Free speech on the internet is a tricky subject, but legislators on both sides of the U.S. party line have called for companies such as Facebook (META -3.67%) and YouTube to get their act together. In this week's episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool analyst Dan Kline explore the issue -- how a proposed law could make business much more complicated for big tech, what this could mean for American free speech in general, how deepfake videos fit into the social media legality picture, and more. Also, the guys take a quick look at Slack's (WORK) direct listing -- why it's got the market so excited, and why the company's profitability should give investors pause.
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This video was recorded on June 21, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It is Friday, June 21, and we're checking in on some tech news. I'm your host, Dylan Lewis, and I'm joined on Skype by fool.com's Dan Kline. Dan, what's going on, man?
Dan Kline: Hey, there, Dylan! It's like a Dan Kline theme week. I guess vacations, or maybe nobody else wanted to tape this week. I have been all over the show!
Lewis: No, don't disparage yourself like that! We are happy to have you on! It is unusual to get you three times in one week. I hope you're still managing to spend some time with the family and get a little rest. We don't want to wear you out.
Kline: You know, I have a 15-year-old son. He was delighted to be able to sleep until 10 a.m. this morning. Now I'm sure he's playing video games. I've promised him lunch at Wawa when I'm done with this.
Lewis: Wawa, one of our favorite chains, Dan, and in my opinion, probably the best sandwich chain out there. It's better than Panera. It's better than Subway. I'm from New Jersey, so I'll be a little biased here, but I'm saying Wawa's No. 1.
Kline: We've talked about this before. It's No. 1 among the chains. The kiosk, where you get to program your own stuff and you don't have to talk to a person, is pretty fabulous. It's an acceptable sandwich, and I don't think any of the others are. But I grew up in Massachusetts, where there's a grand tradition of sub shops and locally owned places. We had a place that used to sell meatballs the size of a car tire. So, yes, I enjoy Wawa, but I think the hype of how great it is maybe a tiny bit too much.
Lewis: I grew up in New Jersey and I want to give a shout out to Italian Riviera in Waldwick, my go to sub shop when I'm home for the holidays and when I'm home over the summer and stuff like that. I know what you're saying, Dan. You can't possibly beat that homegrown place that just knows how to pile the meat on. But I think Wawa does an OK job.
Kline: Again, for Florida, they are gourmet. For Swampscott, Massachusetts, Engine House Pizza, Tony Lena's, here's a shout out to you. I actually have no idea if either of those chains are still in business. I haven't lived there in a decade. Actually, two decades.
Lewis: [laughs] All right, Dan, we are not talking CG. I know you've done a bunch of episodes this week, I don't want you to get confused. We're talking Tech today. We're going to sideline the Wawa conversation.
Kline: We're not doing a sandwich show?
Lewis: No. We could talk sandwich technology at some point down the road. But today, we're going to be just checking in on a couple of tech stories. One is a follow-up on an episode we did recently about Slack. And then we're going to dive into a big story that got our attention this week. But yeah, Slack listed yesterday. Why don't we talk a little bit about this company? It is probably the most anticipated IPO of 2019 in terms of having a business that people actually want to invest in.
Kline: You know, I love Slack. I'm probably on Slack as much as... I'm going to guess I'm top five in a company of heavy Slack users. And I'm on some other slacks that aren't just The Motley Fool Slack. I love this product! What I don't love so much is their monetization. They don't lose a ton of money. They're sitting on about $900 million in cash. We'll talk about why they went public a little bit later. But I don't see a clear path to increasing revenue. They can add customers, absolutely. But in my opinion, to really become profitable at a significant level to justify the absolutely insane valuation that they're trading at right now, they need to create a suite of business products. I don't think that's an easy thing to do.
Lewis: Yeah, shares had a reference list price of $26. They surged to about $40. You look at what that does in terms of valuation for them, it puts them at about $20 billion, which would be 40X trailing 12 months sales. I think it's fair to say that's a little rich, Dan.
Kline: I believe they forecast the entire collected workspace market to be about $26-28 billion. So, yeah, it's really high. But part of that is, there are some companies that you feel really good about. We're on Skype now, I don't think I've ever felt really good about Skype, even though I like Microsoft very much as a company. But Slack is something that just, it really makes your life better. I know on your end, where you have 1,000 people, you're managing people, so Slack can be overwhelming. For those of us who are part of a remote workspace, Slack is a lifeline. It's something that I feel really positive about. I want to be an investor almost as a thank-you, but I don't see how their business model ever justifies that valuation unless they can figure out a lot more ways. It's interesting to me that you could do the equivalent of a Zoom meeting over Slack, and we use Zoom separately most of the time.
Lewis: I guess it speaks to the quality of the technology that Zoom has and Slack has respectively. Typically, what you see with companies in the software-as-a-service segment is, you get known for doing one thing really well and then you add functionality over time. You look at what they're able to do in terms of billing, right now it's about $6.67 to $15 per month per user, depending on how you bill and the tier they're at in terms of service. The easiest way for them to meaningfully grow revenue, especially as they have these loyal customers, is to add killer functionality onto these other product suites that integrate and allow them to charge more for that. I'm not exactly sure what that is. But there is a profitable business here, Dan. I mean, 87% gross margins over the past 12 months. If they bring that sales and marketing spend down a little bit, I think there's something there.
Kline: Here's the thing. I'm not saying this won't be a profitable business. They don't lose very much money for where they are as a company. But to justify the valuation, they don't just have to be a little profitable. They can't just make $50 million a year. They have to be a company throwing off billions and profit. Again, I think they could get there. They might be able to integrate things that are useful. For example, a lot of the writers and I are talking about a Vegas trip. In theory, could they integrate travel services? They see you're talking about travel, "Hey, look, here's a flight at the time. Here's a hotel deal. Here's a value add for being a Slack user." I'm not sure what it looks like. There are things that could go in. But that's a tightrope to walk because one of the best things about Slack right now is there's no advertising, there's no clutter. And yes, we can get overwhelmed by the sheer volume of Slack messages, but you can always dig out from that. You don't have to stop like, "Oh, great, Slack saw I was talking about pizza, and now here's an ad for Domino's."
Lewis: There is a part of me, Dan, that looks at this and says OK, I have heard Stewart Butterfield, their CEO, talk quite a bit about how he foresees the obsolescence of email, and that we move away from a very office-oriented, very Outlook-oriented way of doing work, and instead are in something that there's more Slack-like for everything -- for communication, for archiving, for all of the content that we communicate within a company. I wonder what else they might be able to wrap into that service that is currently much more Outlook-like that could allow them to charge some of those higher tiers that they would need to make it a wonderfully profitable business.
Kline: Yeah, I think calendar would be a big one. They do replace email. You and I communicate a lot during the week, and it's almost entirely on Slack, and it's generally only an email when it needs to be something very formal that maybe we want to keep that record of. So I can see them doing it. But you have to do it very slowly. They have to consult their user base. If I was Slack, I would be taking my biggest customers, people like us, we're part of a test that is integrating multiple Slack channels; we have an external channel and an internal channel, and we're allowed to communicate with each other, and there's varying rules on that that Slack has been playing with.
So far, I see this as a very well-managed company that has done everything right. But that doesn't mean they won't make a misstep in the future. They have to go very carefully.
Lewis: As is often the case with newly public companies, I'm looking at this one and saying, there's a lot of good stuff here, I want to see how management handles being publicly traded for a little bit before I decide I'm putting some money into it. Particularly true because of the valuation right now.
Kline: Yeah. One of the things we promised to explain that we missed is that this was not an initial public offering. In a traditional IPO, what happens is, a company sells shares of itself in order to have money to fund operations. This was a direct listing. What that means is, this is an equity event for early investors. Let's say you were a fund or an individual who had shares, this is a chance to cash out. The company doesn't actually get any money from this listing. But it's important to note, the company doesn't need any money. It actually has some $800 million in the bank. And while it is losing money, it's losing $130 million, about $30 million a quarter. They could go on for four or five years without having to raise even at the current levels of loss. This was a different path to the public market.
Lewis: What I think is really interesting about the direct listing process is the incentives are very different than an IPO. You think about an IPO, and it's a capital raising event. And then there's also this, "OK, we want to pop a little bit on the first day, so we're going to have our shares be priced at a level where we get the ego boost of having the market want our shares." So, you have this very complex dynamic at play. You're trying to raise money at a good valuation that does service to the people that are existing shareholders and is good for the business, but you're also trying to serve this market euphoria that everyone expects. A direct listing doesn't really have any of that because they're just making their shares available at a price that they think people will want to buy them and exchange them, and then just letting market forces take over.
Kline: Here's the thing. I'm a big believer in ignoring almost the first year of trading on a company. We have a media cycle. "Oh my god, Uber is terrible! Its stock is down 40%! It's great!" None of this has anything to do with the business metrics of the company. But one of the interesting things I found for Slack is, they'd been asked for financials from some of the bigger organizations that wanted to use their product. If you're a giant company -- let's pretend you're an insurance company that employs 50,000 people across the company -- you're not going to want to move to Slack and have them go out of business in six months. So being public actually gives them a level of transparency that's going to help their business. That's something you don't really hear about when companies go public. But this actually opens new doors for them and might make it easier instead of harder.
Lewis: All right, Dan, this is a first segment for me, but I think one that we could bring back in the future. I'm going to call it one big story for the week. I think that this was something that I saw in my news feeds and was like, "Wow, this is actually something that may dramatically change the landscape of big tech." Do you want to introduce it?
Kline: Right now, there's been a lot of talk about bias in social media. We won't get into the politics of that. You all know what we're talking about. Maybe one side or the other is being shut out more, not shown in algorithms, being banned. And because of that, a Republican senator, Josh Hawley from Missouri, has introduced a piece of legislation that would force the very largest tech companies -- really Facebook, Twitter, not too many others -- to vet everything that they post. Right now, they have an exception to the liability laws. If I go on Facebook, and I post something terrible about Dylan that's criminally libelous, it is not Facebook's fault. Now, they can police it after and take it down. But they don't have to police it beforehand. This proposed legislation would get rid of that exception to the rule and force them to police everything before it gets posted. I'm not even sure what that would look like or how it would work. What they would have to do is apply for an exception to the rule. And to get an exception, they would have to show they don't have a political bias. Again, without getting into the politics of this, I'm not sure how you show that you don't have something. It's very difficult to show that you don't not do something. Dylan, jump in and help me here!
Lewis: [laughs] Yeah, I think that sums it up; the fact that you don't not do something is hard. Basically, there would be this vetting process, where you are making your algorithms available to be audited, which is a very different approach to what we have seen with these companies in the past. You keyed up the fact that they have this kind of immunity right now, thanks to the way that a lot of laws are written. The carve-out in particular comes courtesy of Section 230 of the Communications Decency Act. Basically, this is something, like you said, saying that if third-party users are making comments on a platform, the company that provides that platform is not liable for whatever those comments might be. The logic there was basically, if you are trying to police all of this stuff in real time before things go live, it would be such an onerous process for a very large platform that it would effectively ruin the utility of the platform, because there'd be no way to keep up with all of the comments, posts, whatever, being put up there. You think about companies like Facebook, like Alphabet's YouTube, Twitter, this is really how they've made money for such a long time. It's all user-generated content. There are a lot of other applications beyond just social media sites that serve up ads that would probably be impacted by that. I'm thinking specifically here about Craigslist, the reviews that you see on Yelp and Amazon, etc. This is a far-reaching possibility.
Kline: And let's be clear: This is only for the largest companies. Thirty million U.S. users, 300 million global users, earn $500 million in annual revenue. So this will not affect the comment section on your local weekly. This is really targeting big tech.
There's a few problems with this. Are you comfortable with the government being able to figure out if a Facebook or a YouTube algorithm is biased? Now, think of every government website you've ever been on. It's basically like going to AOL in 1994. And we also have a government that's become very divided that maybe isn't capable of determining what's a bias or what's not a bias. I do think there's some very dangerous language in what's being talked about here.
Lewis: The focus so far in this conversation has been bias, but I think the reality is, it doesn't matter what side of the aisle you're on; it seems like people are pretty annoyed at these platforms. I know that on both sides of the aisle, there have been representatives that have spoken out about these platforms needing to be policed more, needing some vetting process for the content that's out there. A lot of that coming after the deepfake video of Nancy Pelosi was circulating online. I think the reality for these businesses is, they've enjoyed all of this user-generated content for a very long time and had a free pass, and they are now going to have to start dealing with the fact that there are some serious repercussions for spreading content virally in a way that maybe they weren't prepared for.
Kline: And the technology is getting better. Let me explain what a deepfake is. Let's pretend there's a lot of video of Dylan and myself out there. We've done a lot of these shows. In theory, a not-that-talented programmer, videographer, whatever you want to call them, could take the video of us talking about Facebook and turn it into video of us saying terrible things about the U.S. men's national soccer team. I picked the most benign topic I could possibly think of. And we're just terrible. We're trashing the coach; we're doing everything. And we get a huge backlash. Facebook doesn't know it's fake. We don't know it's out there. And all of a sudden, there's this whole community of people who don't like us.
What happened with the Pelosi video is a fake video made her look like she was giving a speech while intoxicated. It wasn't true. Facebook didn't actually take the video down. They didn't really have the correct procedures in place to deal with it. So for getting this legislation, there needs to be very high-tech methods of figuring out if the video is real. There's been a Mark Zuckerberg deepfake video. It would be very easy to create a video of almost anyone saying almost anything. You can see, easily, why that would be very bad.
Lewis: Yeah, that was probably one of my favorite responses to the Nancy Pelosi issue -- someone decided to go out there and take one of Mark Zuckerberg just to see, OK, this is how you handled it when it was a political representative. How would you handle if it was your CEO saying some things that were obviously not so great to be seen in the public light?
Kline: Right. Are you a Howard Stern fan, Dylan?
Lewis: I'm not, but I know our man J-Mo is.
Kline: Howard Stern historically has taken people's audiobooks and cut them up to have them say things that are clearly things they would not say, but it sounds fake. [talking choppily] "The person is talking like this!" So, you get the joke. When you watch a deepfake video, you do not get the joke. You think, "Oh, my God, did Nancy Pelosi give a drunk speech? Is Dylan Lewis for some reason in the Industry Focus chair, going on a terrible rant?" That has to be dealt with. Figuring out what is legal but odious speech that has to be protected -- you're allowed to have unpleasant views; you're not allowed to have libelous views. You're not allowed to push conspiracy theories that have been disproven. How do you police that? What's the happy medium between self-policing and the government stepping in and saying, "This is how it has to be done"?
Lewis: Yeah. I think the worst-case scenario for these companies is that it makes it much harder for them to have user-generated content that people want to engage with posted on the platform, because then it's harder for them to get people to come to the platform, which makes it harder for them to serve up ads. I think regardless, it's going to be something where, we've gotten very used to executives and management from Facebook, Alphabet, etc. appearing on Capitol Hill. It seems like that's going to continue.
Kline: It's going to continue. And look -- Facebook, YouTube, all these companies have to invest more heavily in figuring this out. They have to be able to show, "Yes, we kicked this person off our service. Here are the terms they violated. Also, here's how this is being applied unilaterally." Because, yeah, if you kick off a right-wing extremist for violating terms, that's OK, but if that person can come back and say, "Hey, wait a minute, here's this guy on the other side of the aisle. What he's doing violates the terms as well," you have to be able to defend that, and they're not spending the money.
What's not going to work -- and I can speak from experience; I used to edit two daily newspapers where I had to moderate the comments. These are papers maybe being read by 20,000 people total, and there were not enough hours in the day to moderate the comments-slash-deal with the people who, when I rejected their comment, usually because they personally insulted someone else, violating our policy, I would spend hours a day on the phone with people upset about it. You have to figure out how to keep this automated and to keep this real-time, and that means investing a lot more than they have been investing.
Lewis: Yeah. And the reality is, a couple of years ago, I think a company like Facebook could have said, "Oh, we haven't realized the scale that we've reached in terms of people accessing information and our role in spreading information and making it viral."
At least over the last three or four years, it's been pretty clear that, you know what? You guys know what you're doing, and you need to be held accountable for it, because there's too much bad information out there and it's really ruining public discourse.
Lewis: And we've been picking on Facebook a little bit, but this is just as big a problem on YouTube, where it's even harder to police because a lot of times, it's in the video, and text is very easy to algorithmically monitor, and video is not as easy. It's pretty much every platform that hits the scale. Obviously, Twitter has these problems. I'm sure there's three others. There's probably LinkedIn issues. I have a friend who legitimately makes money as a model, and LinkedIn takes down her modeling photos because they violate certain terms. On the other hand, that is what she does as a job, and it's a jobs platform. There's all sorts of gray area in dealing with all of this. There needs to be more open public discussion, and I think we need to take some of the politics out of this. This is not a right-left issue. This is a, is this thing I'm saying true, versus, is it a lie or an attempt to manipulate or create other sorts of confusion? Only a handful of companies have the money to deal with this, and they have to take the lead.
Lewis: Yeah, and this bill will be targeting the companies that have the money to deal with this. We'll see exactly how that plays out. We don't talk about legislation all that much on the show, but this one, because it was so targeted at some of the big companies in our space, felt worth discussing.
Kline: I think the gymnastics we have to go through to not be on a political side, because as a basic rule, we don't take sides in politics, makes this a challenge. But this is a greater American freedom of speech issue. Where does the line for responsibility end? As a company, are you responsible for what happens when people view the content on your platform? On some level, you have to be. I don't think there's any chance this legislation passes, but I do think this legislation is a wedge that forces change. I'm a pretty liberal guy, but I think that change is needed.
Lewis: Absolutely, Dan, I'm right there with you. I think you summed it up pretty well. Thanks for hopping on today's show!
Kline: Thanks for having me! We will be back in a few weeks talking fully about sandwiches.
Lewis: [laughs] Save it for CG! All right, listeners, that does it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, shoot us an email over at [email protected], or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes, or you can catch the videos from this podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Dan Boyd for all his work behind the glass today! For Dan Kline, I'm Dylan Lewis. Thanks for listening, and Fool on!