Transcription
Hi everyone. Thank you Jim. I think it's a fantastic opportunity to talk to you today ahead of one of the biggest, actually, IPO in the history. Space goes public this Friday. Everyone is really excited. Bloomberg reported that the deal has been four times oversubscribed. It's really, really hard to find the bearish voice. So what is your, you found one. What is your take?
This is this is an unprecedented deal. I think that's why it's obviously caught the fascination of Wall Street and beyond, Washington, Silicon Valley. I mean, we're going to be doing a $75 billion IPO with an evaluation of close to $2 trillion for a company with revenues of $19 billion, negative free cash flow. So this is really, excuse me, this is really a hopes and dreams IPO. And I think it's an important bellwether for the market as a whole, particularly the tech sector, because if the company is not worth, in my opinion, $1.75 trillion based on any reasonable assumptions over the next five years. This is a company that's being built on the TAM of not only space, but AI. And I think that that's what has everybody sort of fascinated, but also a little bit on edge.
So does it mean that you would short SpaceX? I have to see where it trades first. But you know, the idea is that the company is getting a huge premium based on the CEO. We already have a company that's out there in the marketplace, Tesla, that trades on the same premium to the CEO, right? Based on promises like robotics and full self-driving autonomous software. So we have a bit of a template as to what those kinds of things are worth. Tesla trades at, I think, about 14 times revenue based on the promises of the future. If it was trading as a car company, of course, it would be trading at $30 or $40 a share, not $400 a share. But SpaceX is coming at roughly 90 times revenues, which is a completely different animal than 10 to 15 times revenues.
So this is, as I've joked, the TAM for space is infinite, right? So you really can build whatever stories you want. Colonies on Mars, factories on the moon, data centers in space to sort of justify the valuation. But as I think the walk-on video said, you know, bull markets, you put a premium on promises. And in bear markets, you put a discount on reality. And right now, we're clearly in the former, not the latter.
Let me ask you one more question about space. What do you think would be a reasonable valuation, if you have any numbers in mind? Lower. How much lower? Again, we don't know where it's going to trade. So that's it. I mean, it depends on how far out you think these hoped-for business models, data centers in space, factories on the moon. You can't justify it based on their core profitable business, which is their mobile Starlink business, which has seen slowing growth, by the way, in the past quarter. So you can get to a couple hundred billion dollars on the businesses that exist. Is the rest of it worth $1.5 trillion? And that's where I have some difficulties. I don't know. There should be some premium, but I don't know that it should be a one and a half to $2 trillion.
Let's talk about sectors or specific companies that you are bearish on. And maybe some of those companies are also related to the space economy, because Elon Musk plans to deploy data centers in space. I'm just curious what you think it means for companies that are operating here. Is it a bearish case for data centers? What's your take on that?
Yeah, yeah. He also said he was going to be making chips that are a fraction of the cost of Nvidia's chips in a few years, too. So maybe we should be talking about the impact on the chip stocks. Look, data centers in space sounds great. And while the physics are possibly theoretical, the problem becomes, you have to get the launch cost down dramatically. Number one, you have to deal with radiated heat, which means the radiators, similar to our space station, have to be enormous relative to the size of the spacecraft. But more importantly, you have to have redundancy and it has to be insured. And the redundancy is the problem because we've been following the data center business terrestrially for years now. But when they were cloud data centers, the old legacy data centers, and it's one of the most capital-intensive businesses around, stuff breaks all the time and has to be replaced. Air conditioning, connections, whatever. And if that happens at a critical part in a data center in space, you will need redundancy, right? You will need to move it to another spacecraft, because you can't just send up a tech with some parts to fix it, like you can on Earth. So there's lots of issues having to do with basic business problems like insurability and redundancy. The other problem, of course, becomes that launch costs aren't anywhere close to low enough to make these economic. And let's face it, the one rocket that all of this sort of depends upon, the Starship, has not even reached Earth orbit in 12 flights. They're still waiting to get this rocket into orbit. So a lot of this is really, again, similar to our earlier discussion. A lot of this is really out there a number of years and hopefully everything happens correctly. The problem is you're paying for that now.
So you are bearish on data centers? I'm bearish on data centers. Yes. Any other corners of the market where you see some concerning developments? Because it's really hard to find positions for short sellers right now. Everyone is so bullish. Yes, we saw this sell-off in the past couple of days, but overall the market is doing great. So how do you identify this?
Yeah, I've noticed that. We've been bearish on data centers, say, since back in 2022. The data center business is sort of puzzling to us. It's really kind of a bad business. The guys that have been around for a long, long time have mid to low single-digit pretax returns on capital. And if you look at now, the companies that are building new data centers, a lot of them are the old Bitcoin miners, for example. And then you have the new clouds, which we'll get into in a second. Again, where we've seen granular data, where they've given us enough data to sort of analyze the real estate aspect of the deal there. Mid to high single-digit pretax returns on capital. So these are really, in the case of the comprehensive data center guys who are building the shell, buying the GPUs and renting them out. If we turn our attention to the new clouds like Core, we've, or it's even worse because those are, when you boil it down, those are equipment leasing businesses, right? They buy a chip from Nvidia and then they turn around and lease the chip to a hyperscaler or to a pure AI software company like Anthropic or OpenAI. And their bet is on depreciation and whether or not you can get the chips from the supplier. So we were talking a little bit earlier. It gets back to the point that we've made to clients that anybody that's just a middleman in this chain, like the data center guys are, either as REITs or equipment leasing companies, should never trade at higher multiples than the company that controls their supply. Taiwan Semi and Nvidia, AMD, and so on. Right. They're price takers in all sense of the word. They're middlemen. And so it's really, we're at the point in the bull market where all of these stocks have gone to premium valuations. And I suspect that at some point in the near intermediate future, we're going to start to get to the point in the market where people are going to begin to really analyze the business models and say, okay, what's special and what's a commodity?
I really want to get your take on the stock market overall, as you mentioned. Yes, the trend is bullish. However, in the last couple of days, we saw a pretty serious sell-off in the stock market. We've got a hotter than expected jobs report, a stronger than expected jobs report. Inflation is still sticky. The bond market is now expecting that traders expect that there's going to be a rate hike. We saw elevated yields. To your point of view, is this just like the beginning of the bearish trend? Or it's just like repositioning, or people, some people are taking profits because they want to invest in space? What's really happening?
Yeah. So, so for our clients, we advise a model portfolio, which is a portfolio of 40 short ideas hedged with various different indices. So what I would say, Natalia, is that what's happened in June so far has been kind of the April-May movie in reverse, in that all of the stocks that hurt us on the short side in April, May, AI stories, data centers, new clouds, whatever, those have actually gone down and have been helping us on the short side in June. And the more defensive areas we were short, consumer healthcare, those areas have actually been going up in this decline. So to me, as a just observer of the market for 40-some years, it looks like a rotation where money is coming out of the previous hot area of the past few months and is going into the neglected areas. So again, it's sort of a bifurcated market depending on how you're positioned. And we have short positions in both. So we don't want to be all tech or momentum or all consumer or healthcare. So it's been fine. But I think that's what's been interesting about the last couple of weeks in this sell-off. It's clearly the stuff that was doing the best off the March bottom.
So what do you expect is going to happen next throughout the rest of the year? I was hoping you would tell me. I mean, I've learned after 40 years not to predict where the market's going. We've been running hedge funds since the mid-90s. Look, there's no doubt things are stretched. You've got record retail participation. You've got record options volume. You've had this now for a while. You've got really an environment where there's a lot of speculation going on. The biggest difference in 2024 versus the last few years, however, is now for the first time since 2021, we're seeing just large amounts of issuance. So I've always said, you know, Wall Street has a printing press, too. It's not just the Fed. It takes Wall Street sometimes a number of years to get it going. But now the printing press is printing lots of stock. And so at prices now, buyers are being met with sellers. And in terms of new supply, generally that's not a good sign for the overall market. Last time we saw this was 2021 after the GameStop episode. I remember that in February of 2021, there was a period there of two or three weeks where we were doing $3 billion in SPACs per night, which was sort of equal to the entire US savings rate. We were just going into SPACs in that month. And that was a warning sign. Most stocks peaked out in the first half of 2021 and then sold off into 2022. The issuance we're seeing now with SpaceX and some of the other IPOs, but also secondaries like the Google deal and others that are being announced almost every night now, we're going to break records. I think all equity issuance records, more than 1999, more than 2000, and certainly more than 2021.
So can we see that this wave of huge IPOs is a potential problem for this stock market? Well, every time we've seen a wave of IPOs, that's generally not been good for the stock market. That's what we can say historically. Maybe this time it will be different.
What's different and what's similar versus the dot-com bubble? So what's different? And let's say similar to the dot-com era. Well, this one's much bigger. That's easily the first statement I can say. Having been short stocks in '99 and 2000, there are similarities. And one of the biggest similarities is the impact on a CapEx tech boom on earnings. So back then we had Y2K. I remember my firm replaced all its PCs in 1999. We also had the enterprise and telecom build-out of the internet networks, right? You had not only was the fiber being laid globally, but big companies were basically wiring themselves up to take advantage of the internet to talk to each other. And all of that has a tremendous impact over the short term on profitability, as it does today, with all the money being spent on AI and data centers. And the reason is, is that if I am buying equipment from you, if I'm buying PCs and routers and network equipment like I was in 1999, or today, if I'm buying chips and putting up a data center, that is revenue and profit on your financial statements. On my financial statements, it's capitalized and written off over, depending on five years, ten years, whatever the case might be, on the piece of equipment being purchased. So CapEx booms are tremendously stimulative for corporate profits, and particularly S&P 500 profits, in that it just drops to the bottom line for Nvidia and all the vendors and the construction companies or whatever that are building this stuff out. It gets written off over time by the buyers on the same dollar. And so, for example, from mid-1998 to mid-2000, S&P earnings were up 30%, roughly 15% a year, which was an acceleration from what it had been in the earlier '90s. And then from mid-2000 to mid-2001, where there was a very mild recession, S&P earnings dropped 40% year-over-year. Order books got pulled. People decided they didn't need 10,000 routers, they needed 2,000. And so they cut the order books back and costs were still high and profitability just imploded over a short period of time. In fact, S&P earnings dropped as much in 2000 to 2001 as they did in the global financial crisis, which was a really serious recession. We have the same kind of setup today, and that's why S&P 500 earnings estimates are going up so fast. It's because basically the CapEx boom is translating directly into revenues and profits for a small number of companies. And it's being capitalized for the guys spending the dollars. That is probably not sustainable over the long run and deserves a lower multiple than a higher multiple. The market is giving a higher multiple in the rearview mirror because it's growth, but you have to kind of look at what is driving that growth and how much of it is going to just a few companies versus the rest of the market. And that's one reason why tech has, of course, done better than the broader market, but it does so the seeds of its own demise at some point, because you have to continue that kind of capital spending at higher and higher levels, which is going to be hard to.
So does it mean that you expect that at some point people will not need so many chips? And then like capital was like, how, how, how do we transition from this stage to like the more bearish case? So back then, for the few graybeards in the audience, and I don't see many, but there are a few, there was a mythology that came up because of the internet that was espoused by MCI Worldcom and kind of taken as gospel, that internet traffic was doubling every three months. And it's kind of this became ensconced in people's views and in corporate boardrooms. People were like, well, internet, we've got to build capacity for all of this traffic that now is going to be on our internal or external networks. And it turned out, and there was wonderful work being done by a mathematician at Bell Labs on this, that internet traffic was not doubling every three months. It was doubling every year, which is still a lot. It's 100% growth. But it's the difference between 2x and 16x in a year. And that realization in early 2000 was one of the things that led to everybody suddenly pulling their order books. Right now, we have a similarity in that there's just a belief that there's infinite demand for compute, that whatever chip can be produced, there will be a demand to put that chip to work on LLM training or inference. And that may or may not happen. We'll have to see. I mean, there may be technological breakthroughs that change the economics of all of that. We don't know. I mean, the one thing you can count on technology is that there's disruptions that you don't count on, that make ten-year forecasts very, very risky. But right now, we're in a market where those five and ten-year forecasts are being capitalized.
Yes, I want to switch gears a little bit and talk about one of the most volatile sectors since late February, energy. We saw a huge spike in energy prices, oil, natural gas. People who were short natural gas did not do well. And now we have lots of debates when well, prices stabilize. What is your view on energy stocks across different sectors? Well, I couldn't tell you where oil and gas are going. But what I can tell you is there's a subsector that's tied to our previous conversation, which is the alternative energy companies, which have all been bid up to just crazy prices based on the view that they're going to be needed to power up data centers. Surprise, surprise. So you have lots of companies that are out there that have relatively mundane or bad businesses that are now trading at 50, 60, 70 times earnings, 30, 40 times EBITDA, because people believe that we're going to hook up geothermal to power data centers, or that we're going to need far more solar at premium prices than we thought we would. And so all the alternative energies, and then, of course, you have a whole subsector of nuclear stocks, small nuclear reactor stocks. And that's going to be the answer. And my own view is that the one thing that we're not short of in the United States is actually power. I know that seems to be going against the grain, but we have plenty of natural gas and other things to power. What we don't have is the turbines and the permitting and all of the sort of bottlenecks to get that natural gas to power that's going to go away in two to three years. I think that we will get through that red tape, we will get through the not-in-my-backyard. We will get through lots of things. If data centers and AI are as big as everybody says they are, then power is not going to be the bottleneck. And these companies trading at insane valuations because they would be the third or fourth choice to power a data center, are probably going to come back to Earth. I would say that. So that's a really interesting area to look at on the short side, where there's a true dichotomy in valuations versus reality. It's really hard to believe that we're not going to be able to find enough cheap power. And let me add one more thing. Power costs, as it gets back to data centers in space, because that's one of the reasons you want to put them in space. Power costs for a data center are really low there, actually. Even with rates where they are today, power costs are about 5 to 7% of revenues of the data center. It's not the game changer. So again, I think these will be solved pretty easily over the next two or three years.
So why do we need data centers in space in this case? I don't know. It's a good question to sell stocks.
All right, I want to ask you about talent. Actually, this market has been so relentless, so resilient. Everyone is so bullish. Is it difficult for you to find the right people who know how to short stocks? It's always been difficult, at least over my past four decades. And in terms of shorting stocks and finding talent, the analytical side of it is the same. You know, you should look at companies the same way, whether on the long or short side. The difficulty becomes in sort of the behavioral finance side of the business. And that is when your long stocks, you have a really comfortable cocoon in which to ply your trade because everyone's always telling you, basically, you're right, stocks are cheap. The sell-side, the CEOs on CNBC, it's takeover rumor. But when you're a short seller, you're constantly in an environment of negative reinforcement. I've talked about this a lot, and not everyone does really well in terms of output and emotional well-being by being constantly told you're wrong in an environment of negative reinforcement. And that's what separates generally people who end up being talented on the short side with people with more traditional skills, because you have to be willing to deal with a lot of negative reinforcement. And so we're actually, for our clients, we're actually setting up one of the things we're doing is helping them set up a training program to help identify and train their analysts on the dark arts, if you will. But it's a challenge, I think. And I think after a super long bull market, it's even more of a challenge.
And by the way, we see more and more companies using AI tools, different types of software for analysis, fundamentals, etc. Do you find it being useful for you guys on the short side? Yeah, I mean, AI is a tool and it's still, it still has to be checked. What's good about it is its ability to compile data quickly and in format. But at the end of the day, particularly on the short side, you're going to need to exercise judgment on that output. On whether the business model is sustainable, is there a possibility of fraud? What are the external possible competitive threats that AI hasn't picked up on? Because AI, as you know, is still algorithmic, right? It still goes out throughout the world and picks what it thinks are the right opinions about the facts. It's really good for collecting the facts in a much faster way and in a better way, in a formatted way. But it's still hallucinates. In our case, it still hallucinates a lot when it comes to opining on those facts.
We have 30 seconds left, and I have to ask you about Andrew Left and this high-profile case. What's your take on that? Yeah, I mean, so our take is that it seemed the government had a novel approach, that it was okay to profit on the short side if you hold the position for a reasonable period of time, as opposed to taking profits immediately. If you've told people I want to be short X, Y, Z, and then you cover X, Y, Z within a day or two or the same day. Now, there were other fact patterns that were not advantageous to the defense in that undisclosed third parties, a variety of other things that didn't help the defense. But the question would be, and I would pose the question, if I, and we've never been in that business, we've never been in the activist shorting business, putting out reports publicly and then trading on them. But if I put a report out with a stock at $100 and I based it on facts and my opinions on the facts, and I said, this stock is worth $50 in our view. And if that stock that day traded at $45, would I have a problem in, say, covering the short? Because that's the legal concept at work here. The government might say no, that's manipulation because you did it immediately. And again, if I put my opinion out about a stock and said, I think it's worth this, am I then restricted over a very short period of time trading that I think might be looked at by the appeals court and looked at differently. Some of the other facts in the case, however, were not really good for the defense, and I think that that's still problematic.
Thank you so very much. Thank you. Thank you. Thanks, guys.