was like, this is going to change the world. The companies that were making plastic were the big, innovative companies that had huge growth in front of them.

But plastics didn't change how anyone invested at all. You had a lot of excitement, you had overvaluation. But with the internet, it was, not only is this going to change the world, but now you you can invest way easier and faster and cheaper, and you're just bombarded with more information than ever before. So, you put those two together. I think that's the backbone of what led everything to get out of control so quickly. The other thing about this period is, when people talk about the dot-com boom, they talk about the late 90s, or sometimes they say the 1990s. It was really only a 12- or 18-month period in 1998 and 1999 that it got really out of hand. It really happened pretty quickly. And for most of the 90s, even when this was

going on, there was growth and the stock market was doing well, but it was mostly rational and made a lot of sense from what was going on. It was just this blow-off top right at the end, where things started getting really crazy. A lot of that craziness was really only captured in a small number of companies in that period at the end. If you take a look at the stock market, most individual companies peaked in 1997, 1998. It was the gains that the market experienced in 1999, when things were really getting crazy and the market was going up 30%, 40%, 50% was driven by five companies, like AOL, Walmart, GE, just a few big tech companies, Cisco, Microsoft, Yahoo. That's where all of the overvaluation was.

But a lot of the hype ended way before that. There's a lot of nuance in what happened that I think gets missed when we just lump everything into, oh, the 90s were a big, irrational, crazy time to invest. I think that's directionally true, but there's a lot that went on in between that takes the story in different directions. When did things start warming up with the internet? It's like, the internet, it's a thing! When was that? I think you have to take it back to personal computers, which was the 70s and 80s. Even then, that's when Microsoft and IBM really started getting into the game, particularly mid and early 80s. But even then, it was still seen as something that a tech hobbyist would

have in their house. You had people like Bill Gates, who were the visionary, saying this was going to be on everyone's desktop. But very few people outside of Bill Gates and his... Core Radio Shack customers? Exactly. Those people really started believing it until the early 90s, which is when Windows as we know it took off and the interface of personal computers really started making sense for people who had no tech background. Oh, yeah, the mouse! The mouse! Clicking on things! Not just the mouse. They had the mouse for a decade before that. But previous versions of personal computers, like MS-DOS, you really had to know what you were doing to get any

usefulness out of it. It was really the first version of Windows when it made sense. Oh, you have folders, and you click on the folders, and you have stuff in there. That was the early 90s when it really started taking off. Average individual people could get something useful out of this. In terms of when the internet started, the first event that gets cited a lot as the birth of the dot-com bubble, when people really started opening it up to not just the internet's potential, but the investment potential, was when Netscape went public, which was, I think, 1994. Shares doubled on the first day that it went IPO, that it went public. That was the first signal, the first example of what was to come.

Not just in terms of how this was going to change people's lives, but how it was going to change how people invested, as well. Yeah, spoiler, our young kids listening to the podcast have no idea what Netscape even is, even though it was the one that started it all. That was a big deal. Before that, you had the internet, but it was something that you needed to be a tech genius to use. The browser was the first one that brought to average everyday people in a form that they could use. Yeah. I always used Ask Jeeves. I did, too. That was a good one. Ask Jeeves was a good one, too. And then Google came along, and all those other ones, too.

I remember, I was a teacher, actually, when the internet first started taking off. I got my first e-mail address in 1994, and I still have that same e-mail address. You do not! I do! Really? And for me, being a teacher, that just opened up your world. Being able to show kids different things, to be able to pull up a video. YouTube wasn't around at that point, but you could still get videos. It was just mind-blowing. Then from there, I went to the financial services industry and I started becoming a broker in 1997. One of the first jobs you have to do there is cold call people.

And every time I would cold call people, they'd say, I don't need you, I'm doing better all on my own, which is not something you could say even in the late 80s, because you needed a broker to buy a stock. But that gets back to how things just changed so much that you didn't need a financial advisor. Also, looking back on that, too, people were doing well because they were concentrated in tech stocks. Once the downturn came, they probably didn't do so well. And what so many people did when they could start investing on their own was not investing on their own, but day trading on their own. That's the first iteration of,

hey, I don't need a stockbroker, I can do this by myself, I don't have to ask anyone's permission. what am I going to do? These were not buy-and-hold investors. The whole concept of day trading was born in the 1990s. Here's your E-Trade account, or TD Ameritrade DayTec, that was one of the big ones in the 90s. Here's your DayTec account, what are you going to do? You're just going to trade stocks all day. And because there was so much momentum in tech stocks, they were just going up day after day after day, that just made the concept of day trading that much more enticing. They not only had the opportunity to day trade, But, hey, maybe you could double your money in a day or a week, because it just drew in

all kinds of people who had no idea what they were doing or no business doing then. Earlier this year, the Bespoke Investment Group published a table of the composition of the sectors of the S&P 500 over various increments. You look back at 1990, tech stocks made up 6.3% of the S&P 500. By 1995, it was 9.3%, so growing. By 1999, it was 29% of the S&P 500. They have all the sectors going back to 1990 up until 2017, and at no point do you see any other sector making up that much of the S&P 500.

And so much of the gain in that way, back to what we were saying earlier, was really just a handful of companies. Yahoo, Cisco, AOL, Lucent, there's a few companies that were worth hundreds of billions of dollars that were really driving the bulk of that. Alright, so, the internet. It's going to be the next big thing. Everyone's investing in it. At the same time, The Motley Fool is getting swept up in this. Yeah, we're going through it right along with everyone else. We've talked about this in previous episodes. I joined in 1999 at The Motley Fool when we were 150 employees.

At one point we were over 400. And then things changed. By the time we were at the bottom, we were, Rick, 70 people or so, something like that. I'll say, living through that, one thing that is a part of this in terms of the stock market and how bad it got, part of it was the September 11th attacks happened in 2001. You could look at some things. For example, in 2001, small-cap stocks actually did pretty well. It was the tech stocks that were suffering, but you could look elsewhere in the stock market and find good returns. But then September 11th came, and I think that changed a lot. I remember being in the company and David Gardner saying, there's some things you can't

predict when you're running a business, and one of them is terrorist attacks. By law, are we also required to talk about the AOL Time Warner deal? As we sit here in the Time Life building? It is! We are in the Timelife building, which is crazy! That feels like such an iconic moment of the dot-com bubble, too. In 1999, AOL was the 10th biggest publicly traded company in the country. And we all had their floppy disks and CD-ROMs. You've got mail. You've got mail.

It was a movie starring Tom Hanks and Meg Ryan! Come on! They peaked! It peaked right there, quite literally. What made the bubble burst in addition to September 11? That's one of the big things, too. We were talking about the crash of 87 and even the crash of 1929, where there's not one specific event that you can pinpoint in the newspaper on the day the stock market peaked and said, this is what caused it. It's just, things get out of control. I think when enough people start to question what they're doing and enough people start whispering to their co-workers and their cousins and their neighbors, hey, this is starting

to get pretty crazy. I think those moods can shift pretty quickly. Then it just snowballs just as fast in reverse as it did on the way up. You don't need that much momentum on the way down before enough people throw in the towel. Then, just as momentum gets more buying on the way up, selling does the same thing on the way down. So, stocks peaked in March of 2000. A lot of people have gone back and said, why March 2000? What happened at this time? There's really not any specific event that really triggered it beyond just people's moods and attitudes changing. It wasn't until 18 or some odd months later that 9-11 hit. That's a specific event, obviously, that took the

economy and the stock market down a whole other level. But before that, it was really just a big change in moods. There were some events of companies that were going to go public and their IPO was canceled because there wasn't enough demand, but that in itself is triggered by the same change in investor moods. People start giving up at some point. What did we learn from the dot-com bubble? I think a lot of it, if you look at other new industries that really changed the world, one I think of is the birth of the car industry in the early 1900s. There were hundreds, if not 1,000 car manufacturers in the early 1900s, and three of them survived, Ford, Chrysler, and GM.

I think the same thing happened with the internet, where you had thousands of people try their hand at this new technology that clearly was going to change the world, and a very small handful of them survived. You talked about Ask Jeeves earlier. That was one of the big search engines. Then there was AltaVista and all these other new search engines. Dozens of people that could see the opportunity and said, I'm going to try my hand at it. But in the end, it was pretty much Google that won. You had one company that won it in the end. There's always that big culling of the herd that happens whenever you have a new industry. Thousands of people trying, and only a few will make it.

Because of that, in hindsight, you're going to have all these horror stories from the 99.9% of companies that didn't make it. And then you have investors that lost a ton of money on those, and that scars them for a whole other generation. But the car industry itself changed the world and changed how we live. And the internet did the same thing, even if along the way, it burned not just a few people, but most, if not almost everyone, who partook in it. So, that's the risk of new industries.

Even when you can identify, this industry is going to change how we live, identifying the specific company, I don't want to say needle in the haystack, but close to it, that's going to be the survivor, is incredibly difficult to do. And if you are going to play that game, I think preparing yourself that the success rate of these companies that are going to not only survive but thrive for decades after it is in the single-digit percentage in terms of success rates. David Gardner is one who is not only good at identifying companies that are going to do well, but more importantly, I think he has the disposition to deal with the loss rate

that comes along with identifying new industries. It's not that he's happy about it, but I think he has a disposition to be OK if half the companies in his portfolio do extremely poorly, knowing that one or two are going to do really well and drive that portion of his portfolio. 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.