Motley Fool Money - 0.75 Rate Hike Gets Thumbs-Up From Investors

Episode Date: June 15, 2022

The Federal Reserve raised interest rates three-quarters of a percent, the biggest hike since 1994. (0:25) Ron Gross discusses: - The positive reaction in the stock market - Prospects for much lower inflation in 2023 - Borrowing costs going higher - Expectations for more rate hikes later this year (11:40) Asit Sharma talks with Pubmatic CEO Rajeev Goel about why his company is becoming more predictably profitable, and the growing opportunity in connected TV. Got a question? Drop an email to [e-mail]! Stocks discussed: PUBM, PG, WPP Host: Chris Hill Guests: Ron Gross, Asit Sharma, Rajeev Goel Producer: Ricky Mulvey Engineers: Dan Boyd, Brandon Gentry Learn more about your ad choices. Visit megaphone.fm/adchoices

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What? Oh boy. Fantastic. You guys go hard. Daredevil Born Again official podcast Tuesdays and stream Season 2 of Marvel Television's Daredevil Born Again on Disney Plus. It's the biggest interest rate hike since 1994. What it means for businesses is coming up next. Motley Fool Money starts now.

I'm Chris Hill, and I'm joined by Motley Fool Senior Enlist Ron Gross. Thanks for being here. Yeah, my pleasure, Chris. Let me timestamp this because normally we record this podcast earlier in the day. It is 2.49 p.m. on the East Coast, and we are recording much later than usual because of the Fed. because at 2 o'clock this afternoon, the Fed came out with what we thought was going to happen, which is always comforting, I find, with the Fed coming out and saying, we're raising interest rates 0.75%.

I think that's what most people were expecting and what most people were looking for. The headline, of course, is this is the biggest rate hike in 28 years. We'll get into some of the particulars in a minute, but I couched that by saying, saying most. Is this what you expected as well? The market had a 95% chance that had placed that bet that it would be 75 basis points. So, as I said to our chief investment officer this morning, the safe bet is that 75% basis points will be the number. We said back and forth, if it's 50 basis points, the market's going to be down 4%. If it's 100 basis points, then you're up to the whims of the market, because you can get some people.

saying, yeah, way to go, Fed, way to rip the Band-Aid off, let's get this done. And then you get the other half going, oh, gosh, this is much worse than we thought it would be. So I wouldn't even know how to predict what would happen if they had gone to 100 basis points. Just recently, they were saying 50, and that 75 wasn't really on the table. So that gives you some indication of the need that they feel to really be aggressive here. If you look at their expectations, Right now, that rate, that benchmark funds rate, is at 1.5 to 1.75. That's after this raise, this increase. They see it going to 3.4% by the end of this year. So it was still a significant amount of hikes on the way. They also cut their outlook for this year's economic growth. Now they expect just 1.7% gain in GDP.

That's down from 2.8% from March. So you see the economy slings. slowing. And it's probably important to note that the inflation projection, as gauged by the personal consumption expenditure index, also rose to 5.2 percent this year from 4.3. So, you know, what we're having here is you got interest rate rising because the Fed is taking them there and then the market takes the two-year, the 10-year mortgage rates higher as well. We see expectations for economic growth slowing, which is, by the way, after all, the idea here, it's literally what the Fed is trying to achieve to cool the economy, to bring down inflation. The trick is not to slow us down so much that we end up in a recession, which many people

are already calling for. A soft landing, a so-called soft landing, is the desired outcome where we remain positive on the growth end while at the same time bringing down inflation. And that's not the easiest thing in the world to achieve. They're going to go for it. You see the market almost immediately traded down on the headline news of a 75% basis point increase. Now you see the market rallying significantly. As we speak, the NASDAQ is up 3.5%.

The S&P is up 1.13%, not as robust, but still strong. And the Dow up 1.5%. So the market is digesting this. They think they like what they see. Powell came out and actually spoke. I'm trying to decipher all this while on the fly while we're talking. But I think, obviously, he made some comments that people were happy to see. And even in the statement, the Fed was pretty optimistic, or at least they pretended to be.

Saying things like overall economic activity appears to have picked up. Job gains have been strong. Unemployment remains low. Inflation is elevated, reflecting supply and demand and balance. related to the pandemic, higher energy prices, broader price pressures, quote, broader price pressures, lots of them happening that we all see in our everyday world. But this is important. They did see inflation moving sharply lower in 2023 down to 2.6%. That's almost kind of normal. They also reiterated they're committed to that returning to that 2% inflation objective that they've had for so long.

But if they're right, and we honestly don't know if they are, we're going to get close to that by the end of 2023, which is probably what the markets are reacting to. All right. So there's a lot there and a couple of reactions to what you just said. First, I appreciate that you reminded everyone that I don't want to say this isn't about face by the Fed because it's not. But the last time we were in this situation, J. Powell was asked directly about a seven. five rate hike and basically said, no, that's not something we're considering. And clearly, in between then and now, they have considered it because they've done it. The inflation for next year, I think, is really important. And again, thank you for doing this because you and I are slightly disadvantaged by the fact that Jay Powell's press conference is going on as you and I are speaking. So more information is going to come out. But on the balance, this does seem to be good. I'm wondering, who is this bad for? This is one of those situations where it appears to be what needs

to happen, cooling off the economy. As you indicated, there are a lot of macroeconomic data points that are strong. You look at unemployment, wages, consumer spending in general, all those things are strong. A rate hike of this size, with more to come, my money. likely later in 2022. Who's not happy about that? Well, in general, businesses, companies are not happy. Borrowing costs are now significantly higher and going higher still. Again, that's the point. That will slow the economy. That is the goal here. Doesn't mean you have to like it, but it is necessary because inflation is more troubling than a slower economy is. So you have to just accept that.

If you're buying a home, you're probably not the happiest camper in the world. Interest rates used to be 3 percent and seemingly overnight or above 5 percent, maybe even approaching 6 percent at this point on a 30 year. So that's not great. You can afford less of a home. I don't necessarily, I'm not necessarily seeing house prices come down as a result, but I think that's bound to happen. We've even seen some real estate companies like Compass and Redfin announce layoffs in the recent

days. So that's interesting. But if you're sick of paying $5 a gallon of gas or forget about sick of it, if it's really troubling you and it's very burdensome to your family, you need to see these prices come down. Same with food. You need to see these prices come down, even if that means we're going to have to live with slower growth for a while.

Again, hoping that it doesn't turn into negative growth, which would be a recession. But even if that happens, we'll get out of that too. I'm kind of an optimistic realist. And the way I think of it is even if we do go into a recession for a short period of time, we will build our way out of it. We always have. Sometimes it takes longer than others, depending on what decade and what the reason is. But we will return to some sort of normalized growth.

the market will move higher. We just have to be patient and be long-term focused. Just real quick on the housing. You're right. Across the board, we haven't really seen housing prices come down. We have, as you indicated, we've seen layoffs in the industry due to the fact that activity, buying and selling itself seems to be dropping off. So, presumably, that makes its way to prices at some point. In terms of the next, the NASDAQ, and then I'll let you go. Are you surprised that the NASDAQ is reacting the way it is? Because we had seen earlier in the year part of the sell-off of particularly younger NASDAQ

tech companies that aren't yet profitable, part of that sell-off was due to the narrative, like, well, look, if interest rates go up, the cost of borrowing money is more expensive for these companies, and it's harder for them to raise money. or it's more expensive for them to raise money. Given all that, are you surprised that the NASDAQ is, at least in the time since Jay Powell started talking at 2.30 has rebounded the way it has. Yeah, NASDAX is actually up 2% now, so a little bit of the steam has come off. But I'm a little bit surprised.

It's a balancing act. Higher interest rates are definitely detrimental to growth companies whose stock prices and valuations are dependent on future cash flow streams. So it is bad, interest rates are negatively impact that. However, a economy in shambles is worse than that. So you just have to pick your poison and you pick the least lethal, I think. Plus, tech, NASDAQ, innovative tech has been hurt so bad that perhaps, you know, where the market is telling you, we're somewhere close to a bottom. I don't know if it's now or within 5 percent or even 10 percent or it's happening already. And it's okay for these stocks to come rebounding, even with higher interest rates affecting

valuations because some of these stocks are down 30, 40, 60, 70, 80 percent. So I think that's probably what we're seeing as we see a rebound. Ron Gross really appreciate the time. particularly late in the day. My pleasure, Chris. Thank you. One part of the economy where spending continues to rise is advertising. And one of the companies benefiting from that trend is Pubmatic.

Pubmatic helps publishers sell advertising using automated systems. If you're playing a free mobile game, there's a good chance Pubmatic is selling those ads. They process more than 340 billion ad impressions every day. Asa Charma caught up with Pubmatic CEO, Rajiq. Rajiv Goel to talk about why his company is becoming more predictably profitable and the growing opportunity in Connected TV. Rajiv, I wanted to ask you about this most recent quarter that you all reported. Interesting to me, so last time we spoke, I asked you about your long-term growth cadence.

And one of the things you mentioned was you had an increasing confidence level in being able to predict results. Back in December, you said, hey, we'll be growing next year, somewhere around 25% year over year. And between then, we've had, I think, another little surge, mini-surge in the coronavirus pandemic around that time. We have a lot of geopolitical turmoil interest rates have spiked. And yet the first quarter was largely, according to plan, One of the reasons you cited about your confidence was the increasing importance of something called supply path optimization. Could you explain that concept again?

I noticed that in this quarter that you reported, that played a large role. It was 27% of activity on the platform almost seems like a way to look at more predictable cash flows when you look at this business. So could you explain this concept to us and the increasingly important, role it has in Pubmatic's future. Yeah, absolutely. And to your point, we had a terrific Q1. We were right on target with revenue growth, 25% year over year at 55 million. And we beat on profitability. Justi Bita was 17 million or 31% of revenue. Gap net income was 9% of revenue. And importantly, I think particularly in this environment, 19 million of cash flow from operations.

And so I think, again, you see that really strong balance of revenue growth. and profitability that we have historically delivered and continue to deliver even within a challenging environment. Now, one of the dynamics in the business, as you mentioned, is supply path optimization. And this is a process by which the major buyers of advertising, so think of big advertisers like a Procter & Gamble or agencies like Group M, WPP, and others, they are consolidating their ad spend onto fewer larger technology platforms like Pupport. Maddmatic. And they're doing this because, you know, particularly in this environment,

you know, everybody has to become more efficient as well as becoming more effective, you know, when the economy is facing, you know, some of the headwinds that you mentioned. And so if you're a major buyer of advertising, you're looking at your digital advertising supply chain and saying, okay, how can I achieve the goals that I want to achieve, but do it, you know, with fewer partners, partners that are more innovative that can, you know, help, with bigger parts of my business and partners that are going to deliver, you know, more value in the future than they've delivered in the past. And that's exactly the position that we have put our company in, which is to really be known as a leader in driving increased ROI, so return on

investment for the buyers of advertising, such that they go out in the market and say, you know what, I want to spend more with Pubmatic. And we do that through technology integrations, through automating workflows through data, through the efficiency of our platform. And so, you know, to your point, you know, two years ago, Q1 of 2020, 10% of the activity on our platform was via supply path optimization. And at the end of Q1, it was 27%. So obviously, huge share gains in just two years. And that's in a business, you know, that, you know, grew over 50% last year, right? So the underlying rate of growth is very significant. And so that's a key driver. of revenue visibility for us because we know that, you know, these big advertisers and agencies,

they spend on a pretty consistent basis year in and year out on advertising. And as we grow that portfolio, you know, that smooths out the volatility even further. And it does give us, you know, increasing visibility into our revenue growth. You all cited that revenue from Connected TV grew, I think it quintupled versus the quarter of a quarter. Can you talk a little bit about this opportunity as it relates to PubMatic specifically? Yeah, so Connected TV is, you know, obviously a very exciting, high growth area of the ecosystem. It's a roughly $30 to $35 billion opportunity in the next couple of years. And obviously, there's, you know, consumer time is shifting from linear TV to streaming.

And so then the ad dollars need to follow. Now, the reality is that the vast majority of how connected TV transactions are done today, are through the traditional or old school insertion order process, right? Where a buyer and a seller connect and they do a deal. And that's a very non-automated or non-programmatic way of transacting. And there's nothing wrong with it other than the fact that it doesn't create as much value for the buyer or for the publisher as can be created via modern methods, via programmatic methods of transacting.

So we know that, okay, when we use data, when we automate things, when we move to an auction type of format to support the scale of thousands of different apps that are supplying inventory and then tens of thousands of advertisers that want to buy it, that creates a much more efficient and effective market where advertisers can get higher ROI. And when they get higher ROI, they're willing to spend more. And so publishers can generate more revenue. And so that's really our vision for how CTV will be transacted. And that's exactly the platform that we built. So within this, you know, high growth auction environment, we have now 176 publishers as of the end of Q1, up from zero, two years ago. You know, the growth rate, as you mentioned, is significant. And so

we have, you know, hundreds of publishers inventory representing, you know, even greater number of apps. And we, we highlighted in the earnings call, you know, the variety of different types of content. We have content owners like the TV manufacturers, so we're working with three of the top five manufacturers. We have tier one broadcasters. We have more niche apps that are more specialized, slightly smaller audiences. We also have the free ad-supported TV folks, right, where you can watch for free variety of different programming content. So we have built a marketplace for all of these folks. And I think what you're seeing is strong validation of that approach,

where, again, that publisher growth, the overall growth rate, our Group M, supply path optimization announcement, you know, all point to the fact that this is the future of how CTV will be transacted, and our approach is really resonating in the market. What would you say to an investor who's a little worried about the current macro environment? I mean, we've seen interest rates rising, inflation is creeping up and hitting the consumer in the pocketbook. So for the investor who's a little worried about what this might mean for the digital advertising agency over the near term. How would you frame that if you're having a conversation with an investor?

Yeah, absolutely. So I think there's a couple things that investors should keep in mind. First is that what we've seen in prior, let's say, economic dislocations or periods of stress is that there's actually a shift towards more accountable, more measurable forms of advertising. right? So advertiser budgets may be in flux. They obviously, they don't go to zero. And so what do advertisers do? They think and look at what are all the channels of advertising that I'm engaged in can be traditional means like radio or linear TV, can be digital means, of course. And they say,

okay, well, which are the areas that are the most flexible that I have clearest measurement of the return on investments, where I can clearly see, is this working? or is it not? And they tend to shift more of their ad budget into those environments. And we saw that, you know, real-time bidding arguably came out of the 08, 09, you know, time frame 2010, you know, financial stress. And we saw that again, you know, midway through the last decade, this type of acceleration towards digital and programmatic. The second thing I would say is that, you know, my focus is really on how do we continue to innovate, deliver value for our, customers and use these periods as market share gain opportunities. So there's, you know,

there's going to be whatever the economic environment is going to be. We obviously go into this environment with a very healthy business, you know, no debt, 175 million of cash on the balance sheet, long track record of profitability, you know, significant EBITDA margins, you know, well over 30%. So I think we come at this from a position of strength to really say, hey, look, whatever the near-term dynamics are, that's what it's going to be. How do we find the right path to continue to invest, given the strength that we have, and keep innovating so that when the market does become more stable, we can use that as a market share gain opportunity. And by the way, we did exactly that two years ago during COVID, you know, where in Q2 of

2020, we had 4% shrink in terms of our revenue growth rate. Others were down about. 20%, but we still delivered mid-teens EBITDA emergent. And so I think you would be challenged to find any technology company back in Q2 of 2020 that could still deliver that level of profitability, even with revenue coming down. 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 ourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.