Motley Fool Hidden Gems Investing - When AI Starts Building the Game

Starting point is 00:00:00 Emily Flippen, and today I'm joined by Fool analyst Jason Hall and Lauren Hurst to take a dive into the world of gaming and how AI is changing the landscape as technology continues to push the limits of possibilities. Today, we'll be discussing Project Genie, how gaming companies are looking to better monetize their content, AI or otherwise. But first, we have to take a hard left pivot here and discuss a piece of news that I personally found really confounding this morning, and that's payment processor PayPal. PayPal shares are down nearly 20% this morning after reporting earnings, despite some arguably weak guidance. But it seems like what the market is reacting to most is not the mild miss, but rather a big shakeup in the

Starting point is 00:01:02 C-suite that investors, including myself, really didn't see coming. After barely two years on the job, PayPal CEO Alex Chris is going to be stepping down to allow HP's current CEO and PayPal board member Enrique Lloris to step in as president and CEO. I mean, this to me reads like a clear firing from the board here. It seems like their board is unhappy with Chris's ability to push far enough into things like branded checkout. That was particularly weak in the quarter. I mean, Jason, I was just so surprised to see this move. And I was personally pretty happy with Chris's performance prior to this quarter. So it took me by surprise. I mean, what do you make of it? Yeah. I mean, this feels like palace intrigue in a lot of ways. I was definitely caught off guard.

Starting point is 00:01:44 And I think broadly, most investors were generally okay with the job that Chris has done over the past couple of years. Now the stock has not done great over the past year, but if you start pulling back the layers of the results this quarter. Maybe you see why some investors have been left wanting. Again, I think like the first part of the turnaround plan, refocusing on its best and most profitable products and users was delivering. More recently, we have seen the growth is slowed in a few areas. So there's a concern there. I think maybe the big thing is we've consistently seen a decline in transactions per active account in the quarter and for the full year, it was down 5%. So I think that's part of it. And then before today's huge sell-off,

Starting point is 00:02:36 PayPal shares were down about 27% since the day that Chris took the job and almost 43% from the high that was about a year ago. But what I'm really struggling with is less about the trajectory of the business and more about the decision to replace him with Enrique Louris. I'm going to be very careful with what I say here, but it's not like Louris has been some eye-opening CEO at HP. He was named CEO there November of 2019. Since then, revenues down, cash flows are down even more. Stock's up 11%. Before today's announcement, it's up about 6%. Now that he's out the door at HP, you add in the dividend, and it's up about 33% or 34%. But guys, we're talking about the stock price gaining 1% a year on average and 4.4% in CAGR. This doesn't feel like a leadership

Starting point is 00:03:36 upgrade. Um, like I said, it feels like palace intrigue and it's clear that management or that investors writ large, maybe they haven't been happy with the business over the past year, but a 20% sell-off says we don't love the change that's happening with the new guy that you're bringing in to supposedly fix the business. I'm going to foreshadow Lauren's take a little bit here. I think Lauren is probably right, but I'm going to have to sit with this one for a few days before deciding if the risk is worth the reward and adding to my existing already very beaten down position. Yeah. I really loved personally the vision that I felt like Chris communicated and execution there has maybe been challenging. Granted, Chris has been operating in what has

Starting point is 00:04:24 been a very challenging time for payment processors. And I really hate when boards act reactively to share prices. I'm the same way. I like my management to be long-term in how they think about their company and their performance. And if we're starting to fire CEOs over something like one or two-year stock performance, we're now incentivizing leadership teams to make short-term decision-making for fear of their jobs. And as an investor who likes to buy and hold companies like PayPal for the long term. I don't care necessarily how PayPal shares do in one or two years. I cared about the vision that Alex Chris had communicated. And it was a vision that I very much bought into. So I am interested to see what Loris comes in and says about what the direction he plans on

Starting point is 00:05:08 bringing PayPal towards, because I felt like Chris had the right mindset for PayPal. Clearly, the board disagrees here. But I kind of agree that it'll be interesting to see what the right pivot is here for the company. I'm still digesting the news myself. I don't quite know what to make of it. But Lauren, I personally thought shares of PayPal were cheap prior to this pullback. But now, shares are down over 50% in the past year. They're trading at a price-to-earnings ratio of around 8.5 times. That's a fraction of what the market's trading for. It's the cheapest the company has been on a relative basis in its history as a public company. Part of me screams value trap here. Part of me screens waited out. But do you like to give this a bit more air?

Starting point is 00:05:49 What's your take on the share price today? Yeah, I never want to dive into any situation blindly. But if our manic depressive friend, Mr. Market, is going to offer shares of PayPal at an earnings multiple typically reserved for the likes of a Peruvian fax machine reseller, I'm not going to spend too much time overthinking it and overthinking my instinct to be a buyer here. I made the comment in our team meeting earlier that PayPal is approaching the relative valuation of Caspi, which is a really interesting fintech offering a super app in Kazakhstan that the average customer uses an incredible 76 times a month. But PayPal doesn't come with all the geopolitical risks of a user base almost entirely located in an authoritarian state

Starting point is 00:06:34 between Russia and China. It's really cheap here looking at PayPal. Before I read the press release, I expected top and bottom line growth to be completely flat and maybe see some declining users in transactions. And we're still seeing 9% growth in total payment volume, mid-single-digit growth in revenue and operating income. And even if this means that PayPal's growth story might be largely in the rearview mirror, it now offers a trailing 12-month net buyback yield in the low teens. I've owned shares for years, and I think I'm still a buyer here. Yeah. I hate to be a buyer when I don't know the management team. So maybe personally, I leave it to have some space here. But I agree with your sentiment, Lauren. I think it's easy

Starting point is 00:07:15 for investors to forget all the properties that PayPal owns, all the checkout experiences PayPal owns, and of course, Venmo too. Let's not forget that. There's a lot of optionality built into this business. Certainly one to watch. But coming up next, we'll of course have to be diving into our topic for today, which is Project Genie and the hammer it took to gaming stocks this past week. This is Motley Fool Money. 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.

Starting point is 00:07:53 We see the endless funds fueling the AI hype, while others follow the noise, we follow the money. Learn more at Bloomberg.com. They're not fully immersible yet, Jason, but obviously, we're in shoot first, ask questions later mode. But it is really hard to not imagine the future of gaming to be some version of AI prompting. Obviously, the market is assuming that if game creation gets easier, then the tools and the platforms that create and sell games are inherently going to be worth less. Do you think that's a fair assessment? Video games are software, and we know that AI is already disrupting coding broadly. So we know this is already happening, but I think that it's a little more

Starting point is 00:09:00 nuanced than that. To start, I'm on record with having the position and I continue to believe that writ large, the video game industry is not necessarily really a great place to invest. It's sure it's massive. Global gaming revenue is bigger than the film industry, bigger than the music industry. It's bigger than professional sports, which surprised me when I learned that. It's just not growing very quickly. We're talking global GDP growth numbers writ large. And less than half of the 3.5 billion people on the planet that play video games actually pay money. But with that said, the industry's bifurcated a long time ago to these large, immersive games from these big platforms and the quick pace of play, easy-to-play mobile games that have some addictive factors to them.

Starting point is 00:09:50 Um, and AI writing code is definitely going to read, uh, lead to losers, um, and some winners. I think what we're going to see those that the existing platforms that end up being the winners are going to leverage AI internally to speed up product development, eventually drive out development costs. Now the other end of the spectrum, we may see AI drive more independent winners. Um, but I think about it this way, if Nintendo can leverage AI to produce a better Super Mario or Zelda or one of their other dozen valuable properties games more quickly, it will. And it controls distribution. You still need hardware to win. And I think that means that the Nintendos, Microsoft with Xbox and Sony with PlayStation, they still have somewhat of a moat.

Starting point is 00:10:33 It changes things for PCs and mobile gaming where the threshold for competitive entry may get a little bit lower over the next few years. But then you think about Roblox, it has some compelling things too, because of its network effect that it benefits from and the incentives for small developers to build on its platform where they can quickly monetize the product. But I'm getting ahead of us. We'll talk about that a little bit more later in the show. And we certainly will. I also have a lot of thoughts there. But Lauren, I mean, when you saw the Project Genie demo, was this something that you just kind of wrote off as a nothing burger, so to speak? Or is there something there? Does it make you more or less bullish on gaming companies versus big tech

Starting point is 00:11:11 giants like Alphabet? At first glance, I do understand Unity software taking a bath on Friday if Google could hypothetically be an eventual competitor with the tools from Unity or from Tencent-owned Epic Games to be the gaming engine that handles lighting and textures, simulating physics, handling player inputs, non-playable characters, all the pieces that go into the actual game experience. But the only time that video games were actually mentioned in Google's blog post was the third-person perspective of the character exploring one of these 3D worlds. So I'm surprised that stocks like maybe Autodesk or CoStar, which just paid $1.6 billion last year for Matterport, aren't reacting as strongly on the news when there's

Starting point is 00:11:59 a new technology of translating 2D images into a walkable 3D environment. It looks much less a differentiator for those businesses this week. But in general, the notion that Project Genie might be immediately threatening major studios is just plain wrong, in my opinion. So far, it can create limited interactive environments, but it's not a game without an objective. And in my opinion, it's not a good game without some sort of narrative progression rewards. We didn't see anything like that in this early demo. So if I were a 3D modeler or an animator in a video game studios art department, I might be a little wary right now that the process of creating the visual assets that go into a game might no longer need a human in between

Starting point is 00:12:43 concept art and the early rendering. But as a gamer, I want artists, not algorithms to be polishing the final visuals of any console video game. So the types of procedural generation that make games like Minecraft or No Man's Sky infinitely replayable have been in development since the 1970s, but game developers still have to define all the rules and all the constraints that make those machine-driven shortcuts possible. I agree that this impact might be bigger on mobile games right now, but if your gaming startup is three Dan Housers in a trench coat, referring to the co-founder of Rockstar Games and the lead writer on franchises like Grand Theft Auto and Red Dead Redemption, this is nowhere close to being able to upload a script and just have a

Starting point is 00:13:27 fully functional game created around it. So I think publishers like my favorite, Take-Two Interactive, should actually be worth more if game development is getting easier here. And hopefully they're the ones that ultimately end up successfully integrating those AI solutions into the games as they work through development. And hopefully the value accrues everywhere across the chain. To me, it always sounds a little ironic that we see companies like Roblox and others get caught up into the mix when their businesses are still so heavily ad-based and engagement-based. The more games we have, the better the engagement. So up next, we're going to be discussing more about how AI is helping the world of gaming, in particular with advertising. This is Motley

Starting point is 00:14:03 Full Money. 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. Welcome back to Motley Full Money. As we wrap up today's show on gaming, I want to pivot over to the gaming platform Roblox. Roblox just recently announced a new premium ad format called Homepage Feature that allows its 100 million plus daily active users to see ads at a scale previously unknown. Now, this plays well into the idea that in an AI-accelerated world, so to speak, there are probably more games easily put on Roblox's platform, and maybe that makes more opportunities for advertisers. Lauren, that one-for-one makes sense in my mind. I mean,

Starting point is 00:14:47 part of the thesis for Roblox was always that more games equals more engagement, which equals more monetization. But given the market's reaction last week, it seems like there's a big disagreement here. They see Roblox more as a game engine than a game distribution platform. What do you make about it? Well, on one hand, building an ad platform isn't so special these days. I could say the same about Netflix, Spotify, or Chewy as just some examples of fool favorites that are building their own AI-empowered tools for advertisers to connect with the right visitors on each of their platforms. Unlike hitting the skip button on a disruptive YouTube ad. Roblox's ads are more immersive, though. For example, instead of watching a video

Starting point is 00:15:26 ad that takes over your entire screen, you might be able to watch it in the virtual carnitas cinema within the Chipotle burrito builder Roblox game. You can only imagine that the viewers would have a much more positive reception to that than something that prevents them from continuing on their experience. Now, I could have said something similar about Pinterest five years ago, where its ads are a native part of product discovery on that platform. But as long as Roblox is the platform where users already are, millions of them every month, any development like Google's Project Genie are only going to increase the content on Roblox's platform. So I think there's more upside here than any new risks.

Starting point is 00:16:10 Jason, as you wrap up today's show, I want you to come from it from the perspective of a gaming company. If you're investing or you are a company, where do you want to be in the value chain here? Where do you think is the least disruptible from the perspective of artificial intelligence and gaming? Yeah, I know. I talked a little bit about it before, but I think when it comes to mobile, the distribution barriers are already so extremely low. And the freemium game producers, the ones that make money off that half of global gamers that don't actually buy anything, they have to churn through games to find the next addictive hit. And I think we're going to see that velocity maybe increase. And I think the one that I'm most interested in, sadly, is Valve,

Starting point is 00:16:51 which owns Steam, but it's private. So, I'm just wasting everybody's time either bringing it up here. But those platforms, I think they're going to be the ones that are in the best position, the ones that are really the gatekeepers for content. Again, I mentioned them before, the owners of Xbox and PlayStation. But Microsoft and Sony are huge companies, and these are just small parts of, of the business. Uh, Nintendo is an obvious, uh, one that's in a really good position. Uh, you know, again, the advantage they have, uh, is more than just owning the platform. Think about AI slop on social media. These gatekeepers should be the ones that prevent all of that content. That's just not great content from ending up on a platform where

Starting point is 00:17:36 you're paying upwards of $60 for this high quality stuff. So I think there's a lot of value to that for the users of, of those particular platforms. Now it's going to be interesting too, for Roblox, I've often compared it to YouTube because the incentives are very much the same where the content producers take on the risk and costs to generate the content. And then they share in the revenue that's generated from it on the platform. So there's a tension between quality and getting new content on the platform, that Roblox is going to have to continue to manage that tension. I think they've done an okay job of that. But they're going to have to spend more money now if they do see a significant increase in AI-generated content. They're going to have

Starting point is 00:18:20 to start building AI products to help them vet the new games as they're coming on, or the human capital cost to do that is going to be exorbitant and it's not going to work out too well. That's always been one of the benefits of Roblox, though, is they have the network that they had to spend so much time and resources on maintaining and managing, especially because it's aimed at use. And there's a lot of big tech giants who probably could recreate it, but don't really want to spend the time or energy to do it because the barriers there and the challenges, whether they be regulatory or otherwise, tend to be high. But I appreciate that point, Jason. There's going to be a limit between quality and quantity when it comes to AI initiatives. Either way, it's clear

Starting point is 00:18:58 that AI is changing the game as it applies to gaming. And a new CEO is changing the game at PayPal. So that's something that we'll continue to keep our eye on. So stay here for updates on Motley Fool Money. Jason and Lauren, thank you both so much for joining today. Listeners, thank you all for tuning in. As always, people in 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 sell or buy stocks based solely on what you hear. All personal finance content follows the Motley Fool editorial standards and is not approved by advertisers. Advertisements or sponsored content provide for informational purposes only. To see our full advertising disclosure, please check out

Starting point is 00:19:30 our show notes. For Jason Hall, Lauren Hurst, and the entire Motley Fool Money team, I'm Emily Flippant. We'll see you tomorrow.

Motley Fool Hidden Gems Investing - When AI Starts Building the Game

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