Earlier this month, Motley Fool Money hosted a live podcast recording and meetup for Motley Fool members. There, Motley Fool host Mary Long caught up with Motley Fool analysts Alicia Alfiere and Tim Beyers and engineering manager Tim White to discuss:
- Differences between public markets and the venture scene.
- How money can ruin companies.
- Tesla's AI ambitions.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Dec. 16, 2023.
Tim Beyers: The cost of capital is elevated, it's going to stay elevated. Companies are respectful of that. I just gave you Salesforce as an example of a company that is respectful of that, which is a weird thing to say because they used to be the ultimate disrespector of that. But now that they are getting respectful of that, they're in a much better position and those are the companies that I think will continue to be.
Mary Long: I'm Mary Long and that's Tim Beyers, a lead advisor here at the Fool. I caught up with Tim and fellow Fools, Tim White and Alicia Alfieri in Denver earlier this month for a live member event. At that event, we hosted a round table conversation about the state of tech investing. Today, we're sharing with you some snippets from that discussion. I hope you enjoy Fools.
Alicia Alfiere: We posed this question about whether tech investing is dead. Then last month, all three major stock indexes were up and the Nasdaq led that charge, it was up point 10.7%. Tim White, maybe we start with you. Why are we even asking this question of whether tech investing is debt at all?
Tim White: Sure. In the last couple of years, a lot of the recommendations that we had at the Fool, and certainly a lot of the biggest stocks were tech companies. That was because there was this explosion of tech companies trying to be "disruptors". I'm doing air quotes for those in the podcast. What those disruptors were trying to do is completely change a market with technology. That led to an enormous amount of money flooding into tech companies from both private investors but also big funds and companies like SoftBank, Masayoshi Son, just dumping money into WeWork and Uber and companies like that. Valuation skyrocketed, a lot of us put a lot of money in those. That money is not as much as it was back in 2021, for example. A lot of people have been asking us, is tech investing dead? Should we be putting all of our money back into Exxon and Shell instead of tech companies? We wanted to really talk about why it's tough to be a tech company right now and whether we should keep putting our money into tech companies or not.
Mary Long: The answer to this might be obvious, but Tim & Alicia, let's kick it to you next. Is tech investing dead? Should we keep putting our money into those companies?
Tim Beyers: Certainly, but you want to be discerning. I think one of the features to build on what Tim said, it's something I heard from a Sequoia Capital managing partner, 20 years ago and Doug Leone, he was the guy at Sequoia for a little while, he's retired now. But he told me straight to my face, he said," Money makes companies stupid and it also makes people stupid." I think he's exactly right. You've had a period for the last, let's say 20 years before, was it March 2022 when interest rates started going up? Right up until that point, you had a period of excess whereby there were a lot of dumb companies. I frankly should have been a lot more discerning with some of these companies throughout 2020 and early 2021. I frankly just did not internalize that lesson and use it to have a more focused lens in 2021. It's not dead, but I do think it is more important than it's been in a while to be discerning with the kinds of tech companies and also for that matter, kick it to you here, what are we talking about, when we're talking about a tech company? Like you could be talking about a company that is a really smart user of technology and is changing their operations fundamentally. A good example of that that we could maybe talk a little bit more about later would be Walmart. Walmart's an outstanding user of technology, but would you classify Walmart as a tech company? I wouldn't, and it certainly doesn't get a tech company valuation. But the boy is a smart user of enterprising software engineering.
Alicia Alfiere: Yeah. Tim, I really love your comment that money could make companies stupid. I think we have seen examples of that in the past. I think the benefit of going through this bare market, this difficult time, has been that companies have really shifted their focus from growth at any cost to really looking at things that we get excited about, like gaining operational efficiencies, free cash flow, being able to sustain the business yourself instead of going after debt. These are things that are important and we'll set the companies up for the long term and I think we've really seen that happen.
Mary Long: Tim, you mentioned like looking back and feeling as though you weren't as discerning as you would like. Are there companies that any of you have watched over this period of, let's say the last maybe four years, and get a bit of variety in there that have been discerning even when all others were not, and that did a really good job of managing their cash and were able to read the moment for what it was?
Tim White: Sure, I'll go first and I'll say Apple, a 100%. Like Apple did not go crazy, they kept doing what they were doing pretty much. If you looked back at what they did, you'd had no idea what was happening in the world, based on what Apple was doing.
Tim Beyers: I would say there are companies of the ones that I followed. There are have learned the lesson and maybe some that have learned the lesson a little earlier. I wish the Salesforce had learned the lesson a little bit earlier, but I will say they did it in two stages. The first thing they stopped was acquisitions at scale and then once they stopped that and really started focusing, I would say the last year have been the poster company for 2023 is the year of operational efficiency. They have crushed it. It's really been impressive to see the transformation, because usually that does not happen. It usually requires, I don't want to get too sports ball here, but usually what ends up happening is you switch the coach and then once you switch the coach, you get a new style of play and that new style of play leads you into something new and different. You would expect that what ends up happening is well, Marc Benioff's got to go and we need somebody else to come in and do that but that's not been the case. Being able to internalize that and then turn it around has been impressive to watch.
Alicia Alfiere: Well, and sometimes I think you need almost an inciting incident to get some companies to change their strategy, right? We saw recently with Coupang, previously burning cash, they had some difficulties with the bear market. Their share price went down and they started really refocusing, shifting their strategy, and for the last, I think it was four quarters, they actually generated cash for the first time, which was pretty exciting. But sometimes they need that inciting incident to get them started.
Mary Long: The second half of the lengthy detailed title that I listed off is until interest rates drop and so the Fed still meets again this year. There's a number of expectations about what will happen then. How do you view this moment going forward? I'm not asking you to say whether the Fed is going to cut rates or whether they're going to stay, we can stay away from that. But assuming that this is peak of the interest rate hike period, what are your expectations moving forward? Is there really a question, or a worry of potential death down the road for certain companies, for certain industries, what have you, or is actually more of a buying opportunity where we're going to know which companies are able to handle their cash, and in an environment where money is not as free flowing and it's harder to come by?
Tim Beyers: I'm going to give you an answer you're going to hate.
Alicia Alfiere: Yeah. [laughs]
Tim Beyers: But, it's true, because two things can be true at the same time. The answer is yes. Will you see deaths? Yeah. Will you see opportunities? Both things can be true. Here's the problem, is that we were talking about this yesterday, the cost of capital has gone up. It's gone up significantly, and that is important. Let's talk about what we mean when we talk about the cost of capital. The cost of capital is you have the cost of debt, and you have the cost of equity, and a lot of companies, particularly in the tech sector, use a lot of equity. You've probably heard us talk about it. If you listen to Motley Fool Live, you've probably. I hate to do this in an audio program, Mary, so I'm sorry, but we're going to get a show of hands.
Mary Long: Oh no.
Tim Beyers: How many times have you heard us talking about, you know the phrase I'm going to use, stock-based compensation. How many times have you heard us talking about this? How many hands? Basically, everyone.
Mary Long: Let the record show there are a number of hands.
Tim Beyers: A number of hands in the air. When you're doing that, if you're a tech company, that is using the most expensive capital that you can use to grow, which is equity. Equity is far more expensive than debt. Then the pressure on those companies to grow and grow quickly, in order to outperform the cost of the expensive capital they're using is extreme, and that puts a lot of pressure on these companies. What do you do in that situation? Well, there's a couple of things you could do. One of them is you could ratchet down your growth plans a little bit, and that is something we've seen. We've seen like reductions in forecasts, we've seen that. We've also seen some real focus on levering down your costs. We've seen that too. Lowering your debt exposure. There's lots of things you can do. But in an environment like even if interest rates freeze where they are right now, the cost of capital is still elevated. The pressure is still on, it hasn't gone away. It's just a little bit less than it used to be. Ultimately though, I feel like I'm ranting, I'm not trying to rant. What I'm saying is that the cost of capital is elevated, it's going to stay elevated. Companies that are respectful of that. I just gave you, Salesforce as an example of a company that is respectful of that, which is a weird thing to say because they used to be the ultimate disrespector of that. But now that they are getting respectful of that, they're in a much better position, and those are the companies that I think will continue to be in a good position.
Tim White: I think the thing to think about is that not only is the cost of capital high, but as an investor, you can put your money in things that give you 5-7% interest rate now with no risk. Whereas equity investing has risk. As soon as those interest rates go down, people are looking for a place to put their money that's getting that type of return, even if it has a little more risk. Right now part of the reason money gets sucked out of the market, is it there's safer places to put it than equities. Part of the reason you've seen a raise recently is people are predicting if interest rates go down, they're going to need to get in now, while prices are low on these equities, before they start skyrocketing.
Tim Beyers: Money starts flowing into the equity market. When money flows in, that's when equity prices start to rise, right?
Alicia Alfiere: Yeah. Well, and I would say too that as we've had this difficult time in the tech market, you have had valuations go down, and if you do have a company that's shifting their focus, doing the things that they should be doing with the valuation being down, it could be an opportunity. It really depends on the company though. You always have to exercise caution.
Mary Long: Tim B, you opened up talking about Stripe private company. We've seen in past recent weeks, I feel like some stories haven't made the news as prominently as other news stories, but there's been a number of private companies that have filed for bankruptcy that previously were just flush with cash. How do the private markets look to whatever eye you have into that? How do private markets, venture markets look right now compared to what we're seeing play out publicly?
Tim Beyers: It's terrifying. I really would not want to be an investor in particular in late stage private market tech. That's an illiquid market and so the valuations don't reset easily, and usually, I know I'm oversimplifying here, but in the private market, a private company valuation is essentially a handshake agreement. What do you want to sell me your equity at? I would like a pre-money valuation of $150 million. Will you take that? No. How about 125? It ends up being a handshake agreement, and then you have investors who pile in around that pre-money and post-money valuation. Resetting is like new rounds of money, and nobody wants to go through what's called a down round. In other words, I have to raise more money because I burned a bunch of cash, but I can't raise it. Let's say I had a $10 billion of private market valuation. I need to raise more money, and in order to raise more money to attract a venture capitalists, they're not going to give me a $10 billion valuation. At most they're going to pay seven billion. That's what they're going to value me at. If I want money, I'm going to have to mark my equity down. Guess who hates that? The existing investors.
Tim White: Yeah, everybody, who already bought it.
Tim Beyers: Everybody who's already in. I think because of those valuations, and it's in a liquid market is so extreme that it means that, man see it led me into a downer. But I think the positive side of this is the IPO market for 2024 in tech is probably not going to thaw very much. Probably not. Having said that, I do think there's going to be a real opportunity in public market tech.
Tim White: Right. For companies that haven't been saddled with all this expensive private money where you've got multiple VC firms competing to see who can give you the most money, and then they end up valuing the company that is way more than it actually is worth, and it can't go public because there's not an appetite for very expensive IPO's anymore. That environment means that you're going to have to have companies either wait for an appetite for expensive IPO's again, which will probably happen. It happened in 2000, it happened in 2020. That could happen or they have to figure out some way to get those investors to let go before they go public.
Tim Beyers: Yeah, and to your question Mary, that's where you're going to see some companies heartbreakingly are going to go away. Venture investors tend not to just kill companies, what they do is they tend to neglect companies. Those companies tend to raise more money, they need more capital, and the VCs say sorry, you're on your own, and then that ends into a slow descent into the ditch. But like I said, the good news here is that like vertical software companies, we've talked about vertical software companies, for example, small cap tech, where it's not saddled with the same anchor. That is probably a pretty decent opportunity, honestly. It's probably outperforms private market tech for the next 3-5 years. That's not me saying that, that was a partner at Benchmark that said that on Patrick O'Shaughnessy's podcast, Invest Like the Best, which is another really good one.
Alicia Alfiere: Well, and two, I think just to add some context, there is still venture capital activity happening here.
Tim Beyers: No question.
Alicia Alfiere: It's just a lot lighter than it has been in the past, and there still has been a fair amount of money being filtered to healthcare, for example, and also what we're going to talk about, I think later, the AI. A fair amount of money there too.
Tim Beyers: Yeah, and to be clear, early stage venture investing is still as robust as it ever has been. But that late stage, because there were a lot of fear, it was basically an arbitrage. Late stage, lots of venture investors, angel investors piling in saying, so let me give you an example. I want to get in on Snowflake before it goes public and get the best deal possible. People are just piling in at like a valuation that was just extreme knowing that when it came out it would come out at an even more extreme valuation. That's just not true anymore. But at the seed stage, yes, it's still very vibrant and there's a lot of money flowing in.
Mary Long: After talking about artificial intelligence and making some reckless predictions about the future of attach in Colorado, we handed the mike to audience members so that then Tim and Alicia could answer questions about Twilio, Datadog and Tesla.
Carl Kolesnikov: Hi, my name's Carl Kolesnikov. I wanted to ask you specifically about Twilio. Does Twilio fit into that same situation that Salesforce was in with regards to how they've managed their money over time?
Tim White: We wish that was the case.
Tim Beyers: Yeah, we really do. I'll start here and then either of you kick in here. Thanks Carl. They just did a 5% layoff. The lousy thing is, it's been a bit of a drip, drip, drip. I've been waiting for them to get past the point where they have stabilized the business such that there's no more drip, drip, drip. Yet here we are just again this week with another five percent off. If you can, I would encourage you, the SEC has all of the filings and there's an eight k from Thursday, and in that eight k is Jeff Lawson who is a CEO and co-founder, his letter to employees about this layoff. In it, what it says is that they couldn't figure out, go to market for the new product, the segment product. They just weren't getting enough uptake on it. They've gone back to selling the newer products by bundling it with the old product, the communications product, which makes sense. It means that there are salespeople that they hired in order to sell segment, the new product. They had engineers and support staff to support segment. Those people are getting laid off. Because I own so much Twilio, I want them so badly to figure this out, but I just can't tell you that they have figured this out yet, but I'm hoping. Because the core technology is still very good and tons of people still use it. Anything you want to add?
Tim White: I will say that they did have a similar story where they did a lot of acquisitions, Denver-based Engrid, Denver located Segment. A lot of businesses they bought, they've paused all that and they're still trying to figure out how to integrate it now, which is good news. But integrating acquisitions is extremely difficult.
Tim Beyers: It's very hard.
Tim White: It's something they've really struggled with. I think maybe next year ask us again, Carl, where we're at with that and hopefully it'll be a better answer.
Tim Beyers: Every quarter, here's what I'm looking for. If we could get through two quarters of stabilized no layoffs and then some improvements that show up in rising operating margins, and so you actually don't have to scale up your sales and marketing spend in order to grow your revenue number and that shows up as improved operating margins, that'd be a great sign. That would really be something I'd love to see. I think the stock would respond if they did that.
Alicia Alfiere: Now it's on the record, so we can have someone check back in a year from now.
Tim White: Well, we make predictions every single week and we regularly revisit them and go, we had it, but most of the time we're like, what were we thinking? But the advantage of making predictions every week is it keeps you thinking about the future and that is important.
Carl Kolesnikov: Even though Datadog is not headquartered here in Colorado, they have an office just around the corner. I have a daughter that has worked there and I'm just curious, are they the type of company they keep adding more of these modules and is their future bright?
Tim Beyers: You want to start?
Tim White: I'm just going to say what I talked about, preset license cost optimization applies to Datadog. I do believe that they will be subject to some headwinds there because it is a very expensive product. As you said, they're always adding modules which makes the product more expensive for companies. Open source tech, which Tim and I talk about a lot about competing with this, in the case of open telemetry and some other open source bits are competing with Datadog in a way they weren't three years ago. I do think that there's some headwinds there. On the other hand, Datadog has a lot of very happy customers. I use it literally every day in my job to try to figure out what's going on with our text. It's a great product, I think that they've got a good strategy. I think they've kept their cost is reasonable and there's still a lot of SBC, but generally kept things reasonable. I think their future is bright, but there may be some pivots in order to deal with some of this as headwinds.
Tim Beyers: I think that's exactly right and they've been open about this, Tim. They have said that we have a lot of customers that are coming to us and they are quite literally, they used the term Cost Optimization in the earnings calls. They have customers who are coming in and saying, this bill is too big, we need to find ways to cut it. That is cutting into the growth a little bit. I think that is fair and expected and it would be weird if that wasn't happening, especially with the assault of open source on this. Open telemetry is a pretty darn good product. Now, having said that, man, they are delivering like they are growing their customer base. For the existing customers that have actually committed to Datadog, they're growing their usage slower than they used to certainly. But they're still growing their usage over time, which is great to see. You don't mind. At least if you're me, I don't mind when a company that comes under increased competitive pressure or you run into economic headwinds and the CIO says, you know what? Tim, I see this bill. This bill is 800 grand. I need you to get it down to 600 grand. Then Tim says, well, here's the good thing that I take from it. He says there's zero chance that I am unplugging this, so I'll get it to 600 grand. That's a good sign.
Tim White: It's still solving a migraine-level problem. It just may be that I don't want to pay that much of the Aspen.
Tim Beyers: That's why I still own it and still really like it.
Male: My name is V.B.
Tim Beyers: Hi.
Male: We talked so much about AI, but we didn't talk about Tesla.
Tim Beyers: That's true.
Male: Can you complete the story?
Tim White: Do you want us to talk about Tesla's AI ambition specifically?
Male: Yeah.
Tim White: Sure. Elon a big investor in Open AI in the beginning and wanted to run it himself as he does all things, and really wanted to push for it. He could never convince the Open AI board and Sam to build the AI that he wanted, and in the same way that he wants to make Twitter the way he wants to make it. He's built his own, he's got a lot of money raised for it. He'll probably raise a lot more to build an alternative AI. I think this plays exactly into what Tim was saying about when you have a big free tier, you're competing $0 for everybody. There's no switching costs, I can try one today, a different one tomorrow, another one the third day, and I can use all of them. What you often see software developers do is play this game of, I will use until I hit the free tier so they don't have to pay again, and they just keep going sideways and using as many as possible. Are there going to be people who love Tesla's AI and use it? I'm sure. On the other hand, it's an incredibly competitive landscape. I don't expect them to be a crusher right away out the gate.
Tim Beyers: Having said that, I'll take a side step of that, a different version of what Tim just said because I agree with all of that. The other piece of it, though, is that, if you were to think about the best datasets for AI that exists in the world today, it would be very difficult to think of a better dataset than is in possession at Tesla. It's an astounding dataset because of all of the miles driven by Tesla's and all of the monitoring that they have done. Now, I need to qualify that and say they haven't used that dataset yet to get to full self driving. I don't know exactly what the problem is there, but in terms of software engineering, I think one of the things we know, and Tim knows this better than I do, it is very difficult to create a perfect product. You still end up with errors that appear out of absolutely nowhere. The consequences of an unknown error in full self driving are just unthinkable, you just can't have them. Because of that, even though the dataset is absolutely astounding and I think the AI that's built around that dataset is incredible and probably is going to deliver lots of really amazing things. It's not clear to me, [inaudible] , that it can deliver full self driving in the way that I know Tesla is promising it will.
Tim White: That said, a lot of extremely talented engineers between Tesla and SpaceX.
Tim Beyers: One hundred percent.
Alicia Alfiere: We touched on this before. I think autonomous driving, full self driving, is a lot more complex than people realized. Not only do you have all of these different kinds of roads to worry about, you have something that I think a computer would have a hard time figuring out that is, human drivers to have to interact with. That's the most dangerous part of getting to autonomous driving, is the part where it's humans and computers on the road.
Tim Beyers: When you have to deal with multiple variables like that, you're dealing with a computing problem that may in fact be ideal for quantum computing.
Mary Long: At our Denver meet-up, we collected stock pitch ideas from members, some of which were planning to play on future shows. But we want to hear your ideas too. If you've got a stock you think we should look at, tell us why. Give us a call at 703-254-1445, and leave us a voice mail to pitch us on the companies you're eyeing or would just like to hear more about on the show. 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. Don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.
