September 21, 2020- The SPAC Master Returns as Chamath Strikes Deal for Opendoor. What Does the Market Think of this Blank Check Deal?
Snowflake Shares Surge in Biggest Tech IPO of the Year. Does its Valuation Make Sense?
President Trump Bans TikTok as it Works on its Sale to Oracle. How is this Going to Play Out?
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 podcast listeners to episode 87 of The Absolute Return Podcast. I am Julian Klymochko.
Michael Kesslering: And I am Mike Kesslering.
Julian Klymochko: Today is Friday, September 18, 2020. Some crazy events in the market this week S&P 500 continues to trade down, but IPO is hotter than ever and SPACs. Oh my God, that market is just on fire, going crazy. That is really the focus of today’s show.
- Going to start off talking about Chamath Palihapitiya of Social Capital, the SPAC master himself. He struck a deal for one of his blank check companies to merge with private real estate startup Opendoor. We are going to chat about what the market thinks about this deal. Obviously, the market likes it, but we are going to talk about why the market likes this one.
- In IPO, land Snowflake, which we chatted about on last week’s podcast. Their shares absolutely surged triple digits in the biggest tech IPO of the year. Does its valuation to here make any sense?
- Lastly, we wanted to give you an update on what is going on with TikTok and President Trump, which seems to be an absolute disaster, changing pretty much every day. They are now trying to work on a sale to Oracle and the US may be banning the app this weekend. So how is this going to play out? The first lesson let’s chat about Chamath Palihapitiya of Social Capital.
THE SPAC MASTER RETURNS AS CHAMATH STRIKES DEAL FOR OPENDOOR
Julian Klymochko: One of his SPAC, this one is called Social Capital Hedosophia II; it announced a business combination with private startup Opendoor, which Silicon Valley. You know, real estate technology firm, an online marketplace for buying and selling houses, so-called iBuying. They are doing this deal at a $4.8 billion valuation. This represents a valuation of one times revenue, but I mean, they’re not super profitable, so it’s not really comparable to one of these asset-light type businesses, but nonetheless, the versus their last valuation in March, 2019, when they raised 300 million Opendoor was valued at 3.5 billion.
So not a massive premium, not a massive jump in valuation from their last private funding round to a now go public transaction with Chamath SPAC, Social Capital II. Just wanted to give a quick overview on how Opendoor works. Basically they provide a quote to a homeowner that’s interested in selling their home. This quote comes via an algorithm; basically they have the software that comes up with a fair price for them. Where an owner can sell their house directly to the company. Then Opendoor after they buy it, they could make some fixes to the house and then put it on the market. So basically like a real estate market maker buying and selling homes, counting the sale as revenue, but not necessarily profit on it. So certainly quite a bit of market risk, you would think. Certainly, a very capital-intensive business, not your typical asset-light software technology businesses, is completely different.
More of kind of like a bank or a big holding company. Something that is very capital intensive. They are making money on the spread between where they can buy these homes and where they can sell them. It operates in 21 markets, sold more than 18,000 homes last year. So fairly sizable entity, as I indicated, a $4.8 billion dollar enterprise value on this one. And Chamath Palihapitiya, I call him this SPAC master because he’s done a ton of deals. He’s best known for doing the Virgin Galactic through his first SPAC, which is a very successful deal that closed last year, he claims that Opendoor is his next quote, “10x idea”. Implying he believes it can return 10 times his investment. I’ve got a quote here from Chamath Palihapitiya, he stated. “The company is transforming the $1.6 trillion residential real estate market by combining superior user experience, streamlined operations and machine learning to create a seamless digital experience”. But I don’t know, I’ve never used this service. Mike, what are your thoughts on this Opendoor deal?
Michael Kesslering: Well, yeah. I guess first speaking about the business model, as you had mentioned yeah. It is analogous to a bank or a market maker where it is very capital intensive, but from my view and looking at some of the materials that are available. Looking into the business model of the company, is that it really seems like their model is to actually just come close to break even, or perhaps have a very slight profit, on the actual buying and selling of homes. But really just using that as customer acquisition so that they can take care of the other services that are involved in the buying and selling of homes. So things such as title and escrow services.
Julian Klymochko: Mortgages.
Michael Kesslering: Yeah, which is way higher margin for them. Where they can actually make some real money, so that is what it seems like their real business model is. As well as recently they have had a little bit of traction with having some of their main cities being secondary markets, such as like Nashville, Charlotte, Portland, where you’re taking advantage of that exodus away from, you know, New York City and Los Angeles, San Francisco as well. But yeah, in terms of Chamath like one interesting note with him is, just look at his CNBC interview this week. I mean, that’s, what has gained a ton of press for this deal.
Julian Klymochko: For sure.
Michael Kesslering: And that is where he made the comment around being his next 10x deal.
Julian Klymochko: I can understand why a private company would want to do a deal with his SPAC because he is a very exceptional promoter.
Michael Kesslering: Yeah, so he is very good at that. Now I am not meaning that in a derogatory sense, he is very well-spoken and he is promotional and he provides a lot of excitement around the deal.
Julian Klymochko: Well and when you are running a public company, I mean, one of the major tasks of, say, the CEO is to get out there and tell the story of the stock to the market. Such that you time you know, a good multiple, and you do well for shareholders. I mean, the best case of this is Elon Musk. Look at what he has attained with Tesla. You know, he has a ton of critics, but all you got to do is look at the valuation, and that indicates that Elon Musk is by far a rock star promoter, better than anyone.
Michael Kesslering: Exactly like fundamentals aside. Like he has sold that into a cult-like following, which is, you can speak negatively about that, but you can’t really discount that in terms of the company’s success. That is just another example where Chamath always mentions the IPO 2.0 with SPACs and, you know, just looking at a company that is right now during their quiet period, say like Palantir. They can’t do that, Peter Theil is also very good at having a narrative. He is also an expert level communicator, but Palantir cannot do that.
Julian Klymochko: So a major advantage of going the SPAC route, as opposed to traditional IPO, is the ability to promote the stock in the middle of the deal.
Michael Kesslering: Exactly, and then just moving to the actual transaction itself. It is going to provide about a billion dollars’ worth of cash for growth for the company as it isn’t generating cash flow.
Julian Klymochko: Right, so that is over 400 million, that is within the SPAC and then a $600 million dollar pipe deal, right?
Michael Kesslering: The interesting part of this deal is, insiders are making up $200 million of the pipe. Chamath as well, he has a lot of involvement in these private investments in public equities.
Julian Klymochko: Doubling down.
Michael Kesslering: Yeah, certainly. And there is a little bit of Canadian player in this deal, in the pipe where you do have healthcare of Ontario pension plan, HOOPP is also involved in that. What we do like to see when we are looking at these deals is that existing Opendoor shareholders have agreed to roll over their equity. So there is no major exits, all this cash is going towards growth in the company. Not just cashing out investors, we never liked to see that in an IPO.
Julian Klymochko: Yeah, contrast that to Snowflake and you have some exiting investors and exiting former employees and things of that nature. Always consider a traditional IPO, perhaps a dumping ground for VCs and private equity firms where they’re like, you know, we’re done with this, dump it on up, you know, the retailer stocks.
Michael Kesslering: Kind of down the food chain. Yeah, and one last thing just on the deal is the valuation. I believe you had mentioned the enterprise value of the deal $4.8 billion dollars. That is one times 2019 revenue.
Julian Klymochko: But it is not really fair to judge this company, as you indicated, very capital intensive and significant market risk. I mean, they have this massive balance sheet tied down the home prices. Is it fair, to judge it and value it based off revenue?
Michael Kesslering: Yeah and that is, where you would never look at a bank and judge them off of revenue or other really capital intensive businesses like that. They are in high volume transaction, like a market maker as well. But yes, that’s a valid point. Moving forward you bring up a good point about market risk. Especially in times of volatility that you have this asset or assets and liabilities on your balance sheet, that, you know, if all of a sudden there could just be, you know, the bid-ask spread of the housing market could just completely widen where they’re not able to transact any more.
Julian Klymochko: i.e., the bids go away.
Michael Kesslering: Exactly.
Julian Klymochko: They are not able to sell that up.
Michael Kesslering: We have seen that happen literally within our lifetime in 2008. I mean, in Calgary here, we have seen that over the last number of years where it has been a difficult housing market, so they are exposed to that, but overall, a very interesting deal. As I had mentioned, I continually am very impressed by the marketing of Chamath, he is just an absolute expert in the space. I believe you alluded to; he has a bunch more SPACs coming out. I believe he did mention on that, well, actually it was not the CNBC interview. It was on a podcast that he has reserved IPO A to IPO Zed on the NYSC. So we could expect a lot more specs, can’t we?
Julian Klymochko: Oh, certainly and that is why we have crowned him the SPAC master. I think Chamath is running away with the title here from other potential candidates, such as Michael Klein, Chinh Chu, et cetera. What is crazy is basically an hour before we started recording this podcast is that Chamath Social Capital filed for three more SPACs. That is right, three more. One was a billion dollar IPO, the other 600 million and the third, a tiny 350 million. But I digress, obviously, the market loving this deal pushed up Social Capital Hedosophia II, the SPAC that’s merging with Opendoor. Up 20% on news of the deal, and yes, the bull market in SPAC deals continues.
SNOWFLAKES SHARES SURGE IN BIGGEST TECH IPO OF THE YEAR
Julian Klymochko: On to some IPO news. Cloud infrastructure, start-ups, Snowflake. There rocketed more than a hundred percent in its stock market debut. It completed its IPO this week and this is a head-scratcher because initially when going out with an IPO, they set a marketing range in which they hope to go to raise capital and the marketing range for Snowflake was initially $75 dollars to $85 dollars per share, which some could view as aggressive. Because that was like double its private company valuation just seven months ago from February. So they’re bumping up the valuation double within seven months. But what was disclosed in the IPO documents was that Berkshire Hathaway themselves like the most famous investor absolutely gold plated reputation backing this deal. It was disclosed that they were subscribing to $250 million dollars of stock at the IPO price in a concurrent private placement plus buying over 4 million shares in a secondary transaction. I don’t understand why Todd Combs would do this and not keep that private because the market saw that caught on and say, wow, Berkshire is buying I need in, and then demand just absolutely skyrocketed, which caused the marketing range to go from 75 to 85 to ultimately pricing at $120. So Berkshire basically negotiated against themselves and promoted the stock prior to buying.
Michael Kesslering: Promoted it indirectly in a weird way.
Julian Klymochko: Yeah, they promoted it indirectly by not keeping their interest private, right?
Michael Kesslering: Yes.
Julian Klymochko: If they kept their interest, private, the marketing range and the ultimate pricing would have been lower than $120 dollars per share. So they, in fact, and this is all just speculation, who knows maybe it would have gone up like crazy, but going from the 75 to 85 to $120 dollars per share where Berkshire had to pay basically $40 dollars per share, more. Ended up costing Berkshire Hathaway investors over a hundred million dollars, which is just crazy. I don’t understand it, but I mean they can’t really complain because the stock closed above $253 dollars per share on its first day of trading. So more than doubling up 111%. Now this surge valued the company at over $70 billion dollars, which is nearly six times, its $12.4 billion dollars valuation from February and 140 times, its annualized revenue, which is just insane. What are your thoughts on, you know, the head-scratching move by Berkshire and ultimately the market’s just wild valuation of this tech IPO?
Michael Kesslering: Yeah and I guess first in terms of the Berkshire investment is, where I believe the issue is that they pegged it to the IPO price. If they would have gotten somewhere in between the private valuation in February and the IPO price that would have made sense.
Julian Klymochko: They should have known that they are going to push the price up.
Michael Kesslering: Exactly.
Julian Klymochko: By disclosing, they have interest.
Michael Kesslering: And yeah, like if they would have done just a private placement right before the IPO that would have had to be disclosed in their S-1, but they would not be negotiating against themselves. I do want to push back against one narrative that we just, every media article you saw said that Warren Buffett invested in Snowflake. That is just not true; this is a Todd Combs deal. It is through Berkshire, absolutely, but we are just seeing so many folks in the media perpetuating this claim that Buffett invest in the firm, which is obviously pushing up the valuation, this is just not true. If we can put that to rest, that would be ideal, but I don’t see that being the case in the future here.
Julian Klymochko: You think Todd flipped out of the stock already?
Michael Kesslering: It would be interesting.
Julian Klymochko: I know the entire float traded on its first day or more than the entire float of shares outstanding.
Michael Kesslering: I was asked by, one of our listeners actually, you know, whether he would have traded out and I mean Buffet would not trade out on an IPO pop, but also I Buffett does not invest in IPOs, and he does not do this anyway. Todd does have a different strategy.
Julian Klymochko: I bet he did invest in the Ford IPO in 1955.
Michael Kesslering: It has been a while, I guess, but in terms of valuation at its current market cap of $68-70 billion dollars, keep in mind that their total addressable market that they mentioned in their S-1 is $80 billion dollars. Like this is like point eight four times their total addressable market that never mind revenue, right? Like that’s absolutely crazy. These assumptions are that are being made with the valuation or assuming that they’re going to capture more than 100% of their market, which, I mean, the company has a pretty good gauge on their own market and they have every incentive in the world in their S-1 to, you know, pump their total addressable market up a little bit. They have no incentive to, I guess, sandbag on that estimate. So unless all of these investors have some insight into how they are going to expand that addressable market, I kind of highly doubt that.
Julian Klymochko: Right, and want that 140 times annualized revenue multiple means. Is very lofty future performance expectations because ultimately you trade on a multiple of earnings. And so at a $70 billion valuation, is there any margin of safety? Any room for error in attaining? Kind of growing into that valuation, certainly a lot of hype and a lot priced into the shares here.
Michael Kesslering: Certainly and just, let’s go over a little bit of who did well in this deal and, and front and centre would be Frank Slootman, their CEO. He has been there, I believe less than two years, but this is actually the third hot IPO that he has presided over.
Julian Klymochko: He got the Midas touch.
Michael Kesslering: He certainly does and it becomes very clear. He is the third CEO of the company. In this young company, that is only around eight years old. Third CEO and they brought him in for a very distinct reason. And so going back Data Domain Corp in 2007, he was the CEO of that company where it did have a first day pop up 33% and then sold for $2.2 billion dollars a couple of years later to a company that is now controlled by Dell. And that was the result of a bidding war itself, that sales process. Then moving to 2012, Servicenow, which is still traded. It did have a first day pop up 32% and it has returned excellently for shareholders, 48% annualized since June 2012 and now has an EV at enterprise value of $85 billion dollars. So this is his third, his stake in Snowflake is worth, I believe just under $3 billion dollars as a market close.
Julian Klymochko: Not bad for 18 months of work.
Michael Kesslering: Exactly and just mentioning the founders also did quite well. I believe one of the founders had more of a stake than, Mr. Slootman, but as well, Sutter Hill Ventures, which this company was actually incubated within Sutter Hill Ventures, which is a unique model for, for VC. Typically, not that the normal route for a VC investment and Sutter Hill Ventures very difficult, they have nothing online that you can find about them.
Julian Klymochko: Yeah. I never heard of them prior to this deal.
Michael Kesslering: No, but they have had a couple of other large deals, but yeah, there is no self-promotion by them, but their stake is worth $11.9 billion dollars and I believe the initial seed round was done at around a $5 million dollar valuation. And they have been involved in all of the financings moving forward, but just an absolutely win in terms of Sutter Hill Ventures.
Julian Klymochko: Grand Slam.
Michael Kesslering: a lot of people have been made very, very wealthy in this deal.
Julian Klymochko: Yeah, so they ended up raising $3 billion dollars in their initial public offering and this makes it the largest ever for a software company, IPO currently trading in the market under ticker snow.
PRESIDENT TRUMP BANS TIKTOK AS IT WORKS ON ITS SALE TO ORACLE
Julian Klymochko: Now, lastly, I wanted to follow up on this TikTok fall that we have been covering, which is just an absolute mess. Seemingly changes every day. First, it was expected to sell to Microsoft. Microsoft was going to buy all of TikTok, TikTok US, then, you know, maybe Canada and Australia, and now Oracle goes into the mix. Microsoft gets rejected. Now Oracle is going to be a partner and Trump announced that it will ban TikTok and Chinese app WeChat starting Sunday night as the government continues to take action. Really, what this is about is the Trump administration, suspect apps, Chinese apps, such as TikTok and WeChat of assisting the Chinese Government in stealing Americans, personal data and obviously all these negative security ramifications.
It is also related to why he has banned Huawei from 5G networks. They are very, very concerned about what the Chinese government could do to American consumers and Government. So this threat to shut down TikTok comes amidst suppose that sale process. I mean, it was a sale process where parent company ByteDance was trying to sell off TikTok US prior to it getting banned, but that’s somehow morphed into Oracle becoming, what they call a strategic partner and potentially TikTok US going public in which Oracle, and for some reason, Walmart would buy a steak. Things seem to be changing every single day. This banning on Sunday news came out of left field. That was just announced, I believe this morning. But clearly Trump, he acts in a way where he gets a hold of, you know, a certain notion in his head and he just kind of stays on it like a dog.
And this one is just addressing the Government security concerns with China and has beef with China has really been a long-term play for him. Obviously, a lot of things that China is doing, it is very negative. And you know, they’re running this sort of nanny state with a lot of fingers within corporate China, and that’s really what the US government is trying to prevent happening within the US economy. Now, this specific ban on Tik-Tok that was just announced this morning. It only affects new downloads and updates of the TikTok app, so you can continue utilizing it if you like filming your dance videos or lip sinking, whatever it is, you can use it until at least November 12th. And that’s when some technical restrictions will kick in, but to summarize this. Who knows what is going to happen here at seemingly changing every day but what I do know is that Trump is going to continue his attack against China and a successful Chinese company.
Michael Kesslering: Yeah and I guess within the commerce department, I mean, just what I have read on this. There is a lot of conflicting statements made both publicly and then from leaks that come from the commerce department, so it’s a little bit difficult to follow along here. But right now, really, as you had mentioned, Julian. TikTok users, as well as WeChat users, are not able to get updates or new download, or how this is going to be enforced is really just that the enforcement is going to be that US companies will be banned from distributing, WeChat and TikTok or doing business through those apps. So it bands US companies, for example, from providing services or payments through WeChat, and then as you had mentioned that November 12th date is the kind of drop-dead date for this at this point, as it’s always a moving target as well.
Julian Klymochko: I previously said September 15, he was banning the app and clearly, that did not happen because it’s September 18.
Michael Kesslering: I will note, very interesting timing. It is a week after the election, I believe it was Lindsey Graham had come out and said that he had lobbied the president not to ban TikTok prior to the election. I mean, there is a ton of people in the US that use this app.
Julian Klymochko: 100,000,000 I think.
Michael Kesslering: Yeah, exactly. Obviously, there are children that use the app that are under the voting age, but there is a very material portion of the US population, that uses this. It would be election suicide to do that right before the election. Everything with this, it’s all intertwined between politics and business. You know, it seems like, this is part of partly a mechanism to push forward negotiations with Oracle. Through all their reports, I have seen, it is kind of difficult to see what the status of those negotiations are at this point. As you had mentioned, it is just kind of a cluster and we will be monitoring that moving forward. But luckily myself personally, I’m not a user of TikTok, so it doesn’t really matter to me personally.
Julian Klymochko: Yeah, who cares?
Michael Kesslering: But certainly something interesting to follow along just in terms of US-China relations.
Julian Klymochko: Yeah, the cold war between the US and China certainly continues. It will be interesting to see. I mean, how that plays out. Have not heard a lot regarding the trade war that used to make the stock market go up and down and then phase two. I mean, I have not heard that terminology uttered for a very long time. Everything has been COVID, COVID, COVID and now, you know, we’re kind of past that. So perhaps they can get back to battling over trade and the current account deficit or the trading deficit, but that is about it, ladies and gents for episode 87 of The Absolute Return Podcast. Hope you enjoyed it and if you did always check out more absolutereturnpodcast.com definitely give us a shout out, give us a review, tell your friends and colleagues follow us on Twitter, Mike, what is your handle?
Michael Kesslering: It is M_Kesslering,
Julian Klymochko: And mine is @JulianKlymochko and until next week, which you all the best in your trading and investing and we will chat with you soon. Cheers.
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