All right, welcome to the Risk Reversal Podcast. I'm Dan Nathan. This is Michael Nathansson. He's a co-founder of Moffett Nathansson. Michael, welcome to the podcast.
All right, so if you don't know about these guys, this is Moffett and this is Nathansson. How do you feel about that actually, that you got second M?
He started the firm first because I was under contract so I couldn't leave my firm.
So he has MN, makes sense. It does. Okay, we got that. My initials.
Yes. Oh, really? Okay, there you go. I mean, I figured that out. All right, so you and I got a lot to talk about. Your coverage is, you know, some of the names that I think are the most bandied about in the entire market. We certainly spent a lot of time on them at CNBC. And so, looking at all these names that are reporting this week, we got a lot to talk about. Okay. I want to go into your background and the firm because it's a very unique firm, especially on the street. You keep a relatively low profile. Maybe that helps you get the access and do the great work that you do. You don't have banking to deal with and all that sort of stuff. So that's really interesting. And then after this conversation, my good friend Adam Singolda, CEO, co-founder of Taboola, he is in the adtech market for all intents and purposes and they've made a lot of advancements with AI. So it's a great conversation to see a practitioner after a research analyst. All right, I'm gonna shut up. Let's give folks a little bit of your background because I first, you know, became familiar with your work when you were a media analyst. Now, you have great media analysts at your firm, but you pivoted more to the digital space and it's Google, it's Meta, it's Microsoft, and a handful of other advertising names. Talk to me a little bit about that transition and why it makes sense to you.
Okay. And thanks for having me on. I've been a media analyst. I've been an analyst for 28 years. I started my career at a place called Sanford Bernstein covering European media and for six, seven years I'd fly to Europe and do European media and then got to be a US analyst in 2005. And in 2015, after 10 years of doing that, we added digital advertising. Here's why: it was obvious to us that the end was going to come for linear cable networks, right? Like cord cutting had not started yet but it was clear that the US was at 100 million homes and that the growth was going to slow. And then to the left over there were these companies called Google and Meta that, believe it or not, were relatively small back 10, 12 years ago, were still growing like a weed. And I wanted to be the media guy covering those names to actually hedge our core coverage. So people said, 'Hey, media doesn't interest me but I'm really interested in digital advertising, talk to me about that.' I thought we can create a hedge but also I thought in the beginning I'd be able to call BS.
Wait, were you... are you a skeptic?
I'm a born skeptic. I'm also always...
Is that a Nathansson thing? Maybe that's a Nathansson thing. Okay. I'm really stubborn. Are you born in May? When's your birthday?
Okay. It doesn't make sense. But I'm stubborn and I worked in the industry. I worked in media. So I always had this view that Wall Street fell in love with these companies and didn't really know about them. They just fell in love with the CEO or the products but just kind of lost touch with reality. Right. You know, I learned this really quickly at CNBC that media loves to report on media. They're generally really...
Okay, so I just want to get that.
That's why we were able to build our firm so well is that we were on TV a lot in the beginning because media was not anymore, but was, you know, in the heyday of, you guess, ascending, right? You had all these deals, all these interesting CEOs.
A lot of deals, massive deals.
So it was great for our firm because we were focused on media and technology and media and telecom.
We added internet because I wanted to like hedge our bet on media, right? But what's amazing was I went over, started looking at these companies. I realized, you know, there were two things. They were pretty cheap and they were growing faster than anything I've ever seen before from large bases. Not massively bases the way they are now, but they're growing into the teens on big businesses. So compared to media, why would you ever want to buy a media stock even 10 years ago when you can go buy Meta and Alphabet at market multiples, meaning at the market growing double the market rates. It was astounding to me, right? And they were moving from, you know, I covered brand advertising, which was hard to test and kind of show value, to performance, which is performance is based on return on spend is much more knowable. So it was just a perfect time for me to pick up these names. And about three or four years ago, I started handing up more of my media coverage to my team. Robert Fishman covers media for us because I wanted to spend more time and the media and internet got more complicated with AI. Like it was a relatively simple call. Advertising is going to grow double digits. Stocks are cheap. But now they become more complicated. So I'm spending more time trying to get under the hood of what's actually happening with all these AI investments.
Let me go back 10 years to when you were hedging your bets on media. Did you think companies like Google and Meta would have hundreds of billions of dollars in revenue? Could you have seen that like the pace in which they were growing off a low base? Fine. But like this is kind of staggering. There's very few companies in the, you know, Fortune 100 or whatever you want to call them are, you know, have revenues anywhere near that. Especially with the margins that they have.
Right? So when we build like a 5 to 10 year model we would tend to start mean reverting, meaning we'd start fading the outyear revenue growth to like GDP plus, right? So we never thought... and Google just last year, Alphabet grew search I think 13, 14% 25 years into a search business. And Meta actually accelerated advertising second half of last year. No, if you asked me 10 years ago our models would have shown five, seven percent growth year 10 of the forecast because that's what all companies did. Like eventually you hit your wall on growth, you grow at GDP plus.
Yeah. I'm looking at FactSet right now and in revenue estimates for Google. Okay. Expected to grow this year, 18%, 16% last year, 17% next year and 16% year the year after that.
Yeah, it's 400 billion. I mean it was 342 last year. It's expected to be 4. I mean it's astounding.
There were quarters back in the beginning when I would say Alphabet YouTube actually a subset of Alphabet grew advertising as much in one quarter as the Turner networks which is an entire company owned by Time Warner would grow in a year. So they would add one Turner network in a quarter, you know, I guess would grow, you know, 10, 15 billion a quarter, you know, that's exaggerated, five billion a quarter.
Yeah. So, so the hedge worked out first and then you are skeptical by nature. Um, were there parts of the last 10 years, I mean, obviously metaverse, I'm sure you freaking hated back in 2021. Um, that seemed a bit gimmicky, right? It didn't really feed into what their core model was at, you know, Facebook or Meta, whatever the hell it was called. But what was some of the skepticism going back, let's call it pre-COVID?
So, some of the things I got wrong skeptically was Netflix. Okay. You would have read my research from 2012, 13 on and I was a Netflix skeptic.
Was it the transition, pricing started stepping up, like stuff like that?
Well, my view was I thought that the industry would never be dumb enough to give them their best content because I'm like why would you? But you know what, all these guys took the check. They took the short-term check and...
Because they weren't able to build their own digital distribution.
Was because the industry couldn't collectively figure out some way to come up with a model that was better than...
Like Hulu. What a joke, right? That was probably around the same time.
Hulu could have been, but the guys who run Hulu, who's their friends of mine, they would have said even the people who own Hulu, the Disney's, Comcast was one of them, right?
Yeah. They would not give Hulu enough. They'd have an international model.
Yeah. So, you know, Netflix scaled internationally. Hulu didn't have international content.
I didn't mean like a joke joke. I mean like...
Well, like it could have been, right? So, but in terms of skeptic, you know, I think once we realized that these are businesses that are performance media-based, there's so much ad money that wasn't being measured. So, there's a bunch of coupons or direct marketing mailers or if you go into a retail store like the end cap promotions, there's all this money that's as big as the measured market for advertising that was simply going to go to digital. So, they were just taking money out of all these places that were not competitive. So, what I think we're most skeptical on was... that's a really good question.
Well, I don't want to dwell too much on it because you guys have gotten so much right. By the way...
You know, it's funny what we got wrong in 2021. I thought the ad market would be sustainable. I didn't realize the enormity of a pull forward because remember we're all at home, tied to our computers, tied to our phones and basically brands were cutting back on all kinds of other spend. They were doubling down on digital marketing. 22 came and all of a sudden it hit like a ton. And I think we were overestimating the sustainability of 2022 off of 21, right? That's something that's like you worry about. But now ad spending as a percentage of GDP has never been higher and I think AI is a big part of that. But Meta is something, the metaverse. Yeah, I'm a born skeptic.
But all right, so just let's do 22, but then let's move forward because I think the AI thing is... I know you've been really right on Google and I want to spend some time on that because they report next week. Meta reports next week. Um, I think it's going to be or the week this is dropping on Monday. So this is what we got going on.
It's a big week. Wednesday is a huge night.
Yeah, this is going to be a busy day for you. Busy couple days. Um, so when you think about 22 and Microsoft, Meta, uh, Netflix, Tesla, and Nvidia, they all sold off 65% from their highs. Okay, so let's just focus on Netflix for a second here. You know, we were at home, you know what I mean? Like, so we come out of being at home and they had so many hits and because obviously stopped down on a lot of content that was being created. So that catalog was really helpful and they had a good backlog of stuff. But let's just talk about you being in the business covering the stock market for 28 years, 70% Netflix from its all-time highs. Now it's been up, you know, 800% since then, that sort of thing. Do you think that investors have too short of memories that this could happen again? I mean, a lot of these stocks were in the throes of a 30% selloff when the S&P was down 10%. This is in the last month or so. Exactly. So, I'm just curious, how do you think of that?
That's a really good question, Dan. I think about this is that what I've learned over the years is that I learned the hard way on Netflix. Don't get caught up in valuation. Right. Like think what's changed over my life and maybe you would agree. There was a time when things would hit a valuation ceiling and the stock would not test that level for like forever, like oh it's oversold. It's never overbought. I think what I've learned is the market's willing to pay for winners, structural winners, and you should not...
Well, Amazon's a good example, right?
Exactly. Amazon, even Meta in at the end of 2022, it went down to below $100, right? I think you need to keep riding secular winners and not get caught up in the draw downs. Like, I guess that's what I've learned. So, when Meta got smacked or luckily you referenced my Alphabet call, we're like, look, how is this company not a long-term winner? So, I think what I've learned over the years and that the Netflix beat down, we should have been quicker on the upgrade. We never were. Is like you have to look at four or five years in these tech names and really think about what are their moats, what are their true competitive advantages and how reasonable is it to think that they're going to lose their competitive advantage, right? Like that ultimately... and listen, investors get a lot of things wrong. Like think about, you know, Netflix had multiple gaps on the way down in 2022, like multiple and it really felt like the business was broken to be very frank. And then, you know, the advertising business, their ability to kind of raise prices, that sort of thing. Um, you know, pretty interesting stuff.
Can I say one of the things I've learned is something that I focus a lot on now because I am almost like a... I have a lot of younger analysts in our firm. I'm very focused on capital formation amongst competitors, right? So, I'm really focused on having my team, let's say for example, we have a buy in Uber. What's going on with Waymo, right? Is Waymo going to be a real competitor? We have buys on DraftKings and Flutter. Well, what's going on with Kalshi and Polymarket? Right? So I think what's happened, there's so much capital forming in tech that you need to be really, really aware of narrative changes that maybe make those moats that we thought were much more sustainable less sustainable, right? And I think that's part of our job. And when it comes to like Alphabet or Meta, the question about sustainability is around OpenAI and Anthropic. But I think now what I've learned is I need to be really aware of what's my narrative shift and how true is that risk to that narrative shifting.
All right. So, let's talk about two of those. You just mentioned Google and then Meta. Big narrative shifts happened like in that 21 to 22. And so, ChatGPT comes out at the end of 22. And then all of a sudden, Google's in the penalty box. They try to launch their thing, Bard. It was a disaster. And then, you know, some of the early releases of the models not good. And then this notion that there was going to be this cannibalization of their business. How did you think about that? Because I know I think you were very early to defend. I think there was a lot of folks on the street who were, it was very easy for them to be very pessimistic about that story.
I would watch CNBC. I'd see some of these guys come on there and just like say, 'Well, my kids are not using Google anymore.' I'm like, 'Okay, good. You've done a survey of one, right?' And so here's how I think about it. What killed my media companies way back when was a willingness to not compete, not innovate, right? They were like, 'Hey, we're selling a TV bundle for 90 bucks, right? I know Netflix is $7. It's not a good product. We're at 90 and we're not going to make a product for 10.' What blew me away with Alphabet is, and you're right, Bard slowly happened slowly. Last year at their IO developer day, they started to show more and more of their products and they started actually look pretty good, right? You got a feeling that Sundar and the team kind of unleashed their product management roadmap. They're like, look, we're going to start developing products that consumers want and let's be damned about the economic impact. We need to get the consumer product to be right. Whereas in media, they dragged their feet. They didn't want to self-cannibalize. So part of it was let's look at the product roadmap. Second thing, Dan, is this... and I don't know what our next guest will talk to you about this. Just because you've got traffic doesn't mean you can monetize the traffic. So I covered Twitter from the IPO. We were negative on Twitter from day one. Snap negative from day one. It's because you got traffic doesn't mean you can monetize, right? Alphabet has some of the best first-party data in the world. They've got mobility data. They've got your Gmail interests. I think it's so simplistic to think that just because an LLM has traffic that they'll be able to monetize.
So distribution also more important and then you have better shots at monetization.
Then you have their infrastructure, right? And also ChatGPT is going to give you expensive, you know, LLM answers and not be able to monetize them, have to basically pay Nvidia a gross margin for their chips and...
And then Google has 70% gross margin, right? And then rent a data center somewhere. These guys have it all there. And they've been doing machine learning for more than a decade because talked about in 2015. So like what's going to hurt these guys is the unwillingness to adapt. But then you saw they're starting to adapt and you're right. Bard was a terrible first step and every time they failed at the beginning, the stock would go down. But I think sentiment changed last year when you start to see the products launch.
Also, don't forget the Apple...
That was a gift. The Monopoly case that Judge Mehta kind of let status quo proceed. Gift from heaven because Moffett and I were both worried that Apple would go buy Perplexity, Anthropic, who knows what and basically kick out, you know, kick and basically put their own search engine in Safari and start competing in search.
Yeah. Well, they should have done that a decade ago, but they didn't do it, right? Um, well, let's talk about that. So you didn't say GCP, but that's what you're talking about. So you have this big cloud business, right? And then you're building these models on top of it. You have probably five or six properties that have at least a billion. Half of them have two, two and a half billion, three billion or something like that. So distribution really important.
Oh, they also on Android, right? So you...
A little thing called Android. Isn't it funny that people, I forget about it like talking about phones around the country, around the world? Yeah. Which is amazing. And then think about the other side. So this is a company that's probably spent what, $400 billion on infrastructure. This is Google over the last, you know, let's call it three and a half years or whatever. And then Meta on the other side. So they're spending like crazy. They have not had a lot of success with their models. How do they monetize? Listen, they have, you know, I mean, they have this huge installed base. They keep telling a story about Meta AI, how they're going to monetize, which they've never done in WhatsApp, right? Um, obviously Reels and Instagram, they hit a wall at some point about ad load, right? So, but so they're doing all this spend. Is this the one name in your coverage, and I don't mean to put words in your mouth, where that spend, it's not, you can't be certain that this is going to be that beneficial going forward because if you go back to the late 90s and all the fiber that was laid, yeah, it wasn't great at the time, but it definitely got a return at some point during the 2000s. Right. So, how does Meta stack up in your opinion against Google in that regard?
Dan's putting words in my mouth. Um, Dan, somewhere about a year ago, year and a half ago, I was a big Meta bull from... I still, we have a buy on the stock. So, let's be clear. We have a buy and there's upside. We... there's upside, but a pound the table call in 2022, which was like non-conventional. It felt great to drive that stock from 100 to 700, 800 bucks a share. So remember about a year and a half ago I started thinking to myself what I know from observing Craig Moffett's world of telecom and cable and my own experiences with streaming is that when people are putting too much money into a sector obviously the returns in the sector go down. Now if you've got a cloud business like Amazon, Google and Microsoft or an ads business like Meta and Google you can offset the investment. What I still don't understand, I'm hoping that this week we have clarity is what does Meta want to do with this space long term. I understand to use AI to drive better ad results and we're getting that, they should spend all they can but it feels to me that they're building another business here and I'm not sure are they building an infrastructure business, a cloud business like what do they want to do and what do they want to do with Meta AI? Like how does that product fit, right? Like are you gonna drop it into Instagram so I will train my mind to use Meta AI to...
While you're in there? Yeah.
Yeah. But you know what? It's in there right now. It's in there and our team played around with it last week and we're like why would I just use, you know, you pick the other product outside of Instagram to do the work. So what I debate all the time and I don't want to pull the trigger because I think Zuckerberg is actually a capitalist at heart and if his stock ever languishes too much he's a realist like he was in 2022, I will start cutting back but he hasn't done yet in metaverse, right? The Meta investment I think that's like $80 billion of spend. I know there's a lot of other stuff in there.
But you sold seven million glasses, right? So your point, your observation which became a question was is this different than the others? I think it is. I think...
That's why in the past year or so, the stock has not participated in the rallies the way the other names have because we can't pencil out what the returns are or even what the business model they hope to roll out.
Right. So, let me ask you this. What if they made an announcement next week, okay, on their earnings or something like that that the Louisiana one and the other data center and this and that or whatever and they basically are building GCP or Azure or, you know, AWS as an analyst, would you think favorably of that or would you think that that means a couple hundred billion more in a buildout just to compete, you know, and they're going to have to compete on price and, you know, a lot of customers are going to be skeptical like that. I'm just curious how would that announcement because you just said, you know, we got to see what they're going to use it for.
I would not make me excited because you'd say you have three competitors here already who've been doing it well for a while. You know, we don't know when we have excess capacity, but at some point there's excess capacity. And what do you have to offer? You know, your models are not that much better than anyone else's models. You've hired a team to go work on them, but it feels like, you know, maybe it's temporary. Who knows? No, it would not be a good outcome. But again, we're trying to figure out what are they going to do with this, Dan. But the whole sector, I think, if this is your announcement Wednesday night, I'm expecting the next morning everything else to sell down because you don't want... how many businesses in big tech have four competitors? They don't. Maybe one or two. It's a winner-take-most kind of sector. People thought that GCP, Google Cloud would not scale. They have because of AI, but you don't want to see a four-player market.
Yeah. In anything, right? All right. So, let's go back to you just mentioned 2022, the year of efficiency for Zuckerberg and not too many CEOs would do like the end around like he did. He had a mea culpa, they started cutting jobs, they cut the spend back. So, we have this spend of all these companies and there was a point in which they were being rewarded, you know, every time they went from 50 billion to 100 billion. You know, Amazon went from I don't know like 120 billion to 200.
Yeah. I mean, we've spent a lot of time talking about Oracle, Dan winces. Yeah. Um, and we've been on that for a while and the creativity that a lot of these companies are going to have to get to to kind of build out some of the contracts from OpenAI. And I promise you we'll get to OpenAI in a second. How would you feel about, you know, Meta's already been making cuts, but if they basically said the same thing, year of efficiency, we're going to pull back on capex. We think we have what we need to kind of monetize across all of our platforms. How would you think about that?
That's why we have the buy on the stock because I think that could happen. It should be rewarded, you know, because I think what they're doing now is they're spending in part defensively to scare maybe others out of this market, right? Like look, this is going to be a war of attrition, Mr. Altman. You see what GCP, what Google's doing, you see what Microsoft's going to do, but now here's a third guy willing to spend money like crazy. So, I think part of it is like, look, we own the consumer. We're the number one or two consumer company in the world in internet. We're not going to let you in this business, right? So, we're going to spend. I don't think that deal is going to happen until you see others start showing the whites of their eyes. But I think if and when he does have another year of efficiency, the stock could again rerate quickly because... and it's cheap. It's 17 times earnings fully loaded with all those losses from the metaverse, right? Like we've been for years trying to figure out how do we value this thing? Like do we take the Meta losses out? Do we do it on Family of Apps? You know, we can get to a much higher number just by giving a market multiple on Family of Apps profitability.
All right. So, let's focus just a little bit on this week. So, let's talk about Google and Meta, which we have been talking about, but let's just... one of the things that's fascinating to me about Google here. It had a 23% sell-off from the highs over the last few months, and now it's within a couple percent of its all-time highs. Again, there's very few mega caps that have done that. Okay, so Meta sold off 33% from its highs going back to last summer and it's still, it's nowhere near its prior highs. So investors kind of have the same view as you for the moment is at least the way they're thinking about the stocks. So what would be the thing that causes Google to break out to new all-time highs and what would be the thing, and we'll just do Meta, that gets it back to those prior highs?
So I have this view, I think proven by looking at Meta over the years. We've got some really good charts on this. When a company has margin expansion and revenue beats, it's like a twin benefit. What problem with Meta now is that their margin is going to contract. When you add in the capex, right? So capex is spent first in cash and then the depreciation falls through. You have this waterfall effect of rising depreciation.
Do you think the depreciation is adequate at the rates in which they're using for a lot of the hardware? Because that's like one of the big debates right now.
Well, everyone elongated it, you know, that they went longer.
Yeah, that's what I mean in a way. And a lot of folks, my friend Jim Chanos, thinks that it's like way too aggressive.
Yeah. Three years and out. Yeah. Yeah. I, you know what, we're so early days on what they're being used for, but it's a fair question. That's why a lot of clients will look at free cash and say there's nothing here on either of these stocks. But what Alphabet has done better than Meta I think in the year ahead is that there's less margin pressure at Alphabet because I think the CFO is doing a very good job on balancing the growth in depreciation with the cutbacks other places. Your point on Meta, what gets it rocking and rolling is if all of a sudden we think the margin contraction, which we all expect is going to end more quickly, right? And like all of a sudden they started showing margin either neutrality or expansion, right?
82% last year expected to be 80 this year. So we're not talking about like massive degradation.
Right? Well, is that gross margin?
Yeah. So gimme loaded in with OPEX. What's happened is fascinating. They need to spend money on other people's clouds. There's a huge, they're paying a huge cloud bill in OPEX. So they don't have enough, they couldn't build their own data centers quick enough. So they're renting other people's clouds. So they're getting hit twice with...
They just did a huge deal with like CoreWeave, like so the neocloud...
They're doing, they're trying, they need capacity. I think they did a deal with Alphabet to get Google, right? So they're like, so they're getting double dipped. They're building at the same time they're renting. So let's see if she can control her margins going forward. And I hope, that's kind of why we keep the buy going because what I learned in 22 is that you don't bet against Zuckerberg's willingness to see his stock get clobbered. Right. He doesn't want to be seen as a loser. Right. You know, he needs to fix it.
And people say all the time he's like a good wartime CEO. I mean, do you buy into that like he's going to do the tough things like in late 22, that sort of thing?
So, it's funny. I just had a quick coffee with a friend of mine who talked about wartime CEOs versus non-wartime CEOs. The thing about founders is because it's your baby, you become a wartime CEO pretty quickly. Like you have a good detection system where like you know what, something's wrong here. A rented CEO may not want to go through the same pain, right? May not have the same ownership of the baby and doesn't want to kind of... but I think one of the benefits of wartime CEOs that are founders, they're willing to do whatever they can to keep their company going, right? So that's I think what's different about him.
