Motley Fool Money - Beth Kindig on AI, Semiconductors, and Tech Cycles

Episode Date: February 12, 2023

ChatGPT is getting plenty of attention, but there are other uses for artificial intelligence that investors should watch. Beth Kindig is the lead technology analyst for the I/O fund. Deidre Woollard caught up with Kindig to discuss: - Where we are in the cloud adoption cycle  - A key narrative playing out in semiconductor earnings - What to learn from companies that went public too quickly Companies discussed: MSFT, NVDA, TSM, META, AMD  Host: Deidre Woollard Guest: Beth Kindig Producer: Ricky Mulvey Engineers: Rick Engdahl, Heather Horton Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi everyone, I'm Charlie Cox. Join us on Disney Plus as we talk with the cast and crew of Marvel Television's Daredevil Born Again. What haven't you gotten to do as Daredevil? Being the Avengers. Charlie and Vincent came to play. I get emotional when I think about it. One of the great finale of any episode we've ever done. We are going to play Truth or Daredevil.

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. Money could potentially dry up. I am very firm on the fact that the dot-com bust is not what we're looking at because technology today plays a much greater role and a very, very important role.

But I will say that some of the parallels around the private markets are there. I'm Chris Hill, and that's Beth Kindig, the lead technology analyst at the I.O. Fund. Deidre Wollard caught up with her to talk about how the big macro, has changed everything about tech investing, what to watch as semiconductor companies report earnings, and the uses for artificial intelligence that don't get as much attention as they probably should. You're focused mostly on individual companies, but we've got to talk a little big macro here. How has the macro environment changed or has it changed any of the ways that you're thinking about investing right now? It has changed everything entirely, I would say.

Interesting. Okay. Yeah, 180-degree pivot toward how important macro, how important S&P 500 is, even for tech investors, because the S&P 500 is, you know, the culmination of many macro factors represented in one price movement, basically. So we actually, I would say the best analogy is that macro is in the driver's seat. And we like to track the S&P 500. for that in terms of price movements. Bottom line is in the passenger seat, and I would say growth is in the trunk of the car. That's how much growth has moved down in terms of importance. We, at the IEO fund, everything we do is actually macro-informed, and we made that hard pivot back in April and May. So if macro and S&P 500 is not participating, for example,

we would not enter a stock. If S&P 500 stops participating, we would trim stocks. And that's because macros, like I said, truly in the driver's seat. We see that, obviously, when the Fed comes out and speaks. But at the same time, there's so much more underlying levels of uncertainty that need to be monitored. I would say the number one would be the consumer, actually, we think is weaker than the market today is taking into account. Fascinating. Okay, so growth is in the trunk of the car. That is a, that is a tectonic shift. So how does, you're talking about the consumer, but how does that impact some of the tech companies that you're seeing? I'm wondering about things like the cloud in terms of B2B, which then eventually becomes B2C. What are you seeing in terms of that? Yeah, that's a great question. And, you know, in terms of growth being in the trunk, so to speak, we see that actually, I think, you know, meta had flat growth.

or negative growth by single digits and people are looking for that bottom line, et cetera. So I think we've seen some evidence even already of how little priority growth is being given. But in terms of your question with B2B and B2C, I think it's an excellent question because B2C budgets move faster, you could point toward many things that crash ad tech, but the umbrella or the one common denominator is that ad budgets were greatly reduced, and they are completely every single company. It doesn't matter if you have 2 billion users or just a couple hundred million.

If your mobile desktop, CTV, across the board, they were all penalized greatly due to how much budgets had come down. And so now what we're up against is cloud investors is cloud budgets, which the enterprise moves slower. They determine these budgets usually in the early part of the year. What I would say is most concerning about the cloud software slowdown is that enterprises were actually pulling budgets, reducing their budgets that they had already set for 2022 for Q4. That's a red flag, really. So what we could see is some exuberance, which is what we're seeing in the market now.

I'm talking not respective to price action. I'm saying underneath the fundamentals are weak enough that eventually price will be adjusted. long-term, whether we get an exuberant month or two in the market or not. So that would be something to really closely watch is why were budgets pulled? The deceleration from Q3 to Q4 last year, I don't think Cloud has ever seen that deceleration, not that I can recall. It was nearly a 70% deceleration. There should be typically in 2021 a 17% growth between Q3 and Q4 because it's like a budget

flush, you hurry up and use the rest of your budget. The sequential growth on average across best of breed is now 5%. So from 17 to 5, we're not negative yet, but that's a substantial deceleration. And if we have one or two more of those, quarter to quarter, cloud would be in bigger trouble. So we've taken about a 30% allocation down to about a 10%. We still participate in cloud, and this is across various positions, but we're not overweight cloud. until we see what's going to happen. Again, we could have one or two, three, four best of breeds beat. This is not about getting lucky.

This is about being directionally aligned with the fundamentals of not only a vertical such as cloud, but the companies in our portfolio. Interesting. Okay. So, and of course, we're seeing a lot of layouts. We're seeing a lot of right sizing and kind of, I believe, Mark Zuckerberg for meta. He called it the year of efficiencies. Is that something that you're watching for different companies?

How well they're sort of trimming those expenses to match expectations? Yes. And that's actually another great point about cloud is that it tends to be fairly weak on the bottom line. So they would have to cut quite a bit in order to improve the health of their bottom line. That's actually unique from one of the worst performing sectors last year was ad tech. They, you know, ad tech as a whole tends to be cash efficient. they can pull some levers. Cloud tends to not be cash efficient. So that's yet another headwind. What levers are going to be pulled? What will it result in? And will it ultimately make, you know,

a best of breed weaker to a company like Microsoft, which has, you know, more room to pull levers? I love the quote that Satya and Della had just said, and I'll probably mess it up a little bit, but he basically said there's one law of gravity, which is inflation-adjusted growth, which all companies, are subject to. I think that that quote is like the theme of 2023, which I guess meta repackaged as efficiency. But what I would say is the more that we're in, you know, a higher, you know, inflation rising rate

or an environment combined, the longer it will be for companies to grow. The harder is for companies to grow. The worst their bottom lines will be. The worst their bottom lines will be, the harder it'll be for them to raise money or continue to operate. So it's kind of a snowball effect or a domino effect, which I think Satya Nadella really put it nicely about that gravity,

because we all know gravity affects every human. And he's basically saying it'll affect every company. And there's not going to be too many outliers. I always think there will be a couple outliers because I'm optimistic, but he's basically saying it's a law rather than, you know, something more subjective. Interesting. Well, I want to talk a little bit about cycles in general. You just talked about cloud. Let's talk a little bit about semiconductors and what's happening there. One of the things that I'm hearing, I heard this from Taiwan semi.

You heard this also in the AMD earnings was like they're almost saying K4 was great. First half of 2023. Don't think about it's going to be terrible. And then we're going to be great the second half of 2020. What are you seeing in the semi-conductor cycle, both in the short-term and the long-term? Yeah, if we're underweight cloud, and so we see what these companies are capable of with this reduced spending or lower budgets, I would say we're overweight semis. And a lot of it is not only some of the visibility that we're getting across a few different companies, I hope Nvidia echoes what AMG and TSM are. saying because the more companies that agree on an H2 rebound, the more confident as investors we can be about it rather than just one siloed comment from a management team. So I like the fact TSM and AMD both lined up on those comments. Secondly, what I would say is that they have

better visibility. So in one way, I guess the markets used to be very timid around, you know, how they basically run in cycles. But to some extent, NVIDIA, AMD, TSM, they have better visibility because these budgets have to be allocated far in advance. That's helpful, especially given the reduced spending we may see from enterprise budgets or consumer budgets or consumer marketing budgets, marketing-related budgets, I should say. Ultimately, though, we are overweight, not only for the fact that that rebound is nicely timed to the collapse that NVIDIA had with crypto mining.

AMD had with PCs, that was a Q3 collapse, if you will. So their comps are much easier come the following year specifically in Q3. But I also like their AI positioning. And as much as you're hearing about things like chat, GPT, you know, the T and that stands for Transformer, Nvidia powers that. And so what I like is if you're going to give me depressed prices and if you're going to give me a shallow or deep recession, jury still out on which way it'll go. I want to build my AI positions as cheap as possible. And therefore, I feel like it's a win-win where I'm getting

to build cheap AI positions given all the deep discounts we have. But I also have some visibility into how it might close out the year of these companies, which presumably will be higher price than where we're starting because of that H2 rebound, which has now been echoed across two management teams, and I'd love to get that third in about two weeks from now from Nvidia. So that's what we're looking for. IPOs have to come back at some point. It's probably not going to be a super robust year for venture capital and for IPOs, but what are you looking for in the long term? Do you think venture, are there lessons that venture capital learned during this time period? Are companies going to wait longer before they, before they IPO? Is there a little more

cautious since it's now baked into this cycle? Yes. So money can potentially, to potentially dry up. I am very firm on the fact that the dot-com bust is not what we're looking at because technology today plays a much greater role in a very, very important role. But I will say that some of the parallels around the private markets are there, which is just this exuberant level of funding. So many companies were able to raise rounds. And according to some of the research that we've done, that has not caught up yet to the VC market, and it's more likely that it will hurt the VC market this year. What happens is that you're a mid-sized startup and you're not able to raise more money, so you start to go out of business.

The more that go out of business, the more zeros VCs have, the harder it is for them to raise their next round for funding from their limited partners. So it has a domino effect. It takes longer than the public markets. And I think what you saw in the public markets this last year is going to catch up to VCs. It just is going to take a little bit longer of a squeeze, which is startups run out of money. They go to raise money. The money's not there. The VCs who funded that Angel, that Series A, whatever it is, you know, lose that money because there's no more to raise.

And that is important because a lot of the, I mean, almost all of them, you know, the new growth, the high hypergrowth, new growth companies come out the gate through a public offering. So the IPOs will slow because fewer Series C, let's just say Series B, Series C rounds are going to happen, which means there'll be fewer that get up to maturity, Series D or F, that then will go public. And without that, we're going to have far fewer hypergrowth on the market. and then that affects tech in general as well. So one thing I would characterize about the dot-com bust, let's just say,

is you did have like an Amazon and a Netflix, but there were just very few hyper-growth companies coming onto the market, not only because of some of the macro backdrop, but because the IPO market had gone bust and the venture world had gone entirely bust. It ruined people. We like to talk a lot about how the public markets

ruined people from the dot-com bust, but the venture world was really, ruins as well. So a lot of people lost a lot of money. So that's coming probably. And I follow some people on Twitter and I have to think about their names right now. I have to get back to you on that. But some of them are really very, very, you know, interesting data points on it that I've been following. So tech investors should keep an eye on that. For some of the companies that maybe IPO too fast or that are grossly unprofitable at this point, do you think we're going to see more mergers and acquisitions? We've already seen a little bit starting to happen this year.

Certain companies being taken private, other companies being folded in. How much you're watching that aspect of what might unfold? I mean, that's a great question. I don't think a lot of people, enough people are asking what will happen if the previous Wall Street darlings don't survive or run out of money and valuations remain low for a long time, which makes it harder to raise money. So overall, what I would say is that in verticals like cloud consolidation is coming, but actually, let me back up. The weird part right now is nobody knows how deep or shallow the recession is.

So, yeah, we are in a really strange moment here. On the positive side, it would be, early 2024 that we come out of the recession. There are certainly some endless estimates predicting that. If you look at, for instance, Facebook's return to growth, supposedly they're going to return to growth back half of 2023 and into 2024. That's for every company almost that I've tracked the far majority, let's say 80%. So anyways, let's say it's a shallow recession, then M&A may not happen at the level that you would normally think it would. Let's say it's a deep recession, which would swipe out 2023, 2024. We go all through 2024 with these low valuations,

tech out of favor. M&A will really pick up, and it'll be a survival of the fittest. And the public markets haven't been through this for so long that people probably think I'm talking doom and gloom, but I'm not because it's actually just a pretty natural process where these VCs, actually, speaking of VCs, they will fund a lot of startups, push them off into the public markets. They actually get an exit from that. They get paid pretty well if they go public.

But can those companies survive long term? That's not even a question they care to answer. It's not important to some of the insiders or the VCs. It's imperative, though, for public investors to figure that piece out. Can the company that did so great as a hyper-growth startup, are they able to have a strong bottom line to get through a time when, you know, cash is scarce? You're not going to be able to raise like you were when you were a startup. So basically that's the big question mark.

In that case, mergers and acquisitions would really pick up the strongest, would pick up the weakest if they're lucky, and the rest would go out of business if they're not lucky. So you can expect a percentage of the public markets, companies, stocks, Wall Street Darling's, former Wall Street Darlings, to go out of business or have to sell, be eaten up by the strongest companies with the biggest cash levels. And that would all greatly depend on how deeper recession is. But it's pretty natural process. This is not a doom and gloom. It's actually just how tech operates. And it goes through that about every 10 to 15 years.

and were long due since the great financial crisis for it. Mobile actually had a bust cycle already. Gaming had a bus cycle. Zinga is a great example. It was a darling that I think they are still around, but they're not valued for worth much. So near zero at that point. I want to ask you,

I was really looking forward to talking to you about generative AI and the buzz that we're writing. in the middle of now with Open AI and ChatGPT and we've got the AI art trend. Everyone is so excited about generative AI right now. What should investors be thinking about with that? Is it focus on some of the on Microsoft or what do you thinking? So ChatGPT was a nice catalyst or a nice headline around AI. There will be so many AI tools, AI apps, even image generation tools.

things like that, thousands, basically, over the next five to ten years. ChatGPT happens to be one of the first that is getting widespread attention, which is great. Beneath all of that, though, you do have Microsoft, and you also have Nvidia. And I would look for those companies that are going to participate, no matter what the R&D firm, you know, at OpenAI, I would call mainly an R&D. firm or company, no matter where it's coming out of or what at who's making the app or company. You know, we obviously have a lot of big players that are going to look to pivot and bring those apps to the market.

I also like the enterprise side. Although there will need to be some consumer participation, AI is going to be expensive to adopt it. I think the most likely first adopters will actually be the enterprise, which is a another reason I like Microsoft. Microsoft has really strong relationship relationships with the Fortune 500 and the Fortune 2000. I think that's going to be some early adopters because the goal of AI is to drive down costs. And unfortunately, as you've probably heard, to reduce headcount, who's going to want that more than the Fortune 500? I like that about Microsoft. Where it lands with the consumer is probably harder for a an investor to predict. We've seen that with the Metaverse. Despite there being a lot of industrial applications

for the Metaverse, such as training autonomous systems, the consumers have pushed back. They're not necessarily wanting their kids living in a Metaverse or themselves with headsets. So I think consumer can always be a little harder to predict, whereas Enterprise with AI to me makes a lot of sense. And so Microsoft is right there. So I would look at it broader.

too, not just with Chat GPT, super popular, but who's really going to propel AIML forward? And I believe it'll come from the enterprise. 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 yourself stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.