Top 10 Lessons of the Archegos Collapse

In this episode of MarketFoolery, host Chris Hill is joined by Motley Fool analyst Jason Moser to analyze the chip market and share why Qorvo (QRVO 2.27%), Qualcomm (QCOM -0.20%), and Marvell Technology (MRVL 4.06%) are on Jason's radar. Plus, they discuss Archegos Capital's margin call and the ripple effect (and lessons) for investors.

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This video was recorded on March 29, 2021.

Chris Hill: It's Monday, March 29th, welcome to the MarketFoolery. I'm Chris Hill, with me today, Jason Moser. Good to see you.

Jason Moser: Good to see you. How was your weekend?

Hill: My weekend was good.

Moser: Yeah?

Hill: My weekend was good, looking to ease into spring break here.

Moser: Beautiful weather.

Hill: We're going to talk about semiconductors. But we're going to start with, I don't know where to begin. This is a complicated story [laughs]. Let me start there. This is a complicated story and there are, I think, ripple effects for us as individual investors. Let's start with the context that over the last six months, shares of Discovery Communications (DISCA) and ViacomCBS (PARA -3.94%) have done quite well. They'd been bid up, I think they've roughly doubled over the last six months. Over the past week however, both of those stocks have been cut in half due to forced selling by the firm that had been buying it up. I will also add that today shares of Credit Suisse are down 15% because they said they face a highly significant and material hit to first quarter results, after an unspecified fund had defaulted on margin calls to Credit Suisse and other banks. This is a firm I'd never heard of until today. I think a lot of people had not heard of it until today. Archegos or Archegos Capital Management.

Moser: I think it might be Archegos but anyway.

Hill: Archegos, there you go. The third way, Archegos Capital Management. This is a family office and that's not a quaint term that is an official designation. Apparently, they'd just been amassing all of this stock and reportedly had ownership stakes of both Discovery and Viacom north of 10%. That was not disclosed because they did not have to disclose it. Now we've got two of the most exciting words in investing, and that's margin call [laughs]. There are a lot of different ways we could go with this. Start wherever you like.

Moser: I mean, there are a lot of things at play here into your point. Goldman Sachs, Morgan Stanley, Deutsche Bank, Credit Suisse. There are a number of banks that served as brokers. Let's go with Archegos. I may be wrong, but I'm just going to stick with that, at least to be consistent. That ultimately meant that they were the banks that processed trades and lent cash and securities to this fund. I think it was something, I mean, this was a highly leveraged fund. I think they were managing somewhere in the neighborhood of $10 billion or something like that, but had $30 billion worth of exposure due to short positions and in margin and whatnot. There are a lot of different ways we can go with this. Ultimately what I was thinking about this all morning, there's so much to unpeel here that I feel like it lent itself very well to a David Letterman style of top 10 list. You remember back in the day of the Letterman show, the top 10 list?

Hill: Absolutely.

Moser: Yeah, that is iconic. To me this is just a great opportunity for a David Letterman style top 10 list. Let's go ahead and jump into the top 10 lessons learned from the Archegos Capital's failure or demise. Lesson No. 10, leverage is dangerous. Lesson No. 9, learn to think for yourself. Lesson No. 8, if something doesn't look like it makes sense, maybe it doesn't. Lesson No. 7, sometimes the road less traveled, is less traveled for a reason. Lesson No. 6, hey Chris, guess what? Fundamentals actually matter. [laughs] Lesson No. 5, don't short, it's not worth it. Lesson No. 4, there are greater forces at play in the market that we'll never be fully or even partly privy to. Lesson No. 3, diversification matters, you should do it. Lesson No. 2, there are some things we just can't foresee and know as investors, it's always a leap of faith, but that is not the reason to invest, you simply have to go in with that context, with that assumption already in place. It's why we invest, the way we do. Lesson No. 1, from Archegos Capital's demise here. Chris, you ready? If someone gives you the chance to get in on the ground floor with Bill Hwang's next fund, maybe just take a pass. [laughs]

Hill: Well done, sir.

Moser: Well, thank you. I spent a few minutes putting that together and while that was a lot of fun, I really do feel like all of those lessons really do come into play here. It's interesting in regard to that idea, there are some things we just don't know and we can't really foresee. There's a lot of stuff going on, there are a lot of forces at play in the market that we just don't really have insight to. I think part of this is tied to the way some of these trades were set up via swaps. I think swaps gave Mr. Hwang some anonymity in this regard, which is why ultimately, those ownership stakes that you mentioned earlier, were I guess either never disclosed or they didn't have to be disclosed. I think he held those types of states in a number of different companies. Ultimately, like you said, shares of ViacomCBS, and Discovery a year today, going into after the close last Friday, they were up 161%, 157% respectively a year today. When you look at the fundamentals of those businesses, that is a very big head-scratcher. Now we're starting to really understand exactly what's been going on.

Hill: For individual investors, it's totally reasonable to imagine a scenario where people look at the rise of streaming over the past year. We saw it with Netflix, we've certainly seen it with Disney+, and to varying degrees of success, HBO Max, Peacock, etc. You can imagine a scenario where individual investors look at Discovery Communications, ViacomCBS and say, ''Hey if I just want to bet on all the horses in this race, I'm going to buy some shares of each one of these,'' and then in some cases they look at the rise of those last two stocks and think, ''Okay, maybe I'm late, but this thing appears to be doing nothing but go straight up.'' They bought it two weeks ago. Now they're sitting on significant losses as a result of that on paper. I did an interview last week, where the host of the show was asking me about everything that we've seen play out with Reddit and WallStreetBets and GameStop and that sort of thing. He asked me, do you think we're going to see some regulatory overhaul? I prefaced my answer by saying, I'm not a lawyer, but on the surface there, I'm not really seeing where the necessary changes need to be made. I could see it being made with this, because in this situation and I have to credit CNBC because I thought their coverage this morning was particularly informative in terms of laying the groundwork of what's really going on here and the family office designation. 

This is essentially a private fund and when the Dodd-Frank law was passed, apparently, family offices heavily lobbied Congress not to include them in significant SEC registration and regulatory approvals and all that sort of thing. A big part of their argument was, look, these are family offices. These are private funds, these are conservatively managed and therefore they don't need to be a part of this. Well, now, you're looking at anywhere between 5,000 and 10,000 of these funds around the world managing in excess collectively of $6 trillion.

Moser: Yeah.

Hill: The ripple effect for individual investors is real. This is a situation where I could see this being revisited because it's not just mom-and-pop investors who bought shares of ViacomCBS, and Discovery Communications. I'm pretty sure the people at Credit Suisse are not happy about what's happening. We'll see where it goes from here. But for the moment anyway, the damage appears to have been contained.

Moser: I think you're right. I think just like anything, you work within the rules that you're given and whether it's a game or whether it's taxes, or whether it is, in this case investing in the financial markets. I'd like to believe that this is probably just one bad apple, but my suspicion is that given the number of funds out there with this designation, it's not the only one trying to use the rules to its advantage. That conservatively managed descriptor there is important because I think you could argue that this fund was not conservatively managed. Perhaps it was in Mr. Hwang's eye's. I think most of us would disagree. The question regarding swaps and anonymity. We live in an age now where information is available with the snap of a finger and I think that as time goes on, as technology continues to level the playing field for investors to me, it only makes sense that we see a trend toward more transparency as opposed to the other way around. But I reckon time will tell.

Hill: Our email address is [email protected]. We got a question from Seth Thompson. He writes, 'As you might know, there's a serious shortage of semiconductors in the world right now. I've been researching Nvidia, AMD, Intel, and a few other companies involved in the industry. But I would love to hear which companies you think have the best chance to deliver strong results during this time of extreme semiconductor demand, and do you think the current shortage will have any effect on the way the market moves over the next few quarters. I'll just take that second one first. Yes. [laughs] Yes. All you have to do is look at any news out of the automotive industry and how, crippled is probably too strong a word, but compromised, I think, is a good word to describe the automotive industry with the way that they do their supply chains. The ripple effect of the semiconductor shortage is really compromising automotives.

Moser: Yeah. Much like the [laughs] traffic jam in the Suez Canal. This is a traffic jam of a different sort, but clearly, it's something that's having a material impact on a lot of businesses, a lot of markets. It's not going to be something that remedies itself anytime in the immediate near future. I'm glad you referred to the automotive market because I think that's one where a lot of people just don't even really give it a second thought. But if you think the way cars are today, you're going to see anywhere from upwards of 50 semiconductors in a vehicle these days. Think about that. These are just computers on wheels at this point, and so for one car to have that much exposure to technology, you can see what just any little crimp in supply could do. It just plays out in virtually everything we do now given this move toward everything in our lives being digital and tech-related, the market opportunities, and Internet of Things, 5G roll. There are just so many tailwinds in regard to technology and really the semiconductor industry is a crucial part of it. To see what's going on, it's understandable why it's happening, it's good to know that it is a temporary thing, it's not something that is going to last forever, but it is something that is going to be around for a little while longer. I like that the companies pointed out there by Louis, in Nvidia, in AMD, in Intel, I think they all provide some interesting and different looks. Nvidia being clearly named at the top of mind for its graphics capabilities, and then AMD, a stalwart of the industry that probably a lot of people haven't really thought about a whole heck of a lot lately, but they've got that acquisition for Xilinx that's getting ready to close. Intel making a big pivot. 

That Foundry news, I think, was pretty fascinating and we'll have to wait and see how that ultimately plays out to see if that was a good decision or a bad one. I like those ideas. This is certainly something that I follow in the 5G service that I run here at work, so I enjoy it a lot. They're definitely a lot of companies that come into play here beyond just those Louis, and some to keep in mind, companies that I've enjoyed following, one of them is Qorvo. The ticker there is QRVO. But Qorvo, this is not all that it does, but it has a specific focus on ultrawideband technology or UWB, and that's basically short-range radio technology. It's used to move large quantities of digital data over short distances. It's known for delivering superior location accuracy, and security, and latency compared to other short-range technologies. It's not the only company that focuses on the UWB opportunity, but it is one member of a small club and they made an acquisition here a little while back, a company called Decawave, a $375 million acquisition to give them more presence in that space. Qorvo management on the most recent earnings call, they did make mention of the supply chain constraints. It's not something you can just remedy as an individual company, you have to just weather the storm, so to speak. It may keep a lid on growth here in the next couple of quarters but that growth will ultimately flow through.

They do have a big customer in Apple, but that oftentimes can be a very good thing, particularly as you've established that relationship over a long period of time. Qorvo, I think, is one to keep an eye on with a focus on that UWB technology. Another one that I feel like over the past five-plus years has really flown under a lot of radars, and for a good reason it's been pretty stagnant, thanks to saturation in the smartphone market, is Qualcomm. A name I'm sure probably everybody out there is familiar with at this point, but Qualcomm has just a tremendous business on both the chip side and its technology side. It's got a valuable IP portfolio and really generates a lot of operating income just over licensing the technology that it has in its portfolio, I think somewhere in the neighborhood of 140,000 plus patents in their IP portfolio that really give them just, it feels like, a presence in virtually every device that we own. Again, they absolutely made note of the shortage on their most recent call. Again, they see a very similar timeline to what was described by Qorvo. 

Then, finally one that it's a sleeper I think for a lot of folks, and again, I think a lot of this has to do with the fact that it really hasn't grown over the last several years, and a lot of that is for the same reasons as something like a Qualcomm, but Marvell Technology. The ticker for Marvell is MRVL, and Qualcomm is QCOM. But Marvell Technology is a semiconductor company that focuses on high-performance data infrastructure products, and the markets it focuses on are automotive carrier, data center, and enterprise. For Marvell, they've been more or less stagnant over the last several years, but they've been investing all the way and I think that's been held against them a little bit here. When I say investing, I mean investments in R&D have been around 35% of revenue on average each year since 2016, so that I think has crimped profitability for the business. But they have made a lot of investments in this 5G roll out and they are seeing a lot of demand for it now. Management did note on the most recent call this shortage and some of the reasons for it, understanding part of it is COVID-19, part of it as this just growing role of tech in our lives and whatnot. But from their perspective, Marvell keeps a pretty concentrated customer base, but they have seen with their customer base that this is going to be something where it's more delayed, those customers aren't able to go somewhere else, it's simply more or less a timing thing. 

Then I think with Marvell, they've also got this acquisition of Inphi, which is getting ready to close as well. Inphi is a company that focuses on helping move that data within the data center and outside of the data center. I think that that acquisition of the Inphi is going to give them a nice little boost to that overall market opportunity that they pursue. To my mind, I think Marvell is actually a little bit of a coiled spring going on here. I wouldn't be surprised at all to see Marvell have a great upcoming five years here. But there's a few names in the space beyond what you mentioned there, Louis, I think it's a tremendous opportunity that we're going to watch play out here over the next several years and I'm going to enjoy following it.

Hill: Thank you for reminding me. It was a great email. It was also a little confusing in the fact that up in the header it said his name was Seth and then he signed it Louis.

Moser: [laughs] Oh, yeah.

Hill: We're just going to go with both.

Moser: I'm going with Louis because I didn't even hear Seth. I just saw Louis and I thought, "Okay." But, yeah, [laughs] either one, thanks for the email either way. [laughs]

Hill: That's happened a few times over the years.

Moser: Sure. [laughs]

Hill: It's like the pronunciation of Archegos.

Moser: Yeah, exactly.

Hill: I think I pronounced it three different ways, so hopefully one of those three is correct.

Moser: It's whatever you want it to be, big guy, whatever you want it to be.

Hill: Jason Moser, great job from you. Thanks for being here.

Moser: Thanks, Hill.

Hill: 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 or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. This show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening. See you tomorrow!