Motley Fool Money - We Can Fix You, Southwest

Episode Date: June 10, 2024

Elliott Management amps up the activist activity, and puts Southwest’s leadership and board on notice.  (00:21) Asit Sharma and Dylan Lewis discuss: - Why Elliot Management is looking to shakeup leadership at Southwest after taking a 10%+ stake in the airline. - Nvidia’s stock split, and why this one may matter more than most. - The new names in the S&P 500 – Crowdstrike, KKR, and GoDaddy – and what they say about the state of the market.  (17:57) Are the world’s tallest buildings ego-projects or promising investment opportunities? Ricky Mulvey talks with economist and skyscraper expert Jason Barr, about the state of “supertalls” and how China’s building boom is leading to an increase in homeowners without homes. Companies discussed: LUV, NVDA, CRWD, KKR, GDDY, RHI, CMA, ILMN Host: Dylan Lewis Guests: Asit Sharma, Ricky Mulvey, Jason Barr Producer: Ricky Mulvey Engineers: Dan Boyd Visit our sponsor Monarch Money: Go to monarchmoney.com/FOOL for an extended 30 day free trial. Learn more about your ad choices. Visit megaphone.fm/adchoices

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One major index gets a shakeup, and another one might have one soon. Motleyful money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motleyful analyst, Asit Sharma. Asset, thanks for joining me. Dylan, thank you for having me. Today, we've got an activist investor that just can't get enough action, a breakdown on what's in and out of the major indices, and a look at whether the tallest buildings in the world should be interesting to investors. Asit, we're going to kick off with some boardroom drama, though.

Activist investor, Elliott Management, has a new target. The company has built up a $2 billion position in Southwest Airlines. And in keeping with Tradition, Asset, they have some ideas for how to shake things up. Yeah. Interesting, Dylan. The dollars are big, but the percentage is big, too. Elliott Funds saying today they have an approximately 11% economic interest in Southwest Airlines. So this is no 1%, 2% activists coming in and want to shake things up. This is serious. And that's, I think, why the stock is up today. What Elliot said is that, look, Southwest is amazing airline.

It's been well-run for decades. It's always returned well for shareholders, lots of profits. But in the last few years, a lot of what we're seeing in its performance is due to legacy thinking and current management. The CEO and the chairman between them having decades of experience, they're not up to the task. This airline has to monetize its non-ticket revenue. revenue in a better fashion. It's got to work on its operational deficiencies. So they're

really gunning for some change, and they predict that the company is worth maybe 77% more than current share price if it has a meaningful turnaround. You can understand the positive market reaction here, because as you mentioned, the company has not been a very strong performer under current CEO, Bob Jordan. He took over the role in February of 2022, shares down around 35% in the time. that he has been at the helm. There have been some industry headwinds, for sure. But Southwest also took some curious actions during that time. They were the first major airline to re-institute a dividend post-COVID, and they have had, I think, some of their own kind of self-inflicted issues

that have made it a little bit harder for them to climb out of the depths of pandemic travel. Right, Dylan. Those self-inflicted issues are maybe the heart of this matter. So everyone remembers during the pandemic when Southwest had a software glitch and thousands of people were stranded because their systems weren't up to the task. What Elliott is saying in this letter without saying it explicitly is that the bottom line of an airline's equation costs per available seat miles are suffering because Southwest has underinvested in technology. And this goes back to choices that were made a long time ago. Southwest doesn't have a hub and spoke network like the big Legacy Airlines. It's cheaper because they have all these what are called peer-to-peer flights,

direct flights, with no real centers where they centralized, like maintenance and repair. That's a really good business model if the tech can keep up. If you understand where to put resources and when, where to have boots on the ground, where to have planes waiting to be serviced, how to service them, without modernizing this technology, it costs you more for every seat mile that you sell to service your whole network. Part of this is going to be hard for Southwest to turn around in a short amount of time. It takes time to rebuild a system and make it very robust. But the other part of this, too, is that management has sounded sort of casual about this.

They've never really owned up to our systems are disastrously bad. We need to fix them quick, and we're doing everything we can. So there's impatience in the investor community. I think Elliot is capitalizing on that. Some of our listeners might be saying, wait a minute, weren't you guys just talking about Elliott Management taking a stake in a business? And yes, we were. You don't have to go too far back.

They had a $2.5 billion position disclosed in Texas Instruments in late May, got right to it, sent a letter to the company's board. There, they're looking for focus on cash flow and to be a little more conservative with the CAPX buildouts that the company has planned. The difference between their Texas Instruments stake and the Southwest stake, Asset is, to your point earlier, they own 10% of Southwest at this point. When it comes to Texas instruments, they are a drop in the bucket shareholder. They're, I think, about a 1% shareholder of that business. I feel like they are probably going to be able to throw some serious

weight around in the Southwest boardroom. I think so, too. Now, the boardroom's going to push back, right? They're going to say that, look, some of this is out of our control. We can't help that Boeing has slowed its deliveries, which affects their ability to get more revenue if they're waiting on planes. They're going to say, look, We can't control the price of oil. Jet fuel is such a big component of an airline's expense line that it can hit Southwest, but it hits all airlines as well. But for each of these, I do think that Elliott has a pushback on the Boeing front.

They can question, why did you keep this legacy decision to only use a certain type of Boeing plane? On fuel efficiencies, they can point to companies which have been more innovative or more aggressive with their hedging strategies and say, you're still not good enough. Like, you guys just don't get it. So there's going to be a sort of public back and forth between those, but I will say Elliot is a fairly respected activist. And they're insightful, Dylan. Like you pointed out with Texas Instruments, they tend to hit pain points that the investment

community sees and feels like, yeah, if that were solved, I think this company would be worth more. They're not an activist that just comes out and sprays a bunch of shotguns. or BB pellets, shotgun shells, or BB pellets, I should say, and tries to make something stick. They get right to the heart of what's wrong in a company. So, they're in the hot seat. This board's on the hot seat.

All right. From the friendly skies over to companies with sky-high valuations. If you're an Nvidia shareholder, when you check your brokerage account today, you may find things looking a little bit different than last week. The company's 10-for-1 stock split taking effect today. And Asset, we have the usual split-related updates. We have analysts adjusting their price targets. We have the memes online about the company being down 90%.

Just kidding. Beyond all of the normal speculation, it seems like there's actually something worth checking into here with Nvidia's Stock Split because it's a chance to reflect on the tremendous performance of the company and really how critical it has become as an economic player. Stock splits like this are interesting. A company like Nvidia, take peers, Apple. about Microsoft, so many big tech companies that dominate this landscape of artificial intelligence doesn't need to worry about its stock price.

I mean, they're going to show returns. The stock is going to go up. So why would Jensen Wong, the board management, want a stock split? Well, they want the stock to be accessible to all investors. Now, this is going to trip up some people as I say this, because in this day and age, like, does it really matter? You can use your phone to buy fractional shares of a company, right? What's the reason to split your stock?

Well, investor psychology, I still come across so many members of the Motley Fool investors who psychologically feel more comfortable buying a company if it's priced at $100 versus a price of $1,000. I don't know why that is. But at the same time, there is something to paying attention to having your company be seen as a bellwether. And this is a traditional way to pull more investors in. So I think that's part of the psychology going here.

But as you and I were chatting about, it has other implications, too. Yeah, we have the standard elements where this will affect the options market for NVIDIA. But I have seen the speculation, and I think I am a believer in this speculation, that this stock split may be motivated in part or lead to Dow inclusion down the road. And just as a quick refresher for our listeners, the Dow is a price-weighted index. So, it is not looking at the market cap of a company. It is one of the few things where price really does matter when it comes to shares. And there is no way, looking at current constituents, a stock at an $1,000 share price is making

it into the index. It'll throw out the waitings. But, Osset, an $120 stock, far more likely to fit in with the Dow constituents and be a friendly addition at some point in the future. Right, Dylan, as you were showing me before the show, we looked at a little bit of the show, we looked at a list of Dow components. I think the biggest components were priced around 400 bucks a share. So, again, why would In video want to be included in the Dow? In some ways, it's an old-school barometer. I think the S&P 500 in this day and age has a much broader

following than when I was a kid where on the radio you'd hear the announcer say, the Dow Jones Industrials went up 30 points today. I love that old school radio voice there. That is pitch-perfect, I appreciate it. But I think this is part of the equation for Nvidia. They want the prestige. They want the recognition. It's important for them to be seen as a company that's one of the most valuable, one of the most important in the world. That means getting weight in big indexes. It means attracting capital from investors. It means being the top brand position. So when Elon Musk decides that he wants to catch up in the AI game and maybe take his attention off of Tesla a little bit? I don't know. He wants to be buying Nvidia's GPUs. Now, truth is,

Elon will have tested out those GPUs, and he's been working with Nvidia for years. So they probably with him already have that brand presence, but there are other buyers, too, who are going to look to major players, what they're purchasing, and just assume that important people in the industry have figured out the tech and understand that product is better. So we've seen, like Jensen Huang, really turn up the PR elements of NVIDIA with these big conferences where he comes in like a superstar, getting bobbed in Taiwan, et cetera. I think all this is calculated, and this is, I'm playing conspiracy theory here with your, right? Because you presented this. Yeah, no, this was my hypothetical here, I said. Totally. I like it because I do think that Jensen Huang and the board

and management of NVIDIA understand this is their time to seize the imagination of the public and investors, that helps them stay up on top of their game because they'll attract more capital. They can use that capital to reinvest in the R&D they love, stay on top. Yeah, and it's a bit of a silly, a little bit of a goofy conversation. But also, I think, to the extent that indices are supposed to be reflective of economic activity and the most important companies of their time, if you look at the Dow, I think you can make a case that Nvidia should be in there. It is one of the most important companies in the world. And there are a lot of companies that don't even sniff the relevance of Invidia. And so I think,

while it is something we're having a little bit of fun with, it's generally good for the major indices and the things that measure market activity for shorthand for investors to be reflective of the most important companies of their time. I agree with that, Dylan. I want to point out one last thing before we move on to the next topic. The people who are responsible for putting companies in the S&P 500 and the Dow, etc., sometimes their decisions can be just as hard as ours. Do I buy Nvidia? Like a year and a half ago, it's gone up 30%.

They look like they're going to do really well in AI. And we keep seeing it going up. To the people who are responsible for the criteria of these indices, they look at these companies. They wonder, is it like a flash in the pan with Nvidia? I mean, I'm listening to you, literally thinking, how come? video isn't already in the Dow. That's part of the reason. There's your case right there. We'll stick with the Index talk. We have some new names heading into the S&P 500 this week. The Index is doing its usual rebalancing. And if you're paying attention, say hello to

investment firm KKR, Cybersecurity Company CrowdStrike and Site Builder GoDaddy on the way out, Robert Haft, Camerica, and Aluminah. Asa, we were just talking about the way that indexes may reflect where we're putting money, the importance of businesses, when you see the ins and the outs with this rebalancing the S&P 500, what comes to mind? Well, first of all, it always makes me wonder, what's the latest criteria? The biggest criterion for inclusion in the S&P 500 index is your market capitalization. So when things go out, it means they haven't necessarily kept up with that changing barometer. I'm going to ask you a question.

I'm going to throw a pop quiz at you, Dylan. But don't be worried about failing. in front of so many listeners, because I threw myself this challenge and completely failed. All right. I didn't know the final was going to be cumulative. What is the market capitalization of Crowdstrike Holdings today? Take a guess. Oh, you know, I did some research before the show us, and I know it's about 80 billion. You know, this company moves so fast on you. I'm looking at current as of this morning, because, you know, the stock is again up high single digits.

Yeah, exactly. So you're correct. Pre-market. Yeah, it's about $93 billion today. That surprised me. I follow this company quite closely, but the appreciation it's had, even in the last year, is pretty phenomenal. So, this is a company that certainly feels like it should have a place in the S&P 500. The other thing that I was mentioning before is the company's going out, right? So let's take one of these names, Comerica.

Comerica is not a household name. It's a commercial banking enterprise based in Texas. It's a pretty decent big business, but a slow growth business, being challenged in a high interest rate environment. That company hasn't been able to keep up with the, you know, just need to grow and stay in this index. And I think that's sort of a cool thing about the S&P 500. You can get in, right? But you have to keep being relevant. You have to keep growing to stay in the index. Comerica today has a market capitalization of $6 billion. It's not doing poorly. It's just not a kind of company that might keep up. Another one I want to mention in there, which is a little closer to my heart

and wheelhouse is Robert Half International. This is a company that specializes in placing financial types into companies and even really high-end financial executives into enterprise businesses. It also has a business consulting arm. But Robert Haft may be a little old school in a day and age where so much of consulting is being challenged by AI, and so much of hiring takes place online through different types of mediums, from LinkedIn to just person-to-person outreach. So I wonder, too, about the relevance when you see companies that go out of the index, Is that sort of like a swan song for them? A swan song, Osset, in some ways, for these companies.

On Crowdstrikes case, I would say that this is a bit of a coronation, because the company has performed incredibly well, had been for market cap purposes eligible for the S&P 500, but didn't have the profitability requirements in the past. We have five consecutive quarters of profitability. You need the trailing 12 months, and you need the recent quarter profits to get in. And I think that this is the most,

maturity of a very successful business, kind of being recognized by one of the major indices and probably by more investors now. I like that so much, Dylan, that metaphor. It is a coronation. If you rewind back just a couple of years ago, we had many competing platforms that were prominent names in the cybersecurity industry. I'm thinking about great companies, Octa, Z-Scaler, Fortinet, Palo Alto Networks. Think of all the very prominent, respected cybersecurity companies.

This was one of them, well respected, but they had a slightly different business model. It's a cloud-native company. They have multiple modules they can sell customers. It's an AI-forward platform, always has been. And they've been ramping quickly, first revenue, now profit and cash flow. So while there was maybe some palace intrigue a couple of years ago, clearly this was destined to be king. I'm being a little hyperbolic here, right? Nothing ever lasts forever. But Crowdstrike is sort of

the cybersecurity stock of the moment. It feels appropriate that they should take a lap in the S&P 500. Well, for what it's worth, if we had an index of motley phil analysts, you would be overrepresented. Love having you on the show. Love having you in here to talk through these things. Thanks for joining me today. Thanks a lot, Dylan. I really appreciate it. The old adage goes, it isn't what you say. It's how you say it, because to truly make an impact, you need to set an example and take the lead. You have to adapt to whatever comes your way. When you're that driven, you drive an equally determined vehicle, the Range Rover Sport.

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Explore enhance offers atrangeover.com. Coming up, are the world's tallest buildings ego projects or promising investment opportunities? Ricky Mulvey talks with economist and skyscraper expert Jason Barr about the state of super talls and how China's building boom is leading to an increase in homeowners without homes. You mentioned Oklahoma City in your book captures literally the quest to build the world's tallest skyscrapers. And you say it's more than ego. What drives these folks to build the world's tallest skyscrapers? Why do they want that if it's not just having the biggest building?

Okay, so let's just start with this ego issue because this is something you hear all the time. And if ego was driving these buildings alone, they would be empty monuments. So you start with the revenue equation. And if you can make some money from a super tall building, or I should say some profit from a super tall building, then maybe you say, okay, I'm going to go higher because I can afford to go higher. That's usually like the first part of the equation. So the Empire State Building was not profit maximizing according to the standard for, let's say, 1929, but it was pretty close. I've done the calculations for what a developer in 1929, quote unquote, should build in a, you know, a bustling business district in Midtown versus what the developers actually chose to build. And when you actually compare the two, the Empire State Building, you know, sort of return on investment

calculation was really not that far off. Nobody saw the Great Depression coming, so I don't think we could hold the developers to that standard. But when you look at the Empire State Building, it's because it was taller than it should have been. It was actually more profitable, more architecturally elegant, and the observatories making, you know, millions of dollars each year for the building owners. And the same logic applies today in the 21st century. The Birch Khalifa was part of a large development of a huge lot that had come up made available in the center of Dubai.

And so it was not just the tower. It was the tower. It was a huge mall, restaurants, high-rise apartments facing the Birch Khalifa. So when you factor in the increased values of the apartments that face the Burj Khalifa and also all the tourists that come in, that building makes a lot of economic sense. And so that's kind of what's driving these super-tails, or I should say the record breakers in the 21st century, is really increasing the value of the land around bringing in tourists and signaling to the world that this city is open for business and is growing. So a lot of it has to do with advertising and attracting additional sources of revenue beyond just revenue from those who are inside the building. I think there's a parallel then between what happened in the early U.S. and sort of the skyscraper fever that later happened in Asia. Do you see any parallels there?

So the question is whether there's parallels between the kind of the building boom of the roaring 20s and what's happening, let's say, in China or what has happened in China in the last few years. I think that's true in some sense. I mean, human beings are just subject to bubble mentality. And so even though in the roaring 20s, the underlying economics triggered a skyscraper building boom. You know, by 1929 and 1930, before the Depression took hold, there was really a sense of bubble mentality that prices are going up. Let's build. We'll make a profit. And when you get all these people rushing in just on the expectation of future profits, you create a bubble.

and then the Great Depression came along and burst that bubble. In China, there's this mass urbanization. And there's also, there was this huge demand for home ownership. So I think the analogy is more, I think the analogy in China is more closely related to what happened in the U.S. in the early 2000s with the housing bubble. The difference in China is that all the city governments, all the municipal governments, own the land. they're selling off the land rights. And so they were issuing ground leases, ground leases, ground leases, developers were doing what they can to come up with the money to build. So there was this additional layer of trying to add more land to build, to build, to build. And the bottom line was,

yeah, obviously that they got way ahead of themselves. And now there's a kind of a real estate crisis. Yeah, there's a debt problem. And also, you highlight some of the ways that some property investors in China operate, right, with buying multiple sort of units in these high-rise apartment buildings. Can you talk about what's going on there? A big thing that's going on with households in China is a real preference for owning real estate rather than investing, let's say, in the stock market or something like this. Part of it's cultural. Part of it's just sort of a historical distrust of other forms of investments. So the rising middle class, there's something like a 1.4 billion people in China, let's say.

And so many, many, many of these people have been rising into the middle class. And so they have all of these savings. And also there's been a one-child policy. So you have two parents, one child that also provides disposable income. Housing is cheap because they're building, building, building, building. And so there's a mass pool of savings. A lot of that gets pulled into investing in apartments. Part of why China went on this building boom was because there was this huge demand for investment

properties by households. Are those apartments being occupied, or is it more of a store of value, you think? So there's a primary home, which is being occupied, obviously. But I read a statistic somewhere that something like 45% of urban households own a second property. So those second properties are store of value and rental income to the extent that they can be that you can get it. So some of these cities out in like the western part of China, they're just not being occupied fast enough. So the households that have their savings, they'll put it into this

empty apartment on the hopes that someday they'll be able to find a renter. But for the time being, it's just them getting ahead of themselves. So that's part of the problem too. You have, you're losing your savings. And then a lot of Chinese households will put down money before a building is completed. So a developer will start doing what they call these off-plan sales. And so households will give the money to the developer before the project's completed. And then because these developers were over-leveraged, they go belly up. And then the households, they don't get their money back. So they call this the homeless homeowners. And it's a big problem in China. Yeah, I would imagine. You've done research in the past on something called the skyscraper index and sort of dispelling a myth around it. Can you,

Can you explain your work there? Sure. In 1999, an economist believes he saw a relationship between the completion of the world's tallest building and an impending financial crisis. So this is what he called the skyscraper curse, and it's based on what he called the skyscraper index, which is pairing the completion of a world's tallest building with some financial crisis. And so it's a very sexy sounding idea that when a world's tallest building is completed the financial collapse is just around the corner. The problem is it's just not true. When you dive

into the data and the patterns between skyscraper construction and financial crises, it's what I call Roershock economics. Your eye sees a pattern. But statistically, when you actually try to measure whether this pattern is there, if you could predict financial crises from record-breaking buildings, you just can't do it. And part of the reason is because since 1890, there's only been 12 record breakers. Since that time, there's been at least 25 financial crises worldwide. So you can pair a record breaker with a crisis easily enough because the crises are happening twice as fast. Now, having said that, record breakers frequently do get built and announced when there's a boom time.

You know, the Birch Khalifa was begun in the early 2000s when people were pouring investment money into Dubai. And then it was completed in 2010, two years after the American financial crisis and around the time of the financial crisis in the United Arab Emirates. But one's ability to say, oh, the Birch Khalifa and the financial crisis, are linked in some way. That's just a lot of hooey. Let's talk about the future of skyscrapers,

which is how you finish off the book. Do you think we'll have mile-high skyscrapers? Is this something that you think we'll see in a decade or two? I do think we're going to have mile-high skyscrapers. How many? Well, let's say in the next 50 years, maybe we'll have a couple, let's say. Right now, the tallest building is 0.8 kilometers ahead.

half mile. The next tallest building, which is likely to be completed in five or six years, it's going to be the Jetta Tower. That's going to be one kilometer, 0.6 miles. So the ability to get to a one-miler is probably 15, 20 years away, let's say, at earliest, just simply because of the long lags of developing something like this and working out a lot of new technologies that need to come about to make a one-mile-high building possible. I believe we'll see them for various reasons. One is in 1956, Frank Lloyd Wright introduced his prototype for the one-mile-high skyscraper. So when Frank Lloyd-Ride says, here's my version of the one-mile high, when he did that, it launched the world on sort of the quest for the holy grail of skyscrapers, the mile high.

And actually, it's going to be the two-kilometer high building because skyscraper-construped. has moved so dramatically over to Asia that the kilometer is now the benchmark for the building heights. So we'll get there because, again, the ability to use these buildings to advertise and to create new neighborhoods and get all this money from observatories and just the pride of being able to say our city has the one mile high. Now, whether that pride is ego or good business sense, we could all debate. But, you know, when you look at the history of these buildings, they have been moneymakers. And also, when you plot the average heights and the heights of the tallest buildings and the highs of the record breakers, you know, it's basically about 2% a year or something like this, or maybe a little less. Let's say when you plot the growth rate of the world's tallest buildings, I think it's about 1.8%.

So if you just carry out that 1.8% growth rate, at some point, you're logically going to get to a mile high. As always, people on the program may own stocks mentioned, and the Motley Fool may have formal recommendations for or against. So don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.