Bits + Bips: Meta Fell 10%. Microsoft Didn't Blink.

Transcript

You're listening to a brief segment from one of the Bits and Bips episodes this week. The full show [music] is now only available on its own dedicated Bits and Bips channels. So, be sure to go to X, YouTube, and your favorite podcast platform and search for Bits [music] plus sign BIPS spelled BIPS and subscribe. [music] >> So, let's talk a little bit more about AI. I mean as as you mentioned and anyone watching this I'm sure has is well aware I mean earnings have have generally been very very good uh but there are concerns and I think sort of the like the two sides of the coin you mentioned between Meta and Microsoft I mean going in opposite directions I I think that's a really good sort of microcosm of sort of the the different approaches someone can read what's

happening. So maybe just expand on that a little bit please. Yeah. So, I listened to both the calls last night and you know what what put face uh Meta sorry in the penalty box was hey we raised our capex spend they didn't raise it by a lot they raised the lower end by five by 5 billion which seems like monopoly money to us right but they raised it they g and they talked a lot they gave us a lot of qualitative explanation but they really I didn't see any proof um in terms of revenue growth or maybe no clarification on the timeliness of of discernable ROI. I I didn't hear that. Now, maybe other people did. I didn't hear it. That's why the stock's down 10%. So, they raised their capex guidance and Q3 revenue guide was a little below the midpoint. I

know these are nitpicky things, but this is what the street reacts to. >> And and from my opinion, I don't mean to interrupt you, but I just I mean, just given how poorly their initial LLMs were received, it seems like the from my perspective, the burden is higher for them to prove that they're able to kind of catch up and overtake, especially with some of the Chinese competitors. >> Yeah. And then right after that call, I got right on Microsoft's call, right? I can of course see all the earnings, revenue versus consensus, uh margins, so on and so forth. And the number one metric we're looking for with Microsoft is Azure growth, right? Uh cloud growth.

And that number was super strong. Um that was the first thing I thought, okay, that's really what we wanted to hear about. Microsoft's management, the the quantitative information that they gave us and the tone in which they delivered it was, you know, having listened to earnings calls for 35 years, you you pick up on these things over time. They were confident. You could tell they maintained their capex guidance. So, they didn't raise it. And then so that's the that's the worry around sucking out all the free cash flow generation from these unbelievable companies here in the last six eight months or year where if you and I were talking two years ago and you said hey do you think Microsoft Google Amazon and Meta are going to blow through all their free cash flow? My answer would be no

way. They just did and they're in the market borrowing more. Right? So investors have called time out on that. Time out on that. And you know, I'll lead you to another concept that we've been pounding on here for the last 18 months, but those were the differences to me anyway in the calls last night and why one stock is down and one stock is up. >> Yeah, it's really interesting because when we hear about these big tech companies, I mean, going back to um like the fang and uh I forget some of the other acronyms that that were there. I mean, they were enormously profitable, had had very very very low capex and like unlimited free cash flow. um a big inversion now because of how I mean the revenues are great but I mean like Google went to public markets for the

first time in in in decades. I mean these companies are raising tens of billions of dollars in the debt market. I know Oracle was recently downgraded to like one one ring above above junk status >> and yeah I mean free cash flow is all of a sudden it's a big deal. Maybe for some of my my viewers, some of my listeners that are just trying to get their hand their arms around all this, could you maybe just talk about how from your perspective like you think about these different buckets to sort of ascertain the health of of a company because it's hard sometimes I think to distinguish between like Microsoft and Oracle and like >> it t so it t it I'll do my best in a nutshell from a high level. So it takes you need to consider a lot of different

variables, right? Zuckerberg for example last night talked about total addressable market on and on. Okay, we get that, right? That's why the spend and then there's not nearly enough compute demand and all that sort. So you factor in comments like that, you you look at the company's balance sheet. What I always focused on, especially as a growth manager owning these names and liking these names, you know, over decades is how much confidence do I have in the run rate and revenue? Tell me about COGS. How, you know, I need to know where the margin numbers are likely to go. I don't really care about the tax rate because it doesn't move that much.

But I'm trying to get my arms around all of the different things that will impact net income. Factor in buybacks. What's the earnings power going to look like? And so there are a lot of levers you can pull on an income statement, right? You can reduce expenses to boost margins. You can have an an earnings beat because the tax rate was lower. There's there's all kinds of manufacturing, right? you buy sh you buy outstanding shares back and the EPS number goes up. So you can engineer earnings. You cannot engineer the statement of cash flows, right? And so to to me uh maybe not so much as a growth investor, but certainly if you're a value investor, you're looking at that a lot, right? But in this case where you have the, you know, I'd argue the

bestrun companies on the planet blowing through all of their capex lending it to each other or backing deals in a circular fashion is a concern. I'm not saying it's not a concern. it like that does concern me because if this whole notion that you know the the models are evolving you know by the minute by the hour getting stronger can update themselves and improve right and everything that we that we know at the moment and therefore going to demand these data centers and all this compute power if that if something goes wrong there and they now they're levered right I don't I shouldn't talk about their um you know interest expense ratios because I don't

know them off the top of my head. But if when you take out the cash flow to meet obligations, that is a risk, right? So that's that's the bare kind of argument. I guess you could make the counter-argument by saying, "Hey, Chris and Steve, if they're running one of these companies, they probably wouldn't be blowing through their their cash flow generation and and investing all this money in this unless they completely believed it." High conviction. Doesn't mean we're right, but I think that's what that's what the management teams do believe. >> Yeah. Yeah. I'm glad you kind of brought up the circular nature of it. I I I think the pjorative connotation that I've seen thrown around is sometimes like a degree of incestuousness between all these companies, but at the same point like they're complimentary and

there's a certain level of scale you have to have to to play in that arena. So like where else could they really where else could they really go? But it does like if things if this breaks like it could be calamitous just because of how closely entwined they are to each other. like who ends up holding the bag if something goes wrong? And would one bring down everyone? Uh I know that's a question. I don't know if that's a question you get, but that's a question that that that I often get asked. >> Yeah. Um it's hard to say, but that's you're you're you're talking about the domino effect. Once someone falls, it's kind of, you know, boom, boom, boom, boom, and everybody goes down. I look, anything can happen in our business. We know that any stock can go to zero. We know that. I've seen that. I've owned

stocks and thankfully sold them and watched them go to zero. So that that can happen. uh our our our take on this honestly our bottomup fundamental take on the whole thing the whole AI spend and where we are in in baseball terms we we were talking before we got on there you're a Phillies fan I'm a Red Sox fan so in baseball terms we're probably in the second inning of this and you know don't take my word for it listen go listen to earnings calls and listen to companies all all different cap sizes all different industries all different sectors I promise you right to the listeners, anyone can listen to an earnings call from a public company. Go to their investor relations website, click on the webcast and listen, right?

Read the transcript if you want. On every earnings call already this year, and this has been this quarter, sorry, but this has been true for probably the last 12 months. Every company talks about how they're using AI in their business, whether it's to improve efficiency productivity ultimately profitability, to make things faster and better for their customers, to improve their service levels. We've heard that for a year. I hear that in every single earnings call. So, this is not going away. The the the use case is tangible. And now you've got large public companies talking about, hey, we're not just thinking about this, we're using it. and oh by the way we can demonstrate improvements in efficacy by a whole host of measures but what we really look for is ha has that improved you know

operating income and so we're starting to hear that now I think Microsoft did a really good job last night and their call meta didn't we'll see what Amazon and Apple say tonight right but we're probably in the second inning of the game the risk is there that the whole thing is is a bunch of BS and it falls apart we do not believe that. We do not believe that. We think we're in the second inning of a ninninging game and this is real. Now, that's that's that's okay conceptually. That might not line up to making money in the stocks, which is a completely different >> Yeah. different game.

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