What to Make of the Latest Tesla Report and Elon Musk's Comments

In this podcast, Motley Fool analyst Asit Sharma and host Deidre Woollard discuss:

• The promise of Tesla's next-generation vehicles.
• If Tesla's energy business is finally ready for prime time.
• How ServiceNow's AI push is paying off.

Motley Fool analyst Tom King and host Mary Long talk about Constellation Software's history of acquisitions.

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 Jan. 25, 2024.

Deidre Woollard: Is Tesla learning to surf? Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Woollard here with Motley Fool analyst, Asit Sharma. Asit, how are you today?

Asit Sharma: Deidre, I'm doing really well. Thank you.

Deidre Woollard: I booked you a week in advance because I was so excited to talk to you about Tesla. Whenever I see the Tesla earnings on my calendar, I'm like, oh, here it comes. It was spicy. The thing that I'm hung up on, and I think the headline has been, the Tesla says it's in between two growth phases. It's spending so much right now on building factories on R&D, a highest capital expenditures in company history. They've still got plenty of cash. But tell me about these two waves and how much patience we should have as we sit here in the trough.

Asit Sharma: Deidre, before I do that, I have to say shame on you for revealing how we operate to say that you booked me a week in advance. Now everyone knows that one of the dirty little secrets of Motley Fool Money. At any rate, I think shareholders should be pretty patient here. You should point out that four billion dollars in free cash flow in the last four quarters, it's a cumulative number. But remember, for those of you who are a little bit dusty on that, that means that after all the investment that Tesla has made over the past year, in all this new production capability, it still has four billion dollars in cash that it generated. It's a company that is seeing some margin compression, but it's still churning out very nice cash flow.

I think maybe the elephant in the room which got addressed briefly is the impact of Chinese car manufacturers, EV manufacturers. This industry is maybe one of two or three bright spots that the Chinese government has right now in an economy that's failing. They're doubling down in putting resources toward the production of electric vehicles at scale. Now they have pulled back as a government on some of the incentives both to manufacturers and customers. But what Elon Musk was referring to in the conference call yesterday when he said that, look, Chinese vehicles, they're formidable competitors and they're going to take market share all over the world. I'm paraphrasing here. What he's really saying is that they have already gone through their manufacturing curve, their development curve to, on their own, be able to churn out really great vehicles at a low cost and provide a barrier to entry from any auto manufacturers who are behind in the game.

He sees this as a legitimate threat around the world. I also agree this is something for Tesla shareholders to watch. Now, the story won't be quite the same time as last time with industries like the solar industry. Many governments around the world are a little worried about China's reach in manufacturing and how it can subsidize fairly or unfairly its priorities and then knock out local competition. While I don't think the Chinese wave here of EVs has a free pass into Western markets, it is a competitive threat. Overall though, just to round this out, I do think that the investments that Tesla has made in its production capacity, in its supercomputing capacity with the Dojo supercomputer over the past few years, there's a track record there investors should pay attention to. I think patience in this trough is warranted. I know the stock is down today and investors are disappointed with a little bit slower growth outlook. But the longer term story is still intact.

Deidre Woollard: Well, think about that longer term story because on the call Musk made it very clear, this isn't a product announcement call, this is an earnings call. Yet he definitely wanted to tease out the next generation of vehicles. Didn't give us too many details. Poked fun of it himself for tending to over-promise on timelines, which I'm sure his employees are well aware of. Given that we don't know much here, is he overselling what this next generation could be? It seems like it's more about the computer aspect, the Dojo aspect, and less about maybe any eye-catching new design.

Asit Sharma: I think what he's telegraphing is that the next generation is going to be a lot more competitive price-wise. There was some other color in the call where he was talking about the average selling prices of more conventional automobiles among other auto manufacturers. What Musk is saying here is that, I'm not going to give you any timelines, in fact, I'm pretty bad at that. But it'll be a more cost effective car from the consumers perspective and it'll be loaded with great Tesla features. I think that's enough for shareholders to get a sense of where the company will head next in terms of that wave that you're referring to. I also like that he was humble. I like the self-deprecating Elon Musk. I hate it when he's on a high horse and is dissing the analyst at the table and cursing and walking in with a huge amount of swagger. I think as a shareholder, you want him to be humbled and focused on Chinese competition, on where Tesla can go to find its growth. To make those comments about his own foibles, that signal to us he's much more focused on getting back comfortably ahead of the competition.

Deidre Woollard: I've heard some rumors about that, the $25,000 car and things like that. Tesla hasn't said anything about it. But one of the things that Elon has continually stressed is the idea that the most valuable part of the car is going to be the software going forward. This is just a conveyance device. But I got to take issue when you say he was humble, because I think I'd never find him particularly humble. I think my favorite moment might have been when he was asked about his most recent demand for a 25% of voting control. He was saying he just wants to be an effective steward of the AI technology. It's not about the money. It's not, I think he said, it's not about if I have power and I'm going to go bonkers or something like that. What do you think? What was your take on that and his most recent demands about that?

Asit Sharma: Not surprised. He did actually say, look, it's not about the money. Again, this is the Musk that I like. You're correct. There probably is no true version of humble Elon Musk, but humbler than usual. Maybe that's what I was trying to communicate.

Deidre Woollard: Indeed.

Asit Sharma: When you're asking for voting control so that you can realize your vision, that's more the spoiled child genius who's like just give me the marbles and let me play with them. I want to be like Mark Zuckerberg over here. I think he's just jealous of companies like Meta, which have already established that voting control. This is another way just to get attention and to point the finger at his greatness how much AI has been part of Tesla's DNA. We see that a lot in these calls where he's talking about generative AI and AI in general. He doesn't like that after walking away from OpenAI, Tesla today, it is no longer seen as at the very forefront of artificial intelligence. Rather it's companies like Microsoft, like OpenAI, which is private, and some bigger competitors. Part of what we're seeing here is Elon Musk's theater and so many references to AI ambitions. That's again, you have to take this if you're a Tesla shareholder with the rest of what you get with Elon Musk, which is a lot of capability in terms of manufacturing, production, and investment in future technologies.

Deidre Woollard: One of the things that I look at every quarter is the energy storage business. It's not a big part of the business and it hasn't necessarily worked out the way he wanted. I was remembering recently in 2016 when he made that big announcement about the solar roofs and those beautiful glass tiles, he was on the set of Desperate Housewives. It was this whole moment. Well, energy storage, it didn't quite go that fast, but deployments were more than double compared to the previous year. The profits are growing, small part of the business, but growing pretty quickly. He said, the energy business is going to grow faster than the car business. Maybe. I don't know. But one fact that they said is they're going to start releasing those production numbers along with the car numbers. That seems to me to be a positive sign.

Asit Sharma: I think so, and I think this is something we can start paying attention to with a little more time. Deidre, you're right. Total deployments of Gigawatts in 2023 increased 125 percent versus 2022. So this is a business that's growing faster than that vaunted 50 percent rate, which is really the stretch goal for automotive production and all kinds of signals on the ground that, that automotive production is going to slow next year when you add the energy business to the other services business. Sale of like used Tesla cars, the supercharging revenue that now has become about 15 percent of the total top line. When you have a higher margin businesses that start to approach 15-20 percent of total revenue, that can be a bottom line boost in any business. Here's right about the time, investors should start monitoring that. I think you're right to call it out and I think good on them if they start giving those production numbers every quarter, this could be an neglected aspect of Tesla's total story that will be more meaningful with each quarter as we get into the rest of this year. 25 2026.

Deidre Woollard: Absolutely. Well, I could talk to you about Tesla all day, but I want to hit another one that reported yesterday because it isn't a household name. But man, it's a great story and that ServiceNow. I love for you to explain a little bit of what this company does and why it had such a spectacular quarter?

Asit Sharma: Sure ServiceNow is a company that makes it super simple for workers at an enterprise business to spin out apps to do things. For example, if I wanted to have some way to communicate with you about scheduling on Motley Fool Money, I might be able to use ServiceNow to make that very easy rather than the way we probably go about it now, some slack, some emails, etc. There's a way that I could use their technology because my company would subscribe to their software as a service platform. Just pull down some tools to make that happen. While I'm not a software engineer by any means, I have the technology at my fingertips and they do this really well, they don't like to acquire other companies, they build almost everything on what they call the ServiceNow platform in house, they have a bunch of big businesses that pay them good money to make the technology available across their total global businesses. This is really where they excel is increasing businesses with these Fortune 1,000 customers all the way up to the biggest companies on the planet.

Deidre Woollard: The amount of customers they have in the Fortune 500 I think was something like 85 percent. They work with everybody and the growth is just really impressive. Part of that is that their AI platform now Assist, they said it's their most successful launch ever. One of the things I like about them too is that they break out their customer cohorts, they use their data in a way to really tell the story and the customers that have big spent, so over a million in contract value is just really impressive, keeps growing. On the call, CEO Bill McDermott, he talked about having 186 CEO meetings in the last six months. He's been moving around and he said that CEO's really want to get involved with AI directly. It sounds like this is big now but also bigger for the future, right?

Asit Sharma: Very much so. Two parts of this I think shareholders should focus on or perspective shareholders if you're looking at ServiceNow, Bill McDermott started his career in sales. He's a great manager. He's run some pretty big divisions of companies like SAP. He comes with a lot of executive experience, but at his heart, he's still the teenager who started a store on the corner near his house and was selling merchandise. For him, it's really important to go one on one, even if that means meeting a CEO a day or whatever the cadence is to persuade them that the now technology is the best so that his sales teams can come in afterwards and do the hard negotiations and they're very crisp negotiators, by the way, to lock in these lucrative contracts. But part of the story he's telling makes sense because CEO's now are caught in this uncomfortable position. They have to show shareholders that they are investing in AI like everyone else, but they have to see return on it so they're not losing money because then they'll just be blamed next year or down the line. It's a tough spot to be in for the companies that don't have an immediate clear line of sight to how AI can help them. ServiceNow is making that easy by not trying to be really, fancy. You mentioned now Assist, which is a pretty interesting modular part of their business, it helps a company get a virtual agent really quickly to interface with customers or it helps a business identify a process and let the GenAI figure out how it can be done more efficiently. As a manager, you can monitor the progress. You can see who's using it, how they're using it. So itself provides a really great and easy use case to sea level executives and the managers below them, that they will be able to see a return on all the money they're spending. That is an edge versus some competitors who are still sort of fumbling around and trying to wave a banner of Generative AI and motion people over to their software. I think they've got specific use cases that give them an edge.

Deidre Woollard: And I love the way that they're adding modules on. It reminds me of some of the cybersecurity companies where you've just got that potential for expansion and I love what you said about McDermott and his enthusiasm because I listened to these two calls back to back and they were very different experiences. Musk, he's got the squawker, he's the household name I call it in sus little. He's laid back about it and he wants people to trust him but he doesn't really feel like he has to earn it. McDermott the way I had it in my notes is like the football coach in the locker room, even after the team has, is blowing away the competition and he's like, yeah, we're going to go even further, faster. What do you think about the tenor of the CEO when you're looking at the earnings and you're also hearing their voices and what you're hearing in the voice. How do you balance the two?

Asit Sharma: One I really commend you Deidre for actually listening to calls. Many an investor gets caught up. You can see the lack of time in scanning transcripts. You get so much data out of hearing the voices, the reactions to questions instead of reading what's on the paper or on your screen to actually hear that tone of voice and I think with Musk, we get what you probably want. Given everything we've already said. All the dressing down of Elon Musk that we've presented. You actually want someone like that who's trying to spearhead an entire industry, actually three of them, if we count the energy business, and AI to have the swagger to be a little cocky, to show that he or she is going to attract the capital and invest it wisely and they're not afraid to do so. With a company like ServiceNow, which is just so dominant in its industry and has the next step, which is to get bigger you need a great football coach who can inspire the team to do just that because it's no easy task. Where is ServiceNow going now they're starting to work with sovereign governments because when you get that big, we talked about the statistic, you cited 85 percent of the Fortune 500. What's left? Another 15 percent you have to now go to governments and sell your wares there. You need a coach who's proven, who can inspire the troops, who doesn't get tired, who needs to rest his or her voice at night. Maybe with a cold soft drink or something just because they're hoarse from all the exhortation. I think in Bill McDermott, you get that. As I said before, he's a special blend of a great manager, someone with really fine executive skills, but also the ability to inspire that and he's got that salesperson talent. He's always selling, and you want that in the CEO of a growing company. I think out of both of those calls, if you own shares, you probably heard something that made you feel fairly comfortable about the people in charge.

Deidre Woollard: Absolutely. Leadership matters. Thanks for the time today Asit.

Asit Sharma: Thank you so much, Deidre. This was so much fun as always.

Deidre Woollard: We talk about a lot of stocks on the show, but it's just a peek at the Motley Fools investing universe. This year we're rolling out a new offering. It's called Epic Bundle. The service includes seven stock recommendations every month. Model portfolios and stock ranking, all based on your investor type. We're offering Epic Bundle to motley fuel money listeners at a reduced rate. As a thanks for listening to the show. For more information, head to fool.com/epic198 will also include a link in the show Notes for you. Most CEOs are happy when an analyst upgrades their stock. Not this one. Mary Long cut up with Motley Fool analyst Tom King to learn about a software holding company with a disciplined allocation strategy.

Mary Long: Our good investments written in the stars joining us now for a medium dive into Canada's Constellation Software is Motley Fool analyst, Tom King. Tom, welcome. Good to have you here.

Tom King: Thank you for having me, Mary.

Mary Long: Constellation Software is a conglomerate of over 500 software businesses. The general theme to this family is that they're all, at least right now, well run vertical market software, aka VMS companies. What is VMS and why are these companies such appealing acquisition targets?

Tom King: Vertical market software is software that is designed for a very specific application or for a particular industry. The easiest way to understand it is by contrasting it to horizontal market software, like Microsoft Word, for example or Google Sheets is classified as horizontal market software because it's used in a variety of industries for a variety of applications. Vertical market software has a very specific purpose in a very specific industry, and they're not necessarily more appealing acquisition targets than any other kind of business. It was just that this was an industry that when the company was founded back in 1995, the founder felt that this industry was being overlooked and that there were opportunities there.

Mary Long: That founder, his name is Mark Leonard, and he's like a pretty central part of the story of constellation. He's been called the Warren Buffett of software. What's the deal with that nickname? Where did that come from?

Tom King: I suppose it would be that he has established a very disciplined set of acquisition criteria, and they are criteria that they are not willing to deviate from. So no matter what the rest of the business environment is like, they stick to their criteria, and that can be hard to do because often they're being encouraged to get on the train with everybody else but they're not willing to do that.

Mary Long: Do we have a sense of what those criteria are?

Tom King: Today, they focus on vertical market software companies, and the specific criteria that they look for in those companies are that they are small so typically fewer than 100 employees but they can get bigger, but they prefer small. They also prefer companies that are first or second in terms of market share in their industry. They like them to be mission critical, the service they provide to be mission critical. Also, they want them owner managed. So the owner who is selling to Constellation should ideally be willing to sit around and continue to manage the business. The last criteria is that they expect the business to run autonomously after acquisition.

Mary Long: This is a company that has compounded shareholder value at a rate of 34% over the course of its history as a public company. So clearly this formula that you've laid out, it's worked pretty well for constellation. That set like if you can articulate what they're looking for in businesses, what is stopping someone else from copying and pasting and doing the exact same thing. What's like the moat here?

Tom King: The moat is that they set themselves up as an attractive person to sell to. If you are the owner and manager of a small software business and you're getting to the point where you're thinking you want to sell this business, your options are Constellation on one hand and a variety of other businesses such as private equity investors on the other hand. Typically those kind of businesses, those private equity investors have an exit date, so they're not going to hold this businesses forever. They're probably going to come in. They may make some changes, they'll try to, in inverted commas, optimize the business. They might borrow a lot of money against the business assets. That is how private equity investors typically work, and they look to get out in five years time or 10 years time, or at some time frame. So Constellation sets itself up as if you don't want to go that route, come to us, we'll offer you a decent price. We'll give you an opportunity to cash out. We're not going to tell you how to run your business and we'll hold you forever. If you care about the business that you own and the people who work for you, when you get to the point where you want to sell, Constellation is a good candidate to consider.

Mary Long: Yeah, so it seems like culture is really a selling point here. Again, we've talked about Mark Leonard a bit, but he's a really central point of that culture. Mentioned he's an interesting guy. He doesn't do really any interviews. There are maybe only one or two pictures of him on the Internet. But investors can kind of get a sense for what he's about through reading his president's letters. They're not annual. In 2017, Leonard said he would only write to shareholders when I think I have something new and important to communicate. I'm sure you've read a lot of these letters. Do you have a favorite nugget or takeaway from his writings to shareholders?

Tom King: Yes. I think one of my favorites is from a letter he wrote in 2018. This was one of his last before he decided I'm not going to continue writing these unless it's something useful to say. He said, "One of the analysts who covers Constellation recently changed his perennial see recommendation to a buyer. We lost one of our few critics. Analysts who worry about the quality of earnings and reversion to the mean and the impossibility of trees growing to the sky are valuable." That really stuck out to me because I don't know too many CEOs who would celebrate losing a critic.

Mary Long: Sticking to this culture point, Constellation Software does not do stock based compensation. If not for that, how does the incentive structure work within the company?

Tom King: Everybody is paid a salary, a cash salary, and a cash bonus. The cash bonus is dependent on two performance metrics, Those are return on invested capital and net revenue growth. The return on invested capital has to exceed what they call the risk free rate, and that was set to 5% in 2022. The reason this is important is that they only get paid their bonus if they add business value. So they can't simply trade water or lose value and expect to be paid a bonus. They don't pay any stock based compensation at all. It's all cash. Now executives, managers above a certain level, as well as the directors, are all expected to use their cash bonuses, most of it, to buy Constellation stock and to hold that for several years. There are restrictions on selling it. What this does is that it creates significant alignment between the managers and outside shareholders. Now we often, if you read the proxy statement of any public company, they will talk a lot about alignment. But it's not true alignment because they typically give the stock to their employees and then say that this creates alignment. But I think there's a very big difference between how people feel about something that they've been given and how they feel about something that they've earned. In the case of Constellation Software, the managers and senior directors are all buying stock with money that they have earned. They are not given it so that aligns them with shareholders to a degree that doesn't happen in any other public company that I have encountered.

Mary Long: We mentioned before the really impressive returns that this company has seen since it IPOed, and even just as we're talking and I'm researching this company from a foolish investing perspective, you talk about Mark Leonard, you talk about these like aligned shareholder incentives, and the focus on the long term letting the companies that are acquired run themselves even after they're bought. As I look at all that, I think, wait, what's the downside here? There's got to be some risks that you're thinking about as you look to the future for this company. What might they be?

Tom King: I think the primary risk is price, like what we pay as outside investors to buy a share of Constellation. It's a lot better known today than it was in the past. We face the risk that Mark Leonard avoided back in the early days. The risk of other buyers going after the same thing. Other buyers are also interested in Constellation stock, and we just need to be careful that we don't overpay for the stock. So before you buy the stock, if you're considering buying it, definitely put some attention into the price you're willing to pay.

Mary Long: Awesome. Well, thanks Tom so much for sitting down and giving us a closer eye into what is a really interesting and impressive company.

Tom King: Thank you, Mary.

Cathie Wood: 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. I'm Cathie Wood. Thank you for listening. We'll see you tomorrow.