Motley Fool Hidden Gems Investing - What Happens if Alphabet Breaks Up?

Episode Date: August 14, 2024

Here’s why investors could win. (00:21) Tim Beyers and Mary Long discuss the lawsuit against Google, the likelihood of a big tech breakup, and consolidation in the snacking sector. Then, (14:29) Jason Hall and Ricky Mulvey check in on some solar power stocks. Learn more about the Range Rover Sport at www.landorverusa.com Companies discussed: GOOG, GOOGL, K, ENPH, SEDG Host: Mary Long Guests: Tim Beyers, Jason Hall, Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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with Mr. Tim Byers. Tim, thanks for being here. Good to see you. Good to see you too, Mary. Fully caffeinated, ready to go. Fully caffeinated, ready to go in person from the Creative Density podcast studio. We'd love to see it. Tim, today we've got two different stories about companies having different defining the relationship type talks. Earlier this month, a U.S. district court judge in D.C. ruled that the $26 billion Google had paid to make its search engine the default option on smartphones was anti-competitive. And yesterday, Bloomberg reported that the Justice Department is now in talks about whether to break up the search giant. Before we go any further and kind

of talk about implications of this, there are a number of complaints against Google and other big tech companies that are moving through the Justice Department right now. Which case is this one? I mean, it's by far the top case, is it not? There are very few times in history that we have seriously considered whether or not a corporation should be broken up. Standard Oil is, what, 100 years ago now, over 100 years ago. Microsoft was initially thought to be broken up, and then it wasn't. Then there were negotiations. I remember those days. I remember following that case. This is rare. We don't usually use the Sherman Antitrust Act. For those who don't know what the Sherman Antitrust Act is, a fun fact from history here, that is what President

Theodore Roosevelt in the early 1900s was really making his name over in terms of busting the big trusts back at that time, because those monopolies were exacting pricing power in such an egregious way over the American consumer that it was causing real damage to everyday Americans. The argument has always been, if you are going to actually consider breaking up a company, what harm is being done by consumers in order to extract that kind of price? Here, the reason I think this is by far the top story is, there's an argument that by virtue of Google's dominance of the advertising sector, that it is causing genuine harm to

advertisers, that Google can do whatever it wants, controlling all of the search advertising business, showing what search advertisements it wants to show at the price it wants to show them, because they pay so much money to own the entire distribution network, or at least the distribution networks that matter. So, there's a real argument here for implementing the Sherman Antitrust Act to break up Google. I think that makes this by far the biggest story in this space. But there have been talks about breaking up big tech for a while now. And so, you know, right now these are just talks.

There's nothing set in stone. You love your reckless predictions, so let's make one here. How likely is it that Google actually is broken up? I think it's very unlikely, to be honest, because I don't think regulators are really in the mood to exact this kind of price. I really don't think that's what they want. I think what they would like is to create more oxygen for startups, so we could have a more vibrant ecosystem of innovation, where you saw more companies grow up and become

significant in the American economy. So, there's a question of, do you need to break up Google and other big companies in order to do that? I think regulators would prefer not to. But let me say this, this is my hot take, Mary. Please do it! Do it! I was going to say, when you started answering that question, you sounded a little disappointed when you said it was a lie. I would love it! I would love it! Because, look, when Standard Oil was broken up into Or AT&T. Let's take AT&T. When AT&T was broken up into all of those different regional bells, we got a bunch of different companies that went on to create huge amounts of shareholder

value. The sum of the parts was worth far greater than the whole, what AT&T was and what the sum of the parts became and was given to shareholders. So, look, if they're going to break it up, and I'm going to get my stock for YouTube, I'm going to get my stock for the Google Cloud and Google Apps businesses and the core search business, giddy up, give it to me. I will take all of it. How much of the outcome here hinges on what happens in November with the presidential election?

I think it's material. I do think that we don't like to talk about politics on this, but just to answer this question from a regulatory perspective, I do think if it's a Trump administration, there is a greater chance that they will exact this price on big tech and break them up. If it's a Harris administration, I think there's still a chance, but as it currently sits, I don't see the Biden administration, the Biden-Harris administration pounding the table that says, this company must be broken up. I think they are considering it just by virtue of regulators using their power to extract concessions that allow maybe the market to be a little bit more fair. That's the way I see it going right now.

If there is a change, I could see that under maybe a Trump administration. But even so, I don't feel confident predicting that, Mary. I think either way, you could still end up with just, hey, what concessions does Alphabet need to make to open the doors for more competition in this space? I think that is the outcome that everybody wants. Alphabet's not the only target of lawsuits alleging monopolistic behavior. There's an FTC lawsuit against Meta questioning its acquisition of rivals like WhatsApp and Instagram.

Amazon has an FTC suit for monopolizing online marketplaces. Justice Department says Apple has blocked rivals on its devices. Is this a game of Jenga? Like, if Alphabet falls here and is broken up, does that spell the same outcome for all these other lawsuits? No, I don't think so. But once policy is set, there may be some influence over other decisions. Having said that, though, I think they're going to try to treat each of these cases differently,

because they are fundamentally different cases. How one company acts and one company behaves in exacting market power is just going to be very different. I think there is a pricing, particularly a pricing for search advertising argument that's being made that applies directly to the Sherman Antitrust Act, where you said, hey, because of this market power, prices are X, and you can demonstrate that, that really does lean in to the existing laws that are on the books, specifically that act. With some of these others, I don't know that it's so easy to make a case that maybe Meta exacted monopoly power and so somebody else paid a lot more over here.

Is that actually true? I don't really know that to be the case. It doesn't mean that there isn't a legitimate argument here. It just means the cases are different. We spent so much of today's show talking about the potential for a company to split up. But the other news that we got today is that two companies are joining together. So, CandyMaker and more. There's a lot more to this company than just candy, but primarily at CandyMaker.

Mars announced a nearly $36 billion deal for Kelanova, which makes salty snacks. So, Pringles, Cheez-Its, Pop-Tarts, lots of familiar names. $36 billion is a lot of coin. Kelanova is also up about over 50% in the past month. That's a lot of money, a lot of good news for Kelanova. But, Tim, I thought snacking was supposed to die in the age of Ozempic. That is nonsense. That is utter nonsense. I think we overestimate, and this is true throughout stock market history, it's not just true in tech.

Whenever there is a big change in industry, we overestimate its impact in the short-term and we underestimate it in the long-term. We are totally overestimating the influence of Ozempic right now. You think we're really going to get rid of salty snacks? Are humans going to stop being humans? Or put it this way. Let's put it this way. Will we stop having kids?

Maybe we're not having as many kids as we used to here in the United States. But let me tell you, if you are a parent of children, guess what children love? They love salty snacks, and they love sugary snacks, and they love it in their lunches, and parents like to make kids happy. There is no chance that we are getting rid of salty and sugary snacks. So, yes, this is one of those businesses that I believe falls into the Warren Buffett category of, this is just, look, this is never going anywhere. It may vary a little bit here and there from time to time, but this is a slow, steady state business,

very dependable. Let it just be what it is. Osempic be damned. We will have our snacks, Mary. I will have my snacks. Give me my snacks! Kelanova is the result of Kellogg's spinoff last year. Kelanova got the legacy company of Kellogg, and with it, the snacks portfolio, W.K. Kellogg was rebranded and got all the cereals. So, you were talking about, give me snacks or give me death. How has W.K. Kellogg, the cereal company, the pure play cereal company, fared since that spinoff? I mean, to be fair, I don't particularly know how well it's fared. I frequently see both the General Mills and Kellogg cereals kind of bundling discounts

in the grocery store. I think one of the tests you can run as an investor is, what does the grocery store tell you about these businesses? And so in the aisles where these products are sold, so in the cereal aisle, take a look at the eye line, what is up there on the eye line? Because the eye line is the premium shelf space in the grocery store. So if you're still seeing sugary cereals, and if you're not seeing a bunch of deals, then that ought to tell you a lot. We are not backing away from our sugary cereals, the things that we love to have in our bowls each morning. So I don't know exactly, but I have seen

the bundling deals, particularly inside different grocery stores. But all of this is by way of saying, Mary, do we think that sugar cereal is going away? I think the answer to that is no chance. So the cash flows may vary from time to time. And maybe as things get a little bit more expensive, you may have Americans pulling back on their spending on discretionary items like, yeah, maybe I just don't buy the giant-sized corn pops this month. Fair enough. But we're still going to buy our cereals, Mary. We always do. We talked a bit about the Google case and what that means for competition. What does this mean for competition? This merger would bring Mars right behind Pepsi when it comes to market share in the packaged food market. Pepsi's got

about 9%. Right now, Hershey is in second with 4.7%. This would help Mars leapfrog over Hershey and get to about 8.5% of market share right behind Pepsi. If you're working at any of these other packaged food companies, Pepsi, General Mills, etc., how are you feeling when you're walking into work today? Are you worried about the competition that Mars can bring? I think you should always be worried about the competition, but I also think this is a bare knuckles market. It's been a bare knuckles market forever. It's a low margin market. So the argument for consolidation is that if you can find redundancies, if you can streamline your supply chain, if you can squeeze out any amount of efficiency in terms of combined

operations, you're going to end up getting the margin that you need. And that, I mean, in a bare knuckles market where you really are going to live and die by how efficient you are, this kind of stuff matters. Scale matters. So, I don't think you should be nervous, per se, but I do think this is a market where it wouldn't surprise me at all if we see more consolidation to the degree that more consolidation is even possible right now. Tim, always a pleasure talking to you and going through the news of the day with you. Thanks so much for the time. Thanks, Mary. A&W. You gotta try breakfast at A&W. And what better way than with a delicious Pret Organic

Coffee, starting at just $1 all day, every day, now until December 31st. You gotta try breakfast at A&W. At participating A&W locations in Ontario. The solar power market's taken a beating, but is it still investable? Up next, Ricky Mulvey and Motley Fool contributor Jason Hall take a look at two companies in the space. So if you want to be a contrarian investor, then you've got to run towards sectors that other people are avoiding. The problem with this is that the crowd is usually right. One spot that the market has really soured on lately is residential solar and these residential solar stocks. Jason Hall, why has this space become such a mess?

It really boils down to just a couple of factors. We'll start with the beginning of something that started up in the market a little bit. California is a massive solar market. I'm really going to focus on the U.S. There's some similar things happening in Europe, too, that's affecting residential solar. But California, again, massive solar state. And they made some changes to their net metering policy. So, quick 101 on net metering. Historically, the biggest solar proponent states, for every unit of power your solar system makes, the utility is required to give you a credit for that same amount of power. What the problem is, is that that doesn't always make the economics work. And in California, they've had to make some changes to it. And

The way it works is, you might sell your power, and this is the way it works in a lot of states, the power you produce, you sell, and you get the wholesale rate. But then when you're buying power to consume, if you're not producing solar right then to offset it, you're having to pay whatever the market rate is. You might be paying three times as much for power at peak demand than you're getting for it on your solar panels. California has changed some of their net metering policy that's upended things. Then more recently, over the past year or so, year and a half, skyrocketing interest rates. you're still going to pay $30,000 plus after tax incentives for a solar system for most homes to

meet your demands. It's really expensive, and you have to finance that in most cases. It's just absolutely caused the industry to plummet. The interesting thing is that follow the stocks, and they've gone down. We've seen the revenues go down for a lot of companies like Enphase and SolarEdge that we'll talk about today. 2023 was still a record year. It was actually a record year. Fifth year in a row of record capacity installations for residential. 2024 is not going to be another record year. Let's focus on SolarEdge and Enphase. We've talked about Enphase a little bit on the show, but I'm not going to assume everyone knows what they do. How do these businesses fit in the solar power market and how do they make money?

As a starting point, they make the electronics that connect your solar panels to the grid and your house. Your solar panels produce DC current from the sun. Everything runs off of AC. That's the grid, so you have to invert that DC. Also, there were some big changes in regulations just a few years ago in North America and increasingly in European markets. It used to be the way it would work is, you'd have one inverter, and all your panels would connect to what's called a string inverter. These two companies were early innovators with panel-level electronics. At every single solar panel, in the case of Enphase, they put a micro inverter on every panel. For SolarEdge, they have a power optimizer at every panel. So it's safer

for grid workers. And also, it optimizes the amount of power you produce. And you don't have single panel risk. One panel goes haywire and causes a fire. Now you can shut off every panel individually. So they were ahead of the regulations there. And they have a duopoly now. They have around 90%, give or take, North American market share. They've also been early moving into energy storage. I talked about the net metering changes. One of the ways to get around some of the challenges with net metering is to have batteries. So you can buy power when it's cheap to store on your battery. Or if you have a charged battery, you can sell it into the grid when it's worth the most. They've both leaned into getting in front of those growing areas of the solar market.

And neither of these are on the sales side. They're purely making the products that other people sell and install, right? Yeah. You're not going to pick up the phone and call your local SolarEdge or Enphase company, you're going to call a local installer. Actually, they're probably going to show up at your house and knock on the door. They're going to send you a flyer or something like that. A lot of this is small, local, regional installers with a couple of large national players that do it. And where SolarEdge and Enphase have established a lot of strength is relationships with the panel manufacturers, that they'll include the equipment to the distributors or to the installers, and also relationships with distributors and

installers that the installers are buying directly from. That way, they're already there. Then getting in the door is the starting point. We're going to talk more about how they keep you locked into their products as you expand with what you have. You mentioned earlier why sales have taken a bit of a dive. We got interest rates and we have power, essentially, the way that energy is sold in California if you have solar panels. I mean, it seems like there's got to be more to the story. Trailing 12-month revenue for SolarEdge, at least, is halved from 2023. What else is going on for these companies? Halved is actually better. If you go back a couple of quarters ago, revenues were down closer to 70%.

So the way you have to think about these businesses is the way you think about any other manufacturer. They make the product, but they don't sell it to the end user. So there's a lot of middle ground in between. And what we've seen happen over the past year almost is the distributors, the resellers, the installers, they've been selling down their inventory. They're not buying new stuff. So, a lot of inventory depletion has happened. And that's why we've seen their revenues fall much more. 2023 was a record year. But if you look at their sales in the third quarter and fourth quarter of last year, we're talking 60%, 70% declines, because the ones that were closer to the customer, they were just selling through

their inventory and not ordering to replenish. Through this cycle, Enphase has been able to stay profitable on a free cash flow basis and on an operating income basis. SolarEdge, not so much. Not even not so much. They're well into the negatives on both of those. What's the difference between these two businesses? They've taken slightly different strategic approaches to this downturn and it's really shown in their results. Enphase made the decision to aggressively cut costs and also cut production. Both companies use a lot of contract manufacturing, so that gives you some flexibility. Enphase, they do a little bit less. SolarEdge also has some other products that they sell. But Enphase, they closed manufacturing facility in

Europe and they closed a manufacturing facility in the Northeast and consolidated into a couple of manufacturing facilities. They have one in the Southeastern United States and one in the West. And a couple of things happen by doing that. Number one, you just lower your cost of goods sold, right? You're not having those, those, you know, your, your fixed manufacturing costs come down a significant amount. That means that it's easier to get cashflow gross margin, right? The other thing that it did is because of the, some tax incentives tied to the inflation reduction act, bringing some of their manufacturing that was overseas, that was actually still supplying the U S market into the U S increased incentives. So they've been generating an

increased amount of, of tax incentives by shifting some of that manufacturing back into the U S in phase or a solar edge that hasn't done that. They've kind of stood pat and it shows as a result, I think in phase had maybe one quarter where they might've lost like a little tiny gap loss. They've generated free cash flow every quarter. You take a look at SolarEdge, and I don't think SolarEdge has had even a profitable quarter in over a year now. And they're pretty consistently burning cash as well. As a result, you look at their balance sheets and you see $400 million in net cash for Enphase. And SolarEdge now has maybe $50 million in net cash. You go back a couple of years ago, Enphase and SolarEdge both had several hundred

million in net cash. So the strategy just hasn't worked so far for SolarEdge. And it looks like Enphase has just really threaded the needle. Let's look ahead. Right now, both of these companies have a duopoly in the microinverter business. You mentioned they have a 90% share. But as we look in the coming years, do you expect more competition for them? We're already starting to see it. If you go back to 2019, Generac makes the generators. They have the No. 1 market share for residential generators. Anybody who lives in the Northeast, you're very familiar with those snow power outages and that kind of stuff where you need to have that backup power. They do a big business in commercial generators as well. The reality

is that they have to be defensive. Energy storage is going to take more and more of that power backup business away, but it's also an opportunity to be offensive as well. Back in 2019, they started making some acquisitions. They bought a lot of little small bits and pieces, but we haven't really seen them in a cohesive way put it all together. We're going to find out more, Ricky, next year in 2025 is when they have their first internally developed product that they're bringing to market. So, we'll see if they can be a real serious third competitor. We've talked a lot about these companies being in a down cycle, the dark clouds surrounding them, but are you seeing any green shoots for these businesses?

So, first thing, we're actually seeing some green shoots potentially in their core business. If you look at the numbers, revenues look like they may have bottomed in the first quarter. One of the things management from both companies talked about on their recent earnings calls was that it looks like channel inventories have stabilized and are starting to normalize again. So that means their customers are starting to buy from them again, still at much lower rates than we saw at the peak, but they're starting to add to their inventory and not just deplete inventory. That's a green shoot. But I think if you look even more broadly and think about more growth opportunity, we're still really early in energy storage. Energy storage has

continued to grow through this downturn for both, because the attach rates are moving higher, because of stuff like the net metering challenges, where to be economic, you need energy storage in a lot of markets to even think about going solar. We also see things like EV charging become more of an opportunity. What makes these companies really strong is the ecosystem. If you have Enphase, you use the Enphase app to monitor your system. You want Enphase batteries because you want it to all be tied together. If you get an EV, you're probably going to get an Enphase EV charger because it's all going to be tied into that same ecosystem. So things like EV chargers are on the horizon. And also moving into commercial, moving upscale. One of the reasons,

Ricky, they've been able to dominate this space is because residential solar is maybe a third of the total solar market. Utility-scale and commercial-scale solar combined are much, much bigger markets. That's why a lot of the big players moved away from residential and really focused on the biggest opportunity. We're starting to see these two move into that. Enphase has been working on commercial-scale microinverter. What that means is it's going to handle higher voltage, so bigger panels. They've started to move upmarket a little bit, too. It'll be interesting to see if their installer relationships, because a lot of commercial installers are the ones that do residential too. And they're increasingly

doing commercial because there's more opportunity because of the mess with residential. We're going to find out if those relationships pay off with their commercial products. So, for your money as an investor, as someone who looks at this space closely, are you taking Enphase? Are you buying SolarEdge? Or are you taking a basket approach? Historically, I would have said the basket, because they have been so dominant. Super profitable, too. The margins that they've been able to get, just great economic results, well run. Right now, though, Enphase, I think, is a buy. Neither really. As much as the stocks are down, I wouldn't say they're cheap because you're anchoring too much on where the market was two

years ago. And how long is it going to take to recover is another story. Enphase, I think, still is worth buying because they've handled this really well. They've continued to generate free cash, manage their costs. SolarEdge's strategy of saying, you know what, we're just going to soak up some losses because we think this is going to bounce back quicker hasn't paid off. I'm waiting for signs. It could just take one good quarter for SolarEdge's results to turn quickly. But I want to see some signs of a little bit of strength from the business before I would say SolarEdge is a buy. Long-term, I think the basket approach probably makes sense. But right now, I think SolarEdge, you have to have a little bit shorter leash. Let's end it there. Jason Hall,

appreciate the look at these companies, the industry. Thank you for your time and your insight. Thanks, Ricky. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.