August 27, 2020- Former House Speaker Paul Ryan to Launch Blank Check IPO. Are we at Peak SPAC?
Apple’s Market Cap Ripens to $2 Trillion. Is the Valuation Justified or is the Stock Market in a Bubble?
The Creator of Fortnite Sues Apple and Google in App Store Dust-Up. What’s the Issue Behind the Lawsuit?
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Transcript:
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.Accelerateshares.Com.
Julian Klymochko: Welcome ladies and gents to episode 83 of The Absolute Return Podcast. I am Julian Klymochko.
Michael Kesslering: And I’m Mike Kesslering.
Julian Klymochko: Today is Monday, August 24, 2020 on the tail end of summer here, a little bit slow in the markets, but we expect things to pick up, come September when everyone back in the seats, back at the desks, back in the office. Hopefully, I mean, we certainly are, but many people still working from home, but if you look at what the market’s done since the March low’s, I mean, S&P 500 hitting new all-time highs. It’s basically completely forgotten about that whole coronavirus pandemic. But nonetheless, we have a few interesting things to chat about in the markets, just reviewing what happened last week and key insights on those important events, off the top.
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- Wanted to chat about interesting news in SPAC land, former house speaker, Paul Ryan. Yeah, that is right. Politician Paul Ryan is launching his own blank check IPO. That is right, Paul Ryan launching a SPAC, and we ask. Does this mark peak at the SPAC market?
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- On to Apple news. Their market cap ripen to 2 trillion, is this valuation justified or is this just a big stock market bubble? As Donald Trump used to claim prior to becoming president, but now he loves tweeting about your all-time highs.
- And lastly, touching on Epic Games. The creator of Fortnite, the battle Royale game that every kid loves. They are actually suing Apple and Google in a big app store dust-up. What is the issue behind this lawsuit?
FORMER HOUSE SPEAKER PAUL RYAN TO LAUNCH BLANK CHECK IPO
Julian Klymochko: But first let’s chat about really interesting news in SPAC land. Former Politician Paul Ryan is trying his hand at another form of deal-making outside of the political arena, this time in the business arena. So he will serve as chairman of special purpose acquisition company called Executive Network Partnering Corp, it’s ticker is ENPC. Solamere Capital, a private equity firm run by Mitt Romney Sons is set to be the main sponsors. Everyone involved in this one seems to have pretty tight political connections. The company will be nicknamed CAPS, C-A-P-S, which is an acronym for capital, which aligns and partners with a sponsor or conveniently SPAC backwards.
Fairly clever team here, I suppose the launch of SPAC involving people far outside the areas of business. I mean, previously we saw RedBall Acquisition Corp, which featured Billy Bean of Moneyball fame. So the famed baseball manager getting into the SPAC game. Now we have a former house speaker launching his own SPAC, so really branching outside the areas of business. Further signifies how far this asset class has come and also indicates that perhaps the market is a tad bit frothy. I mean, we are seeing S1 filings left and right for basically multiple new SPACs filing every day for an IPO. Just want to put some numbers behind the sentiment here. So far, in 2020, new listings of 75 SPACs have raised nearly $30 billion dollars. That is more than double what was raised during all of 2019 and we have that over the first eight months of the year and 2019 was the highest volume year on record for SPACs, so 2020 absolutely blowing the previous record out of the water. This year SPACs account for roughly 43% of IPO volume, which is a near record year for IPOs in 2020. It hasn’t been this great in IPO land since the 2000 tech bubble, so a lot going on in the SPAC asset class, clearly things are looking frothy here. I am not sure if we have reached the peak. I expect quite a bit more.
A lot of companies, especially companies in the earlier stages of their growth are choosing to utilize the SPAC structure for a number of reasons. I mean we have Virgin Galactic, we have Nikola. These are super successful, at least in the stock market, super successful companies that utilize SPAC and each and every day, we’re seeing new deals announced specifically in the electric vehicle space or anything to do with that sector, which is super-hot right now, especially for a blank check company. But interesting dynamic. Mike, what do you think? Do you think that Paul Ryan SPAC, which actually filed it’s S-1 today, ENPC, they’re raising $300 million. Do you think this marks the peak of the market?
Michael Kesslering: Yeah, I guess it defines how you define the peak. I guess argue that we may be close to peak SPACs sentiment in the sense of the overall market share or mindshare that SPACs have in the average investor’s time during their day, but as well, I mean, just looking at other avenues that typically would never be focused on SPAC. So things such as the daily email from Fortune term sheet, I mean, they’ve talked about SPACs a lot lately, which is just very interesting in terms of the mindshare that’s SPACs have been getting.
Julian Klymochko: Yeah, the other thing is, that pretty much every startup founder now knows exactly what a SPAC is and has their eye on the asset class.
Michael Kesslering: Especially any VC-backed founder should have an understanding of what a SPAC is if they ever intend on going public. But in terms of being the peak, I don’t think that we’re anywhere near the actual peak in terms of SPAC volume peak because as you had mentioned, 2019. It has just been a steady growth in the sector for the last number of years. A real multi-year trend, but as well, looking forward to how this sort of trend can continue is. I think the big key for them will be some of this large $ 1 billion dollars SPACs finding targets, and I think that will go a long way in further legitimizing the space. If you see an Airbnb or a company of that stature that goes public through a spec, I think that would do a lot in terms of the space.
A Little example on this is a couple of days ago. It was reported, once again, that Palantir. The Peter Thiel backed Company that they were looking to file their S-1 soon, but also with that. There was leaks regarding their loss numbers and prior to this, it had been assumed for a few years here, as it is not a new company, I believe you had mentioned Julian. That it is about 16 years old. It was always assumed that they were profitable businesses because they are a little bit more mature company, a little bit lower growth.
Julian Klymochko: You figure after 16 years. They figured out their business model on how to be profitable.
Michael Kesslering: Exactly, and during the IPO process with the quiet period, you can only discuss what is disclosed in your perspective. So if there’s just the big loss number and you can’t really explain it away too much in terms of the actual numbers, in a perspective, because it’s a legal document. There is not much room for just speculation and things of that nature.
Julian Klymochko: Yeah, and look what happened to WeWork during their quiet period after they filed the S1. They just got absolutely torn apart,
Michael Kesslering: At the end of the day, during that quiet period is you lose the narrative. You lose control of the narrative. Whereas during a SPAC process, because it is done through a merger. You can talk about what the proforma company will do.
Julian Klymochko: Marketing.
Michael Kesslering: Yeah. You can talk about your estimates in terms of where you think the business is going to be in a few years. It leaves you with a lot more flexibility, and that is what I think is going to be really interesting in drawing more attention to SPACs for founders. It just gives them more flexibility in telling their story, which I think any founder that is going to be a large public company needs to be able to do, and probably does quite well, is they have pitched Cs already to get capital into that company.
APPLE MARKET CAP RIPENS TO 2 TRILLION
Julian Klymochko: I wanted to mention one number, $2 trillion. Now $2 trillion is significant because that is the market cap in which Apple hit last week, the largest publicly traded company in the world. It just recently hit 1 trillion; I believe in August 2018, they increase the 1 trillion of shareholder value in a pretty quick time period, two years. And in fact, I mean, their stock more than doubled off its March loads, and that created over $1 trillion of shareholder value. So something to realize is if you’re buying the S&P 500, these large cap growth names are taking up a larger and larger share of the benchmark index. I believe Apple is now north of 6% and perhaps might even be larger than the entire TSX in terms of that $2 trillion size. And one thing that I wanted to note is Apple is a really interesting stock for one main reason, and that is sentiment.
If we go all the way back to 2013, I’ve always been a big fan of Apple and was a huge fan of the stock, especially back in 2013 and if we rewind to that time period, if you remember, Carl Icahn was undergoing an activist campaign on Apple. And the reason is, I mean, it was dirt cheap. It was trading at four and a half times EBITDA, and was universally hated. One of Carl Icahn’s thesis or one of the crux of his thesis was that it was so underweight by mutual fund managers that they would have to be buying, you know, as the stock does better and better within the index, are they at risk underperforming, and he certainly nailed it then. He called the Apple at four and a half times EBITDA, and I quote no brainer, which, I mean, it turned out to be fantastically true. I believe since 2013, the stock compounded at about 33% annualized on a total return basis, an absolute monster of a stock. And it’s gone from four and a half times, EBITDA seven years ago to 25 times EBITDA it’s largest, multiple, I believe ever. Everyone hated this stock in 2013. Now it is universally loved in 2020. The multiple gone up over fivefold and it is just incredible to see because, you know, it is pretty much the exact same company.
Still selling iPhones, still got the Apple store. Certainly, they are trying to tune investors’ perception away from being a straight hardware company to more of this services integrated company with more stable cash flows. Certainly, the bearish thesis has not come to fruition. I remember shortly after or at the same time that Icahn, you know, he made a bunch of money on the stock. Was successful in his activist campaign shortly after commencing it, he was exiting the stock, worried about China, et cetera. Warren Buffet got into the stock and as we know, I believe he has earned what? like a hundred billion dollars off of it or something.
Michael Kesslering: 87 billion.
Julian Klymochko: Which could be or perhaps one of the best investments of all time. Wanted to give a bit of background in addition to sort of that multiple expansion, which is really story for the ages over the past seven years, driving the S&P 500. You did not see it with only Apple, but other companies as well. I mean, Apple, it’s kind of gone from zero to hero multiple times. In the mid-1990s was struggling. Went through three CEOs in four years prior to bringing back Steve Jobs, and he went on to introduce the iPod, the iPhone and the iPad, which were all just grand slam of hip products. Those help Apple become the largest U.S. Company in 2011 when it surpassed ExxonMobile. Unfortunately, Steve Jobs died a few months later and then Tim Cook became CEO. And I remember back then 2011, no one thought that Tim Cook could do the job that he did. I mean, he has been one of the best CEOs of all time in what he is done with Apple. Really continued innovation that most people thought he would not be able to after Mr. Jobs passed. But nonetheless, I mean, you look back in 2011 when Apple initially toppled Exxon to become the largest U.S. listed company. It is now 11 times bigger than Exxon, so it really shows the divergence in sentiment between tech and oil. It’s, you know, that is really the story right there, Apple a hundred percent sentiment-driven and I just wanted to point that out Michael, what are your thoughts on this milestone? $2 trillion dollar figure.
Michael Kesslering: Yeah, when you talk about the sentiment and multiple expansion. For any aspiring, hedge fund junior analysts, or on the mutual fund side. Any sort of investment analyst, if you are pitching your portfolio manager on a stock thesis and your thesis is 100% geared towards multiple expansion, that is probably not going to work for your portfolio manager; they will laugh you out of the room, as that is typically something that is very outside of your control and your analysis in terms of that.
Julian Klymochko: Conversely, that really is the crux of value investing, where you’re just buying these dirt-cheap stocks and waiting on that multiple expansion, which unfortunately for most has not really worked over the past decade, aside from Apple and Microsoft.
Michael Kesslering: And typically, to de-risk your thesis, you would be looking at levers that that company can control in terms of increasing their earnings organically. And then hoping, I guess, for some multiple expansion, but early basing the crux of your thesis on that actual earnings power increase.
Julian Klymochko: The other thing to mention, I mean, multiple indicates kind of risk. In my opinion, if it is trending up four and a half times, EBITDA, there is typically many ways to win and like, it can’t go much lower than that, unless it’s going to go bankrupt.
Michael Kesslering: Yeah. Unless it is just a very clear melting cube, where the earnings today are not representative of where their earnings will be in the next couple of years.
Julian Klymochko: Right.
Michael Kesslering: On the topic of Tim Cook with regards to the sentiment on him, when he took over from Jobs. The view was that he wouldn’t be able to innovate and in the product sense, it’s not like he is even in this same realm as Steve Jobs, in terms of a product sense of innovation.
Julian Klymochko: Yeah no kidding. Well, I mean, you can’t really recreate the iPhone, but you know, he did have a couple of big wins in terms of the watch and the AirPods. I mean, those products are pretty universally loved and absolutely dominate, basically create an entire sector.
Michael Kesslering: Yeah and I would focus more on would be the innovation in their business model, moving from product hardware to the services side, which yes, it’s not innovation in the most direct product sense, but it still is innovation and very interesting. And one thing as well that you had mentioned was Buffet profits here. And, you know, the scale of that is just massive where his cost basis only a few years ago was $35 billion where their value on a pre-tax basis is $122 billion, obviously a lot of unrealized gains there. This accounts for 44% of Berkshire’s stock portfolio, so it is a very concentrated bet that Berkshire making on Apple with Berkshire being the third largest shareholder of Apple. But as well, you look at what has happened with Apple over the last year where they’re up over 150% over the past 12 months where Berkshire down 8% this year.
Julian Klymochko: Right, incentive.
Michael Kesslering: And when you look at, in terms of the Berkshire investment today versus in the nineties and early nineties and late nineties where as an investor in Berkshire at that time, you were very levered to Berkshire stock portfolio. So levered to Buffett stock picking abilities. Now the operating companies play a lot larger role than the actual stock picking, so it is no longer just a pure play on Buffett alpha. But the really interesting thing is a lot of this sentiment in Apple is really due to the view on services revenue. One of their main sources of revenue in that being the app store, which we are going to be talking about versus hardware and what investors view that potential has versus the kind of saturation of the hardware market moving forward.
Julian Klymochko: And it’s interesting that you mentioned their app store because as you indicated Apple and also Google, you know, they’re trying to promote, say their app store as a services business, really consistent revenue stream, that investors should place a high multiple on just due to its profitability, its consistency and its growth.
Michael Kesslering: Capital light nature.
Julian Klymochko: Yeah, exactly but what has been happening is that business model is perhaps at risk.
CREATOR OF FORNITE SUSES APPLE AND GOOGLE IN APP STORE DUST-UP
Julian Klymochko: Epic Games, the creator of the wildly popular online Battle Royale game Fortnite. They are suing both Apple and Google claiming that the tech giant’s app store fees are anti-competitive. I believe both charged Fortnite 30% rate on any revenue that game players you know, they are buying skins, they are buying axes or whatever they, are buying in Fortnite. They are going to hand over 30% of any of those fees to Apple just for basically hosting the game. What Fortnite did is they implemented a method in which customers could pay for in game items without paying the platform providers 30% fees, and boy, did they not like that. Both Apple and Google banned Fortnite from their app stores alleging a violation of company policy. Obviously, they can’t have people doing that or else every single app store would do the same and get around all the fees and there goes Apple and Google app store services business. Nonetheless Fortnite or Epic Games sued, launched lawsuits against both Apple and Google arguing that the company’s rules surrounding in app payments are anti-competitive. Both Apple and Google came back, stated that their platform rules are designed for the safety and security of mobile users. But what I wanted to point out here is this case, although highly unlikely to be successful. It does underline the risk in this business model transformation from, you know, relying on hardware in Apple case and advertising in Google case. This transition to these app store type businesses, the large rake, the large amount of fees that they are taking. Both companies have built sizable, consistent revenue streams out of their app stores and investors have placed very high multiples on this, but in my opinion, what Epic Games’ Fortnite is trying to do is really start a movement, trying to get others. Like Facebook and other app creators to join this movement and really stand up to, these tech giants and demand lower fees. What are your thoughts on what is going to happen here?
Michael Kesslering: To go over a little bit of what Epic thinking with this lawsuit, as well as I think I have a little bit of a different opinion on the success any sort of movement could have theoretically. At the very first glance is that Epic court filing in the case that they are bringing against Apple, and I am mostly focused on Apple in particular. As they are a lot more stringent in their app store than Google is and they have been the one that people talked about, but their argument isn’t that app developers should pay less commission in their documents. They have actually argued that the court should dismantle the entire app store model, removing all the barriers to entry that Apple and Google have created in terms of the store and then the payment processing, which is a very important aspect, which has been a huge advantage for them.
But when you’re looking at that, so it’s one thing to say that 30% is a very high take rate, but there’s also the fact that when the app store was developed that it really took the job of the app store curation. App curation of what is available to you, and payments onto that platform, which was good for nontechnical users and making apps a lot more broadly accessible. As technical users would be able to look at apps and they would be able to change the privacy settings so that, you know, an app was not able to steal your credit card information or take data that they don’t want.
Julian Klymochko: Or one of the best things. Not having to worry about viruses. I remember back in the day, you know, you download something on your Dell and next thing you know, it’s going to haywire and it doesn’t work anymore because the game was actually a virus.
Michael Kesslering: Exactly and this is what’s been called the sandbox approach where as an app developer, you have to build something that can fit within the iOS framework and really removed the element of trust where you would simply just have to trust Apple as a platform, as opposed to every single app developer. In terms of creating, a movement where anybody can do payments within their own app is only really viable for someone like Fortnite, who has a ton of trust in the public or other very large brands. So really in terms of anti-competitiveness, doing something like that would actually just further instil the competitors that have big brands as an ever dominant position in terms of the developers.
Julian Klymochko: Yeah, you have a good point that the app store does provide a lot of value in terms of lead generation, safety, security, payments. They are right to charge something because they are providing a valuable service but the key question here is that take rate at 30%, just too high.
Michael Kesslering: Yeah, when Epic had put in their own in app store within the game of Fortnite, they adored the take rate; I believe it was to somewhere around 12%, which was basically their breakeven cost, which is interesting. Because where the 30% with Apple came from, was actually Steve Jobs where they never intended in the Jobs era to ever take a profit on the app store. They were just running it to be breakeven which is quite interesting, but now it is such a large revenue generator that they can’t really afford to not actually make a profit on it. But in terms of the battle that Epic going for, and I agree with you Julian. I think they are highly unlikely to prevail with this but it is. I did want to point out that it is fundamentally different to the battle that Spotify is fighting with Apple. If some of our listeners have been following that situation. In this situation, Epic margins would allow them to pay the fee. They have quite high profit margins. It is not a question of can they? Epic really likes to be developer friendly and they like to create the ecosystem. Whereas Spotify literally cannot pay a 30% fee on top of their entire margin structure right now. Because 65 cents of every dollar in Spotify for subscriber revenue is going to the music label.
Julian Klymochko: Yeah. They can’t make money as it is right now.
Michael Kesslering: Exactly, and so adding another tax on that. They would not be able to continue as a business, so it is a fundamentally different deal. But as well would like to point out that other large companies have come to terms with Apple and decrease that take great. Say for example, Amazon prime video, they have reduced that take rate from 30% to 15%, and there were rumours prior to all this, that Epic and Apple were actually in negotiations. And it’s very clear that these obviously broke down and here we are with lawsuits filed. So I think the most likely event with this is because the anti-competitive legal structure is just takes a very long time to go through the courts that this is likely just a bargaining chip in negotiations and that both parties will settle, and Fortnite or Epic games we’ll agree to a lower than 30% take rate. And they will move on not happily ever after, but they will move on as partner.
Julian Klymochko: Yeah, good summary on that case there. To wrap up the podcast here, are we at peak SPAC? No. I expect more charlatans to come into the business. Where some guesses? I would Michael Jordan, Drake, Leonardo DiCaprio. Those are my three top picks. Who do you think is going to be in an odd duck in the SPAC space?
Michael Kesslering: I think Ashton Kutcher, since of his involvement in the VC world; I think he is highly likely. As you had mentioned, like the NBA players, they have been really very good in terms of their business managers and themselves as public figures and getting involved in the VC world. So maybe Kevin Duran or somebody like that could get involved given his connections to Silicon Valley.
Julian Klymochko: Right.
Michael Kesslering: But it will be interesting to follow.
Julian Klymochko: Yeah, maybe Ryan Reynolds, as well as for stock market bubble, Apple bubble, certainly. I mean, you can’t really justify that sort of multiple expansion, but nonetheless that wraps it up for us on The Absolute Return Podcast. If you enjoyed it, definitely leave us a review. Check out more at absolutereturnpodcast.com. Mike where can they follow you on Twitter?
Michael Kesslering: You can find me @M_Kesslering.
Julian Klymochko: And my Twitter handle is @JulianKlymochko, K-LY-M-O-C-H-K-O. We wish you all the best in you’re investing this week and we’ll chat with you soon, cheers.
Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.
