Tobias Carlisle (00:03:16):
I just felt like he was saying, this is just something that I’m seeing and I’m obliged to tell my shareholders and probably obliged to tell the wider world. But he’s not necessarily making any… He’s not an inflationester. He’s not making an argument for gold or for Bitcoin or anything like that, he’s just saying we’re seeing it, and then he leaves it to everybody else to interpret it. And then, of course, everybody else grabs it and so there are people who say there’s no inflation and they say he doesn’t know what he’s talking about. There are people who want to sell you some gold and they say that they completely agree with him, and the Bitcoin guys are the same.

Tobias Carlisle (00:03:48):
It’s funny that he just made a comment about his own business and everybody else gets to twist it and use it for their own purposes, which I’m going to do in a moment.

Stig Brodersen (00:03:56):
I love that you’re saying that, Toby. And I couldn’t help but notice the 4.2% inflation year that came out here in recent news. So also going to save the inflation piece, oh God, it’s so boring. But that’s-

Tobias Carlisle (00:04:09):
Must be right.

Stig Brodersen (00:04:11):
That was what really stuck out to me, and I couldn’t help but think, my biggest equity position, that’s Berkshire, and I was like, oh my God, they have so many [inaudible 00:04:19] expenditures, they have so much [inaudible 00:04:21]. I think Buffett even mentioned it in the annual letter, they’re number one and AT&T is number two, and that’s not necessarily a list you want to be at the top of, especially in times of inflation.

Stig Brodersen (00:04:33):
Then you might think, well, I should go into the Googles of the world, because once you have an inflation-proofed business, but then you’re like, well, if the Fed is going to increase interest rates, that means that all those future [inaudible 00:04:45] are being discounted back at a higher rate, which means that they’re dropping value, too. So, this just a very interesting dynamic that you see going on right now. That was definitely also my key takeaway.

Stig Brodersen (00:04:56):
Then you can’t mention that without saying the slip that Munger did with, Greg’s got to keep the culture. That was just, I don’t know, it was just a fun one. I just loved the way that you were looking at Warren Buffett’s face and he was like, what happened there? So I guess that’s how I’m going to remember the 2021 meeting.

Tobias Carlisle (00:05:15):
It was a much nicer one than 2020 one where he was alone in that gigantic auditorium with the COVID haircut that we all had at the time. So it was a much better one, given that they were in Los Angeles and paying tribute to Munger, among the others.

Stig Brodersen (00:05:30):
Trey and I did our own breakdown of the meeting a few weeks ago. It’s episode 350, if anyone wants to check that out. And Toby, I know that you did one on your episode, too.

Tobias Carlisle (00:05:41):
Yeah, on the podcast with Jake and Bill, we just gave our impressions of the meeting. Jake and Bill have both been long-time Buffett watchers. There’s some good takeaways. I don’t know the exact number, but it’s this season [inaudible 00:05:55] it’s a few weeks ago. 317, or something like that.

Stig Brodersen (00:05:58):
Perfect, we’re definitely going to link to it. So Toby, I’ll throw this over to you here in a sec, because, as per usual, you’ll kick off your pick first, but I also really liked what you said before about all these guys, they’re talking about Buffett’s inflation prediction and they’re just using for their own good, but then you were also like, but I’m going to do the same. So with all of that said, let’s kick that over to you.

Tobias Carlisle (00:06:24):
The way that I run my businesses, we’re mostly systematic with some other additional effort put on after we find these position. So just one thing that I have noticed over the last, so we’re bottoms up rather than trying to make any macro calls, so to the extent that I talk about inflation or the gold price or other things like that, just to preface where I’m going here, you should know that that portfolio is always constructed from the bottom up. I’m not working backwards from something that Buffett said or anything like that. It’s not me trying to predict where I think inflation is going. It’s not me trying to predict where I think gold is going.

Tobias Carlisle (00:06:58):
But the theme of what I want to talk about, is gold. I have just noticed that my screens have started filling up with gold miners and there’s some interesting names in here. I don’t own any of these things and I may not ever own any of these things, but I think that there’s a very good chance that we do end up owning some of them. We’re going through that process now, trying to work out which ones we like.

Tobias Carlisle (00:07:20):
I just want to talk about gold a little bit, and gold miners. So the last time that gold had this great run-up was in the first decade of this millennium and it was part of that commodity supercycle, where China was going to buy a whole lot of commodities so everything ran like crazy, and they were the sassy tech stocks of the first decade, and if you weren’t in commodities, you missed out on that run.

Tobias Carlisle (00:07:46):
At the end of that, in 2007, when the market fell over, where people might ordinarily think that gold miners or gold might provide some hedge or might perform a little bit better through a market crash, they all performed worse. But the reason for that, in my opinion, was that going into that crash, they were all very expensive, including gold, because it was the end of that cycle. Now we’re at the other end of that cycle, where it’s been a long period where value’s underperformed, gold is underperformed. More recently gold has run up, but if you think about the conditions that you would like to see for a good gold run, it’s probably fairly similar to the conditions that you would like to see for a good run of cryptos, or something like that. The only difference is that cryptos have had a very good run and gold is where it was around about in about 2007, which is a long time ago now and there’s been a whole lot of money printing over that period of time and not a whole lot more gold discovered.

Tobias Carlisle (00:08:43):
In fact, there’s about the same amount of gold in the world as there was in 2007, maybe a marginally larger amount, but not much. So with all of that said, I think that if you just go through the list of gold miners, there’s some very interesting names in there.

Tobias Carlisle (00:08:57):
The one that stands out to me is Barrick Gold. And the reason I like Barrick Gold, and the ticker for that is GOLD, just so you folks know. The reason I like Barrick Gold is twofold. One is that I think that all of the gold miners have got religion about their capital structures and about their costs, so their margins are great and their returns on invested capital are getting towards acceptable points, which is interesting, given where the gold price is. So it has run up to about where it was in 2007 and it looks like, if Buffett is right about inflation, that’s likely to be a place where there will be some protection.

Tobias Carlisle (00:09:35):
Gold has traditionally operated in that way. It’s an inflation hedge. So I think that Barrick Gold is one that Berkshire has owned very briefly in a very small amount. It’s very likely that it was Ted or Todd who bought it. It wasn’t a Buffett position. It was never big enough to be a Buffett position. And they only held it for about a quarter or so, maybe a year, and then they spat it back out again. Take from that what you will.

Tobias Carlisle (00:09:58):
The only comment that I would make is that it’s difficult to value gold companies because that commodity input, that gold commodity input, means that you’re very much tied to what the performance of the underlying commodity does. But I think this is an unusual period of time because we’ve had a very unusual year with COVID and the shutdown, and then we’ve had very accommodative printing from the Fed, plus we’ve got now the federal government, the fiscal policy is as accommodative as it has ever been, so there seems to be a lot of money going out to a lot of different people.

Tobias Carlisle (00:10:32):
Those are the conditions that create inflation. So there’s a big debate whether it’s transitory, whether it’s here to stay. I don’t think that anybody has really ever predicted it properly in the past, so I don’t think that anybody’s predicting it now. I just think it’s a risk, and if you’ve got a portfolio and you fill it up with Bitcoin and software as a service type stocks, lots of tech, probably doesn’t hurt you to have a little bit of exposure to the gold miners.

Tobias Carlisle (00:10:57):
Why gold miners rather than gold itself? You just get a little bit more leverage in the miners. They tend to go up a little bit more when the gold price moves up. That cuts both ways, they tend to go down a little bit more when the gold price goes down. So I think that if you were to look around for some safe companies with a good balance sheet, good cash flows, that would benefit from gold going on a pretty strong run here, then I think your list would include Barrick Gold. I’d also things like Alamos Gold, which the ticker is AGI there, and Kirkland Lake, similarly the tickets KL. All of those companies have got net cash balance sheets, good margins. I think that they’re well-positioned and big enough and broadly diversified enough that you get some safety if it doesn’t work and you get a pretty good ride if it does work. That’s my pitch, fellas.

Hari Ramachandra (00:11:44):
Hey, Toby, that’s a very interesting pitch. True to being a value investor and a contrarian. I had two questions, one at the macro level about this Bitcoin replacement goal. How do you see it? Because that plays into your pitch at the macro level. And at the company-specific level, buying gold, one of the issues with gold miners is, as I said, discipline in terms of their capital allocation, which I think you’ve already looked into. But the other one is access to safe mines, or operations in safe geographical areas. I was curious to know about those two aspects.

Tobias Carlisle (00:12:22):
Well, that’s the nice thing about those guys is that they are pretty well diversified around the world, which is why I prefer the bigger ones that are a little bit more diversified. You might get less lucky, in the sense that we’re not necessarily looking for discoveries here, we’re looking for miners who are already producing across a variety of geographic regions. So if there is any strife in any particular region, and I know that Chile has traditionally been an area where has been a quite a good location, just jurisdictionally, and they’ve passed some recent laws that might change the way that royalties are treated on gold or the way that miners are traded.

Tobias Carlisle (00:12:58):
It’s true also in Peru. It’s true also in many of these South American countries. So there’s always geopolitical risk with gold, which is why I just think diversification is the easy answer, that you just look for companies that have got diversification throughout.

Tobias Carlisle (00:13:12):
They all look pretty good to me now, because anybody who’s survived over the last 14 years [inaudible 00:13:20] has had to get religion about their balance sheet and about their costs, and so they all look much healthier than they did in 2007. I would say that if we get the big run from gold here, you would need to start watching that stuff because it’s a feature of gold miners that their margins don’t really move much over the cycle because their costs go up exponentially as the gold price runs up, because you need more people to mine it, they want to get paid more. The mines become more expensive, so when they buy a new mine it becomes more expensive. They’re not right businesses all the time forever and ever, they’re just at a cyclical low relative to where the gold is, and I think that if we see some inflation, then these things will perform very well.

Stig Brodersen (00:14:03):
One thing that I can’t help but ask you Toby is, do you see any ESG pressure coming to gold miners here soon? So for those of you who are not familiar with this, ESG is like the new black in finance. So the E is environmental, S that’s social, and G that’s governance. So you see a lot of that right now. No mention of Elon Musk or anything that’s going on with all that. But I feel like some gold miners probably have been under the radar. Do you feel like there’s going to a big pushback as more and more money is flowing in? And we might even see a green bubble, who knows, but I guess there are some of my thoughts going into that.

Tobias Carlisle (00:14:41):
My view is that all of that stuff really helps incumbents. If you’ve already got an operating goldmine, it’s so much easier for you to continue to operate. And you might have to make some additional disclosures in your financial reports, which is what they all have to do, but contrast that with the position of someone who’s trying to get a new gold mine permitted, that may be an incredibly difficult process, particularly in some of these countries like Chile, they’ve just had an election about this. Peru has these ongoing battles with the gold miners.

Tobias Carlisle (00:15:10):
I’m of the view that if you have an operating goldmine, you’re at a huge advantage and if they bring these ESG type regulations in, if they just tighten them up, if the world goes in that direction, then it makes your operating goldmine, you get a real competitive advantage by virtue of the fact that it’s already there and already working, because they’re not going to approve any new ones, so you’re going to constrain supply further or not allow supply to grow right when the demand kicks off because we see inflation and then we might see some speculation. That’s the way that I feel about it. That’s potentially more of a good thing for them than a bad thing.

Stig Brodersen (00:15:46):
It’s so interesting you’re saying that. There’s just so much money flowing into these ESG approved funds and it’s just, I guess, one of the things that’s a bit odd is that it really helps big tech right now, as you might even think that they have enough tailwind simply because they’re disclosing what they’re doing, they’re not a mining company or anything like that so it’s not like they have a lot of emissions and they’re big, so since [inaudible 00:16:11] is ESG approved, you’ll just have to buy a bunch of big tech as that money is flowing into it. So I just feel that’s interesting.

Hari Ramachandra (00:16:19):
I think that’s a interesting one, Stig. I had another question to Toby about the cost of producing an ounce of gold. I think I had heard in one of the podcasts where they went into the detail, but I don’t remember which podcast it was, about what price at which companies usually breakeven in terms of price of the cost. Toby, do you have any insights on that? I’m just curious.

Tobias Carlisle (00:16:46):
It varies from company to company, it varies from mine to mine. It depends on how far away it is from where you’ve got to get it to, how difficult it is how high up, because a lot of, funnily enough, the gold is found at altitude. There are some mines that there’s not a lot of oxygen around near the mine, so they’re much, much harder to mine. That’s what I was referring to before when I said the margins on these things are good. They all have lower costs. They’re all lower-cost producers, which is how they’ve been able to survive through this period where the gold price has been pretty depressed.

Tobias Carlisle (00:17:14):
If you look now, the gold price has run up a little bit over the last, I don’t know where it is necessarily on a week to week or month to month basis, I just meant over the last decade it is now back close to where it was at its peak in 2011. But that’s a very long run. That’s 10 years now that it’s been way down and running back up.

Tobias Carlisle (00:17:33):
I think that the biggest threat or the reason that the takeoff has been a little bit delayed in these things, is I do think that previously it was hard to get exposure to gold itself, the proliferation of gold ETFs, particularly ones that are backed by the physical gold. [inaudible 00:17:54] expressly backed by physical gold and other things like that, have made it, for people who are looking at the financial version of gold to invest in it.

Tobias Carlisle (00:18:02):
There are gold guys who want their gold ingots in their own safe and so those guys aren’t going to be affected by what happens in the financialization of gold. But there are guys who, maybe more like me, who it’s just a way of expressing a view at any given time. I could look at GLD, which is the gold ETF, or PHYS, which is the Sprott Physical Gold ETF, or one of the miners, and so you just have to know basically what you’re buying and what you’re doing, and then what your attitude is.

Tobias Carlisle (00:18:31):
If you’re thinking that the entire global financial system could shut down, then none of that stuff is going to help you. I don’t know necessarily that gold ingots in your safe are going to help you then either, but they’re going to help you further along the path then having a unit in an ETF.

Tobias Carlisle (00:18:49):
But then again, Bitcoin clearly is serving that function for some people. If you’re worried about inflation, there are people who are out there buying cryptocurrencies to get out of the financial system and to hedge themselves. And I think that’s part of the reason why we haven’t already seen a great run in gold and gold miners, that there are these alternatives out there.

Tobias Carlisle (00:19:09):
It’s difficult to know what’s going to happen with Bitcoin. I don’t want to really discuss it too much because I don’t have any specific view on it, but I would just say that Bitcoin has had a very good run and gold has not and gold miners have not, and I think that just the contrarian in me says that you want to be where everybody’s not, which means that I think that you probably, if you have those concerns, than gold and gold miners might be a more interesting avenue.

Stig Brodersen (00:19:35):
Let me ask you a question, Toby, that is impossible to answer, so that’s going to be my disclaimer.

Tobias Carlisle (00:19:41):
Sounds good.

Stig Brodersen (00:19:42):
Right on. What’s the intrinsic value of gold? And please let me put a bit more color on that, because I’m sure you’re not going to be like, Stig, it’s going to be 2323.8. I’m sure that’s not going to be the answer. The reason why I’m asking is, I’m so [inaudible 00:19:59], I guess I’m just wired that way. I’m looking at this as if this was an oil company, and if I were to buy a position in, I don’t know Exxon or Chevron, I would like to have a pretty good idea of what do I think the value of a barrel oil would be? What do I think the price of natural gas would be? And then just pedal back from there in figuring out what’s my potential, what’s the short term implication, what’s the long-term implications of that.

Stig Brodersen (00:20:23):
With that said, whenever you look at something like gold, you already out laid out inflation and some of the concerns you have with that, but how do you see the price of gold in relation to your thesis?

Tobias Carlisle (00:20:36):
There are various methods for figuring out, not really an intrinsic value, but where the gold price should trade. I don’t know how useful or how predictive any of that stuff really is. I just think it over-complicates matters. The only observation I would make in relation to the gold price is that it hasn’t advanced since late September 2011, so we’re basically where we were, or slightly below where we were, at the very peak 10 years ago. That’s a meaningless statistic, I get. It bottomed in something like 2015, it got down to a 1000 bucks around about, something like that, and then now it’s $1700-1800 and it’s run up a lot since then, but it’s still below where it was in 2011.

Tobias Carlisle (00:21:20):
I think over that period of time, not much more gold has been discovered in the world and we’ve printed a whole lot of money, and so at some stage that inflation starts turning up somewhere. And I do think that we’re seeing it now. Buffett’s mentioning it. Gold price is going bananas. Every single financial asset is going bananas.

Tobias Carlisle (00:21:39):
Just in my life, I know that things are more expensive than they were, from kid’s childcare to the grocery bill. Just everything seems to me to be a little bit more expensive. So I’m anecdotally a believer in inflation is here. I don’t know whether it’s here permanently, but I got that feeling that we’re at the very beginning of our return to inflation that’s north of where the Fed has targeted. They’ve been targeting two, I think it’s going to be a long way north of that.

Tobias Carlisle (00:22:05):
There are other weird things in the system. The 10-year is never going to get up over 2% because all of the federal government’s revenues would be consumed by interest payments if that happens, so there’s going to be a pin on the 10-year. That’s going to have weird effects in the system, and one of them might be a blowout in commodity prices, which we’re seeing it across lumber, we’re seeing it across just about all commodity prices, and we’ve seen a little bit of it in gold. I get the feeling that gold’s time has come, given where everything else is, and gold miners will be a big beneficiary of that too.

Stig Brodersen (00:22:37):
Fantastic, Toby. It’s good to hear that a true value investor like you, are not looking at macro, and I’m just chasing a bit here because I feel the same way. I’m taught at the church of Buffett and Munger I’m not supposed to look at macro at all, but it’s hard. It’s hard not to look at everything that’s happening right now.

Tobias Carlisle (00:22:56):
The people who say don’t look at macro, the people who I’ve learnt that from, mostly that’s from Buffett himself. But the only thing that I would point out, there was a period of time in the 70s when inflation really kicked off and gold did as well as Berkshire did for a period of, I think, 15 years or something like that. So you got the yellow rock that doesn’t really do anything performing as well as the greatest investor the world has known for a period of 15 years. That’s a reasonable recommendation for it.

Stig Brodersen (00:23:23):
Well said, Toby. Hari, why don’t you go next with your pick? It’s a very interesting pick. I’m really looking forward for you to present that to the audience.

Hari Ramachandra (00:23:32):
I’m pitching a company from my backyard here in the Silicon Valley, and that is Splunk. Splunk is a provider of software solutions that enable organizations to get operational intelligence by harnessing their data, indexing it, searching it, monitoring it, and analyzing it. And when I say data, it’s mostly from machines, whether it is servers in a data center, IOT, internet of things, manufacturing systems, or healthcare systems, all these machines are generating data.

Hari Ramachandra (00:24:08):
And that all are hooked to internet. And Splunk provides a way to gather the data and makes it easy to search and makes it easy to analyze it and monitor it, which is very critical for business operations. And in that line, some of their main offerings include cybersecurity threat detection, which is a growing field nowadays, MO and predictive analytics, application performance monitoring, IP, even management and operations management and so on, which are all critical functions for any business.

Hari Ramachandra (00:24:44):
Their claim to fame, they were founded in 2003. I’ve been using Splunk in many of the companies that I worked for, both startups and bigger ones, so they are pretty pervasive that way. And the key technology is what they call schema-on-the-fly. And to put it in layman’s terms, what it means is that traditional databases, like Oracle, for example, needs data to be in a very structured way, so you’ve got to know how you’re going to generate your data before you generate your data. That is all these machines have to conform to a particular schema, and that’s operationally almost impossible in today’s world with diverse systems generating data.

Hari Ramachandra (00:25:27):
It’s all freeform, and that’s the whole genesis of big data, and you can think of Splunk as one of those early big data companies in that way. They basically pioneer, along with other companies, this schema-on-the-fly model, where you can collect unstructured data, but there are some able to help you query it and get insights out of it in an easy-to-use interface.

Hari Ramachandra (00:25:51):
They say easy to use, but in my experience, it takes some learning curve, and that’s actually one of the more competitive advantage. So I see as two competitive advantages that this company has. One is that switching costs. So one, they’re mission-critical, so there are a lot of moving parts and a lot of tentacles that the software needs to have into your various segments of your operations or infrastructure, so it’s not easy to just uproot and just put some other solution. It will take a lot of effort. There’s a lot upfront investment.

Hari Ramachandra (00:26:25):
Second, as I said, it’s easy to use, but in order to really get good value out of their systems, there is a learning curve for employees, so there’s a lot of training that goes in, so companies have to do quite a bit of investment to get best results.

Hari Ramachandra (00:26:41):
The second one is network effects. So as more companies get onto Splunk, or start using Splunk, they will generate more data that helps fine-tune their MO systems and their machine learning systems, that makes them even better for new customers and so on and so forth. So it’s like a cycle. Same cycle holds true for Google search, for example. More people search, Google gets better, and then more people will use Google.

Hari Ramachandra (00:27:08):
The second network effect, or you can call it the platform effect as well, is that they have an app store, what they call it Splunkbase, where other vendors can develop apps on top of Splunk, and there are more than 2000 apps now, which makes it very convenient for new customers, because they can just pick and choose apps instead of developing their own solutions, which incentivizes more developers to develop apps on Splunk, so that gives them that competitive advantage.

Hari Ramachandra (00:27:39):
But there are other competitors in this space, like AppDynamics from Cisco, IBM is getting into it, and even the big cloud providers can also take a stab. But my presumption is it’s so pervasive now and with all these stickiness, they can hold out.

Hari Ramachandra (00:27:55):
In terms of their growth strategy, apart from the organic growth by expanding into new customer base, they’re really good at cross selling. In fact, in the past couple of years, their annual revenue per customers, once a customer sign up, effectively doubles within a year, and then over a period of few years, three years or so, it goes up to six times. That is just from one customer. So the lifetime value per customer is quite high that way, because they’re able to cross sell because they’re saying you’ll get into application performance monitoring, then you cross sell into security threat detection, IP, even management, and so on and so forth.

Hari Ramachandra (00:28:36):
This reflects in their numbers. For example, the number of customers generating over 1 million in annual recurring revenue went from 124 in 2018, to 510 in this year. So they’re constantly increasing customers that are generating considerable revenue.

Hari Ramachandra (00:28:54):
In terms of year over year revenue growth, they’re having consistently upwards of 30% up to 40% in the past couple of years, except this year, and I’ll come to them soon, why they dropped in revenue this year. Gross margin has been averaging around 80%, which is typical of other SaaS companies.

Hari Ramachandra (00:29:13):
They’re sales and marketing costs, as you can imagine in a high growth company, quite high at 63% of revenue, but like every other company, the hope at least is that it will reduce. And today their ad option is quite good, 90% of Fortune 100 companies use Splunk for their monitoring platform.

Hari Ramachandra (00:29:31):
Their retention is also best in class, nearly north of 120%, which you can compare it to any other SaaS companies. And the average revenue per user, and this is important in SaaS companies because ad option is an early indicator for retention or attrition, their average revenue per user has been growing 12% for the past five years, which is quite healthy.

Hari Ramachandra (00:29:57):
One of the things that they have been investing heavily is machine learning and their machine learning performance has been growing quite significantly in the past couple of years, so that is something that’s under the hood, its results are not directly known, but it keeps making them stronger over a period of time.

Hari Ramachandra (00:30:15):
Those are some of the key statistics that show their growth and their mode. However, their stock recently took a big hit. They are now at $118 per share, and that’s down from $220 per share in August 2020. So in less than a year, they have fallen quite a bit. Their price to sales went from 11 plus to 8.5, and if you compare it with other companies, like Microsoft and Google, they actually have a higher price to sales than Splunk, which is a growth company with a small revenue base and has the potential to grow quite high.

Hari Ramachandra (00:30:55):
The reason for this, I believe, is that they have embarked on a change to their business model wherein they’re transitioning from licensing-based revenue to cloud or SaaS-based, subscription-based, revenue. If you’re aware of this, many years back Adobe went to the similar transition and they took a hit in their revenue. In fact today, as we speak, 50% of their bookings are coming from cloud or SaaS, and that’s one of the reasons why this year we see an impact on their near-term top line and cash flow.

Hari Ramachandra (00:31:32):
As term licenses see large upfront payments are going and recurring revenue is increasing, so in the long run, this is good for the business, but in the short to medium term, it will be [inaudible 00:31:44]. So that’s one of the reasons why I’m interested, because I believe that as companies digitize significant part of their operation, especially during COVID and post COVID, as we are seeing, the need for managing, monitoring, analyzing, data, detecting security threats, making predictions, all that stuff that Splunk offers, becomes more and more important for customers and hence their term is going to keep expanding for the foreseeable future. So that’s the reason I am interested in Splunk, but I would like to hear from you about the valuation part, which I really haven’t gone into. That’s the reason I brought it up here.

Tobias Carlisle (00:32:26):
In full disclosure, I have been short Splunk in the acquirer’s fund. The reason why is it has been a valuation short and a few other things when I look in the financial statements. I think, and this is not necessarily something that’s specific to Splunk, although the reasons why I’m short are specific to Splunk. To be full disclosure to you, Hari, my wife has a Splunk t-shirt and she’s been wearing it around the house to troll me, and I’ve been saying, because I’ve been short Splunk in the past and it didn’t work out, but this time it has worked out, and I think many of the conditions that made me want to be short when we put it at the beginning of the year, have been fulfilled and so it’s no longer something that I would… I wouldn’t initiate a short here, it was initiated earlier on at a much higher price. I think that a lot of that obvious short has come out of it.

Tobias Carlisle (00:33:16):
The reasons that I’m short, when I look at the something like it has to be a high growth company and so that transition from licenses to a software as a service model or cloud-based model, that was always going to impact earnings in the short term and that was going to frighten people out of the stock. But they also have this, when I look at the financials, it seems to me that the revenue growth is great, but I just don’t see how it falls through to the bottom line of the business. How do shareholders benefit rather than insiders and employees?

Hari Ramachandra (00:33:46):
That is a good point, Toby, and that is a question for many Silicon Valley companies, I guess, in some degree. I agree with you, because their net profit of net income has always been in the red so far. They have never shown a profit. And the benefit of doubt I give them is that, okay, they’re reinvesting in their business. But if you’re a public company for a while, it becomes harder and harder to defend after a while if you’re not generating any profits. Yes, I can see that particular aspect of it. I don’t have an answer to you, apart from giving them a benefit of doubt.

Tobias Carlisle (00:34:27):
With each year that revenue goes up, EBIT gets worse. And, as I was saying before, this is not, and you acknowledge as well, it’s not specific to these guys. I realize that there’s a competitive advantage to building out and becoming the dominant provider of whatever it is that you do, and you have to spend to do that and that means that your financial statements don’t reflect the quality of the business. And it’s true this is a very high-quality business, it’s got high margins, and they could, at any stage, turn some switch and make this a profitable company, all that requires is the will of the management to do that.

Tobias Carlisle (00:34:59):
The problem, I can already hear the arguments on the other side, the moment they try to run this thing for profitability, they lose some of that advantage in a business sense. Some of these companies need the support of the financial markets to continue to survive the way that they burn money, and I just wonder whether a crop of these things, and I’m not saying it’s necessarily Splunk specifically, but if the market’s sour on the stock of these companies, which there does seem to have been a tech wreck over the last quarter and a half, or two quarters, mid Q4 last year to where we are now, and maybe it’s turning around now, but that’s been my thesis for a while. That you could be short these things because the valuations were just so stretched, and that any hiccup in the road was going to lead to a little bit of carnage, which I think has played out. But when I look at these valuations, they’re still high from my perspective.

Stig Brodersen (00:35:52):
Another question that I would have for you, Hari. You mentioned the networking effects before, the advantages of a heavy developer building on top of it, and I can’t help but think about whenever you were pitching Slack too, and you mentioned that as an advantage as well. I’m not trying to be like, a year ago you talked about Slack and how did that go about. I guess my point of saying this, also because of the pick that I’m going to later you can give the exact same criticism to, about do you have a platform with networking effects, do you have something that’s been covered?

Stig Brodersen (00:36:23):
Whenever I’m looking at something like Slack… I love Slack. I use it every single day. And whenever you mentioned it back then I was thinking, wow, that’s a great mode to have, and you have people developing apps on top of that, and it’s just network effects are getting better and better. And then I realized what Microsoft were doing with Teams and how much of that that could be copied. And then Salesforce came in and took over Slack and everything that happened with that.

Stig Brodersen (00:36:46):
But I guess I was a bit surprised that the networking effects weren’t better than they were at the time. And so whenever I look at Splunk, I’m just trying to make the segue into Splunk here, the biggest three times as large as the next competitor, Datadog, and you had New Relic too, that’s even smaller, and these are the networking effects that might be spawning here. It’s getting bigger and bigger. 90% of the Fortune 500 companies are using it. How much of this can be copied and how much disruption can we see here? Is this truly a platform bet with networking effects or can someone replicate it?

Hari Ramachandra (00:37:25):
That’s a great question, Stig. And in fact, when we talk about platform effect, it varies, all platforms are not created equal. For example, Apple Store is a different platform than Splunkbase app store, because of the many to many relationships that Apple has, like numerous consumers and numerous producers, but as Splunk is enterprise business and the app store is much smaller in scale, so it’s much harder to defend a Splunk app store compared to Apple App Store. They’re not equal, for sure.

Hari Ramachandra (00:38:01):
However, within the enterprise world, once you get adoption to a place where there is enough adoption among good customers, really a good engagement among employees and developers, it’s really hard for a newcomer to replace them. Having said that, it doesn’t mean that they can’t be, but it just becomes much, much harder. And that shows in the statistics that you just laid out, like the three X bigger than the nearest competitor.

Hari Ramachandra (00:38:34):
Those things give me confidence about the platform effect, but where the risk actually rises for them is this big public cloud vendors, like Google, AWS, and Microsoft, because all companies are moving to public clouds now. This is called the futurization of companies, of products, basically. If Splunk becomes a feature in AWS, or Azure, or Google cloud, because they can just give it away for free or for very little price as part of a bundle, so that’s what I would be watching out for. They might be just an acquisition target for one of these guys.

Stig Brodersen (00:39:14):
Thank you for your response, Hari. And remember that question, because whenever you going to hear my pick, you could give the exact same criticism. I’m not completely sure what to answer to that either. And so I’ve been struggling a lot with which pick I should come up with here for you guys. I’ve been looking at Pinduoduo, which is actually going to be my pick, and another company, Franklin Covey, which is also doing the transition from license to subscription-based. But I think it can only be one today.

Stig Brodersen (00:39:43):
I’m actually going to have a mastermind meeting, and the investing mastermind meeting was a slightly different format, with Toby, Jake, and Wes here in a few weeks, and I’m going to pitch it then. At least the Franklin Covey.

Stig Brodersen (00:39:55):
Anyways, I’ve been buying into two stocks this year, which is very unlike me. I don’t trade as much as that. I feel I’m over-trading if I’m buying… What, we’re at the 23rd of May and I already bought two different stocks this year.

Tobias Carlisle (00:40:08):
Profligate, Stig. Profligate.

Stig Brodersen (00:40:11):
It’s horrible. I feel I’m one of those Robin Hood traders. I’m all over the place.

Tobias Carlisle (00:40:17):
Crazy.

Stig Brodersen (00:40:18):
It’s crazy. I’ve been looking at this company, Pinduoduo, here for an awful long time. If I can just start sending Pinduoduo first, I guess. So that’s my pick. The stock ticker is PDD. And it’s a major e-commerce platform in China and has market cap of $160 billion, with more than 788 million active users. It’s a relatively new company. It was founded in September 2015, but already this year it’s projected to overtake jd.com as the second biggest online retailer in China. Number one is Alibaba’s Taobao.

Stig Brodersen (00:40:54):
This is a stock that I’ve known for a long time. As some of the listeners know, I’ve been holding a position in Alibaba for quite some time and this company, Pinduoduo, has just always been coming up as a competitor, and because I’ve been trained so well in networking effects and platforms, I was like, no, that’s just never going to happen. How can anyone compete with Alibaba and Taobao and jd.com, and here we are. Here we are and Pinduoduo just did that.

Stig Brodersen (00:41:24):
What’s happened since, just over the past years, the price is now six X and I’m starting to slow to catch up, trying to figure out Pinduoduo. And just for the record, I haven’t taken a position in Pinduoduo, which I probably should have a long time ago. I’m still trying to figure it out, which is also why I’m bringing this to the group here today.

Stig Brodersen (00:41:44):
The name in itself, directly translated, means together, more savings, more fun. And the company is just very interesting for so many reasons. It was the fastest company ever to hit $100 billion in market cap. Google took 12 years. Microsoft took 25 years. Pinduoduo, just short of three years. It’s just an incredible growth story.

Stig Brodersen (00:42:08):
I think the easiest way to think about the business is that it takes the best from Google, Amazon, and Costco with a twist. They said themselves that they are Costco meets Disneyland. To me, that doesn’t make really any sense, so I’m going to go with the Google, Costco, Amazon, with a twist kind of thing.

Stig Brodersen (00:42:25):
They are Google in the sense that their primary business model is that they make the money on sellers promoting their products to potential customers. And you will also notice that Pinduoduo almost have Google-like margins with cross margins nearing 50-60%. And the Google resemblance is no coincidence. The company was founded by Colin Huang, one of the lead people of Google China.

Stig Brodersen (00:42:50):
The way I feel it resembles Costco is that the business model is built up around the cheapest prices, and just like Costco, the savings are being passed on to the customers. Like Costco, you also buy you’re more, call it, boring household staples here, and perhaps you’re going to save some of your more exciting shopping for other platforms. Perhaps you even want to go out in the physical world and go out and shop with your friends. And so as much as Pinduoduo is slowly changing their approach, starting to selling more branded goods and they’re also going into the so-called tier one and tier two-seaters in China, which is, think of the Shanghais and Beijings of China.

Stig Brodersen (00:43:27):
Historically, their bread and butter has been the more boring products in tier three and tier four cities in China. So they’re very back in the rural area as compared to JD and Alibaba, which have not been doing as good a job in the more rural areas.

Stig Brodersen (00:43:41):
They also resembled Amazon, to some extent, because just like Amazon also gives you tailor-made products, big data, that if I recommend to you, you go to Pinduoduo with the intention to buy, which is extremely powerful. Whereas if you go to Google, you have search in mind. You will also get targeted with ads, of course, but it’s information you’re seeking, typically.

Stig Brodersen (00:44:04):
Unlike Amazon though, Pinduoduo has no warehouses of stock, products are shipped directly from the seller, and they also have to cover shipping costs. So where does this twist come in? Well, the shopping on Pinduoduo is different than anything else I’ve seen here in the west. It’s so-called social e-commerce, so even though you’re sitting at home, you can, to some extent, get the same experience as you do whenever you shop with your friends.

Stig Brodersen (00:44:29):
What does that mean? Well, whenever you enter the app, you’ll find that there is not a huge search bar as whenever you go to amazon.com, rather it’s set up to browse, so it’s more like if you’re shopping around with your friends, and when you find a product you like, you see two different prices. So one is a price for one item that you can buy right away, and then a lower price, that if you buy the product with a small team, you can then get a lower price.

Stig Brodersen (00:44:57):
This is one of the fantastic things about Pinduoduo. No one is supposed to just do it yourself. That’s the entire point. It’s like Tupperware, I think that’s the best example I can come up with. You use and see friends and that’s how the sales process works. And as we all know in business, doing the actual sales, that’s the most important thing and that’s the hardest thing to do.

Stig Brodersen (00:45:17):
Let’s say I’m going to buy 10 apples. I can buy them at click here now price, which is a higher price and it’s almost hidden, that price, or I can buy together with my friends, and that price is determined 24 hours later. The more of my friends who buy the product, the cheaper it will be for all of us.

Stig Brodersen (00:45:33):
Pinduoduo is then integrated with the Chinese super app, WeChat, owned by Tencent, and this is just such an important logistic advantage. WeChat has over 1.2 billion monthly active users. WeChat users spend 82 minutes on the platform every single day. WeChat users send 4-5 billion messages daily. It’s so incredible to think about how impactful WeChat is. And by the way, Tencent also owns stock in Pinduoduo, so they have a very good middleman there to help them communicate and market the products.

Stig Brodersen (00:46:06):
After my purchase, I do have multiple options to ask my friends, both on Wechat but also on QQ, to go in and help me with this purchase so we can all get a bargain. If you’re not familiar with QQ, it’s a Chinese platform, social games, music, shopping, micro bulking, movies. It’s a huge website. It’s actually the fifth most visited website in the world. So I know it sounds a bit odd, because a lot of people in the west haven’t heard about it, but it’s pretty big in China.

Tobias Carlisle (00:46:32):
It makes total sense to me. Makes total sense to me. I think it’s a really clever way of shopping. The way that I thought Groupon originally was going to work was something exactly like that, where they say, look, here’s the price if you just want to buy this thing immediately for yourself, but if you can get… Because anytime a vendor wants to sell something, it makes so much more sense to sell more of it. You want to sell more of it and you’re happy to give a lower price. That’s how wholesale works and every gradation along that scale. If you can get a whole lot of people together and buy more of them, we’ll sell it to you for a lower price, and it works for both parties. They make more sales. So it seems like there’s a virtuous circle to it that should power something like that forward.

Tobias Carlisle (00:47:10):
That social is so powerful. If four of your friends are buying something and they need a fifth one purchased and you’re the person who makes up the five, it’s very hard to say no. You have to go out there and buy it. So it’s a brilliant business strategy for selling stuff. That growth is just absolutely bananas growth, including in the revenue line and in the stock price.

Tobias Carlisle (00:47:33):
I guess that’s the thing that is always going to be the tripping point for me, is just this, I don’t know how you value something like this and this thing looks nosebleed, eye poppingly, expensive. I don’t want to derail you if you’re going to deal with it.

Stig Brodersen (00:47:48):
Toby, it’s a good point. How do you value it? It’s around, what, today 40 times free cash flow, which I know it’s a crazy world and we’re sitting here, three value investors, and were talking about, well, is it cheap if it’s 40 times free cash flow? What you’re looking at is a top line that just, oh God, it’s just growing so fast. So in 2018, 13 billion yuan, the exchange rate is one to six, it’s about, what, 2 billion US dollars. Then it was more than doubled in 2019 to 30 billion. And then 2020, it was 60 billion. So 100%.

Stig Brodersen (00:48:20):
To Toby’s point, how do you value something that grows 100% or more a year, that’s trading at 40 times free cash flows? Is that cheap or is it really expensive these days? That’s very interesting.

Hari Ramachandra (00:48:35):
I think that’s an interesting pick. As you mentioned, they have a good platform effect going for them, but at the same time, the pattern that I have seen with Chinese companies is that there is a much more faster rate of disruption than other markets. And as you said, Pinduoduo just dislodged JD, that might happen to Pinduoduo as well, because I think Chinese users seem to be more open to new ways, new habit formations, than, say, the US or other markets. So that’s number one.

Hari Ramachandra (00:49:11):
Number two is, when we talk about any Chinese companies it’s hard to argue against their growth because of the huge market they have and the growth potential, ever-expanding term, and then hence the high valuations. However, one of the things I wanted to bring up, which is not in the conventional wisdom today, is the coming demographic bust in China. That means people aging faster, there being less folks in their twenty to thirties and forties, and more people in their sixties to seventies to eighties, which means their consumption will go down and savings go up.

Hari Ramachandra (00:49:52):
China is supposed to be one of the fastest aging populations in the world would today, even if you go by their official numbers. And some folks like Peter Zeihan in his book, Disunited Nations, puts it as much higher than the official numbers. So that is one concern for the longer-term investors, if we are looking for the next one or two years, I think that should not be a big deal.

Hari Ramachandra (00:50:14):
The second one is their financial reporting structure. How much can we trust? That has been one of the concerns Kyle Bass and other investors have been bringing up when it comes to Chinese companies. And we have seen Luckin, I forget the coffee Starbucks of China, recently accepted some of the misreporting that they did, so then that’s a huge risk we have to assume when we are investing in any Chinese company.

Hari Ramachandra (00:50:42):
The third one is the heavy-handed government regulation. And we don’t know when that will drop on any of the companies and for what reasons. Tencent, for example, got dinged for their video games being too addictive to children, so there were some regulations introduced, which they took a hit. Alibaba faced a lot of regulations and fines because Jack Ma said something in a speech. So it is safe to say that in China, regulation doesn’t work like US.

Hari Ramachandra (00:51:13):
These are some of the risks that I assume for any Chinese company, any ADR from China that I’m investing in. So those are some of my key concerns.

Stig Brodersen (00:51:22):
Great questions. You talk about regulation, I think that’s very, very tricky. I mentioned before I have a position in Alibaba. I’ve been trimming that position and bought more Berkshire, but it’s still a position that I think have around 3% of my portfolio in Alibaba. And that took a huge hit with everything that happened with Ant Financials and the regulation coming in.

Stig Brodersen (00:51:44):
Lately, what we’re seeing, we’re seeing Pinduoduo, it’s trading today $130, and it was trading around $200 not too long ago, and a lot of that came from the regulation coming in for all e-commerce. The Chinese government wants to know all the data of these companies, and an investor, that’s probably not what you want to see. So yes, that’s a huge risk. Not sure what to do about it.

Stig Brodersen (00:52:10):
Knowing your limitations of your circle of competence. I would say that Chinese regulation is not one of them. I think it’s one of those where I would just say, I’m just going to pay a little less because I just don’t know really what to do about it and I don’t trust it that much.

Stig Brodersen (00:52:25):
You’re talking about the disruption before also, Hari, in one of your first questions. I think that’s a great point. There’s so much disruption going on in China, people form habits so much faster than what we see in the west, especially online. We used to talk about the big three, the big three being Alibaba, Tencent, and Baidu. Now Baidu is almost not there. You’re talking about Pinduoduo and Meituan, and both the companies have just been tarnished all the past few weeks with all the regulation stuff that’s been going on.

Stig Brodersen (00:52:57):
I don’t know. I can easily see the argument why you would buy an index fund or buy a Chinese tech index or something like that, simply because it’s so difficult to figure out. Another risk, just to give the bear case to this, because I’m not, and people should definitely keep the bear case in mind, I was doing one page on my pitch. I actually wrote nine pages down with all my bull case and I don’t think I can cover all of it today, it would probably be way too long, but there are so many good things going on for this company.

Stig Brodersen (00:53:25):
The bear case to that is that this whole social e-commerce, that has really taken off and what happened, well, Alibaba and Tencent said, let’s try and do the same thing. Let’s also try and subsidize our customers. Because one of the reasons why they’ve been growing so fast is because they’re subsidizing so much. They’re burning cash to a huge extent.

Stig Brodersen (00:53:46):
Actually, if you look at the financial statements, the earnings are not looking pretty. The free cash loads are looking a bit prettier. Colin Huang, the founder, owns 30% of the company, and one of the reasons why he haven’t been diluting more, because you’ll be thinking a company that’s been growing so fast and been subsidizing so much, is because he’s just burning cash and he has to raise capital all the time.

Stig Brodersen (00:54:06):
It’s because counterfeit products, I think everyone knows that’s a big deal in China, and Pinduoduo has been struggling with it, together with Alibaba and Tencent too. They’ve had those issues too. They have the so-called 10 X rule, where Alibaba has the three X rule, and that is that’s the penalty for counterfeit products on the revenue basis. And so that’s one thing.

Stig Brodersen (00:54:26):
Then all the merchants who are on the platform has to pay a lot fee to be a part of it, as a measure of, hey, we know we can deduct that fee if there’s any counterfeit issues that you’re going to have, so they’re being flooded with cash, they have a really good cash cycle.

Stig Brodersen (00:54:42):
The other thing is that once they do the purchase, they already received the cash even before the final price has been settled. They have a really good cash cycle, so it’s not being diluted that much. But they’re still on this growth spree. Now they’re facing Alibaba and Tencent coming in and starting to subsidize and building their own social platform.

Stig Brodersen (00:55:00):
That’s where the test is really for Pinduoduo, and I don’t really know how this is going to go down at all. Is this a platform? Do they have the true networking effects? Or is it more something that can just be copied, because Alibaba have approximately as many active users and if they’re doing the same thing with the social shopping, well, why not just stay on Alibaba and they already have the whole ecosystem there?

Tobias Carlisle (00:55:24):
I was just going to say, that was one of the things that really stood out to me when I looked at the financial statements that the free cash flow has been surprisingly strong and growing commensurately with the revenues, which is something that you would like to see in a really strong company, and at 37 times free cash flow, growing at 100% a year, if those things all hold true, it’s cheap.

Stig Brodersen (00:55:49):
Yes. That’s the thing, if that holds true, it’s cheap. If they’re going to see the same disruption as they’ve been put into the market, it’s not cheap. You’re buying something stupid at four times free cash flow. You don’t want to do that.

Hari Ramachandra (00:56:02):
Based on all the numbers, I agree with Toby and you that it looks very interesting, except that we got to know some of these unanswered questions very well before we can make it a big part of our portfolio.

Stig Brodersen (00:56:18):
That’s the thing, Hari. The reason why I would argue that it’s relatively cheap, now I’m looking through that lens that it’s growing 100% a year right now. Of course, it can’t continue to grow 100% a year, there’s only so many Chinese people, but you see a high growth. And I guess one of the things that if you want to invest in this, and again, I haven’t made my initial investment, I probably should have a long time ago, but it’s if you really want to wait for clarity and see what Alibaba and Tencent is doing, well, a lot of that gain is probably gone whenever you realize that Pinduoduo is going to make it.

Stig Brodersen (00:56:50):
But what I want to say is that one of the key metrics I really look into is how much merchandise do each customer spend on Pinduoduo, because that’s one of the issues that they had. So if you look at something like JD, they have around 6,000 a year, which is just short of, let’s call it, 8-900 US dollars. For Alibaba it’s around, well, $1200-1300 a year. And now for Pinduoduo it’s $350. So people do not spend as much money on their platform as the other platforms. But it has doubled in a year. That’s one thing.

Stig Brodersen (00:57:26):
The other thing is that it’s expected that you’re not spending as much on merchandise with Pinduoduo because they have been targeting tier three and tier four cities in China. Historically, it used to be women 25-35 from tier three and tier four cities in China. They just don’t have the same kind of budget, and for many of them it’s their first interaction with e-commerce.

Stig Brodersen (00:57:50):
Then if you add on top of that, most products are commodity-type products and their white-label, so it’s not like Alibaba and JD, which are targeting typical tier one and tier two cities, more branded goods. And so what’s happening right now is that Pinduoduo is targeting Alibaba and JD’s market and vice versa, and who’s to win? That’s one of the things.

Stig Brodersen (00:58:11):
Let me try and actually go back and answer one of your questions there, Hari, about demographics. We have seen the new consensus coming out here, which has been done every 10 year, and it was first postponed, and then they came up with the numbers and there were saying, well, we’re still growing as a population, and as happened so many times whenever the Chinese government is coming out with that, no one really believed it. A lot of people are talking about that it was actually shrinking, which is probably not what they want to hear, but because of so many reasons, the one-child policy and everything that they came with that, that is what we’re seeing right now.

Stig Brodersen (00:58:44):
I think you bring up a good question. How is that going to influence a company like Pinduoduo? The short answer is, I don’t know. I would say that there’s still a lot of runway, especially in the short term. Pinduoduo is really big in the rural area. Internet penetration is actually still low in those areas, so short term that’s something I’m looking at. Just in 2017, June, number here I pulled up is 34% internet penetration in the rural area, whereas it was 69 in urban.

Stig Brodersen (00:59:14):
Here, fast forward, three years, June 2020, we were looking at 52% for rural area, so going from 34 to 52 now having internet, and then urban went from 69 to 76. So there’s just so much growth still. Obviously, whenever you look at markets where people don’t have internet, that’s not where the biggest orders are coming from, but it is something that’s worth mentioning.

Stig Brodersen (00:59:39):
How that’s going to play out over, I don’t know, 20 years, 30 years, for the demographic growth, how much the adaptation rate is going to be as we see an aging society. I guess my shorter-term worry off that would more be disruption just general, Can they still compete with jd.com? Can they still compete with Alibaba? I guess, I don’t know the answer to that. I think that it’s such a commoditized space.

Stig Brodersen (01:00:05):
I guess if you’re going to see the full potential of a company like this, you want to see it start spawning, just like you’ve seen Alibaba start spawning into cloud and other businesses. Like what you’ve seen with Amazon. I don’t necessarily see this company doing your three X or five X if it’s only online sales. I think the competition is too fierce.

Stig Brodersen (01:00:25):
I’m saying this even though you’re looking at huge margins. If you’re looking at Pinduoduo for instance, the latest growth margins were 67%. It’s incredible. It’s not like the retail rates that you see for your Walmarts and Costco. There’s just so many other things that just really going on for this. And I know I’m [inaudible 01:00:47] feel some of the bad case, but if anyone is bear, I guess it’s me, which is this also why I haven’t taken position.

Stig Brodersen (01:00:53):
But a framework that I want to use for them, we’re talking about sales. I’ve been focusing a lot on sales here recently, because I feel, too, we need to understand the sales models of the companies that we’re investing in. I talked before about Franklin Covey, they’ve been going to cover a lot more and they’re building up a Sales force and the implication of that, and I’ve been thinking a lot about the sales process of this social e-commerce and if that’s going to be the new way of doing commerce.

Stig Brodersen (01:01:21):
The framework that I used was Cialdini’s book, Influence, which is just a wonderful, wonderful book. We also covered it on the podcast, so if you’re interested I’ll make sure to link to that in the show notes. He has six principles that are universal for making a sale or getting your way, which to most companies is to make a sale. And that’s reciprocity, commitment consistency, social proof, liking, authority, and scarcity.

Stig Brodersen (01:01:46):
I would like to talk about the business model of Pinduoduo and how that ties back into that framework. So reciprocity, which is the internal pull to repay what another person has provided us. If I call you Hari, and I’m saying, well, would you join my team? Assuming that you like me, it might be hard for you to say no. Or perhaps it’s been the other way around. Last week, perhaps I was supporting your team, and now I’m like texting you and like, could you support my team? So that’s reciprocity.

Stig Brodersen (01:02:15):
Commitment consistency is another bias we have. So if we advertise a product for our friends, we try to talk them into it so we can all get a little prize. We are susceptible to have confirmation bias and to continue to buy the product because we already put a name on it. This is what we should be buying.

Stig Brodersen (01:02:30):
We have social proof, another bias, whenever we are unsure, we look to similar people, we look to peers, what do they provide us with in terms of getting the right action? So social proof just fits right into Pinduoduo’s model.

Stig Brodersen (01:02:44):
Liking, another thing going back to the Tupperware party, you’re inviting your friends. So the friends that you’re going to invite to your team, that’s people you like, that’s your friends. Even if you don’t want the product, it can be hard.

Stig Brodersen (01:02:57):
Authority, that’s another thing. And this is actually a really, really cool thing for Pinduoduo. So whenever you’re trying to buy a product, it’s very interactive. So whenever you go to the platform, you can speak to the seller. You can actually literally speak to the seller, not just through promotional videos that they recorded, but actually just with… They’re sitting online, talking to you, showing off their potatoes or whatever it is that they’re doing, and they have a small army of social media influencers too that are selling and getting paid by Pinduoduo to do these things and getting commissions out of that. So authority, that’s another thing.

Stig Brodersen (01:03:29):
Then one thing that’s just amazing is scarcity. It’s almost like a senior algorithm whenever you use the platform. So I mentioned before you had the whole 24 hours to close the sale, but whenever… Again, you can get two-hour coupons. Think about it, two-hour coupons, that you log in, you might just get a small present, that’s one of the way they’re subsidizing and generating that growth. It’s going to expire in two hours, so you better go and find something and then recommend to your friends.

Stig Brodersen (01:04:00):
It’s almost difficult to explain, but it’s like, you go in there, you get a few points actually just to log in. The more you interact, if you share something, even if you don’t buy, you get more points. And once you get more points, they activate different coupons. They also have roulette wheels that’s spinning and you get different kinds of awards depending on how many points you get. All that dopamine is just being released over and over again.

Stig Brodersen (01:04:23):
For those of us who read Influence and we talk a lot about psychology and how that plays into the stock market, I just wanted to mention that as one of the frameworks why I found Pinduoduo interesting. I’m not saying that a major platform like Taobao can’t replicate it. I still think there’s a bear case for that. It’s something I can definitely see why it’s so effectual and why they went from zero to $100 billion market cap in less than three years.

Hari Ramachandra (01:04:48):
That’s interesting, Stig. I think, as I said, if I just look at it as a company without any of those caveat, it looks really compelling. And also, I think you mentioned it’s a Google plus Amazon plus Costco. Maybe you should throw in Facebook because of the social aspect. That makes me think, why can’t Facebook do something like this as a feature in their product? And again, that’s the problem with the habit formation, is where I have seen, at least what I’ve observed is, in US habits stick much harder than in China, because there, for various reasons, the user seemed to be very dynamic in taking on new habit, whereas in US, it’s much slower. Like Facebook, WeChat hasn’t happened with Facebook yet. It is still Facebook and WhatsApp. There’s a lot of backlash if they try to do something like WeChat and WhatsApp.

Hari Ramachandra (01:05:46):
There’s a lot of, of course, for privacy and security concerns. I think those things are on top of mind for US customers or consumers, whereas we don’t have such values in China. So definitely I feel it’s a compelling case.

Hari Ramachandra (01:06:00):
The reason I brought up my concerns was more at a macro level. They’re not specific to this company. And I don’t mean to say this company is cooking their results or cooking their books. It’s just that it’s base rate. We have seen such companies, we have seen such scenarios, how can we make sure these guys are not doing something like that? That was my only comment.

Stig Brodersen (01:06:26):
I think you bring up a good point and I don’t have a good response to that. I don’t know if they’re cooking the books. I looked through the financial statements, those are the numbers that I look to, especially if I invest in foreign markets, I’m just a bit more cautious and it just want to pay a low multiple, which is also why I’m like, is 40 times free cash flow, even though it’s growing 100% a year, is that cheap or not? I don’t really know at this stage. It is something I’m definitely keeping on my watch list.

Stig Brodersen (01:06:54):
I think you have a good point whenever you’re talking about habit formation, how does the work commercially in China compared to the US. In China, 50% of commerce that’s online and that’s growing rapidly. In the US it’s 13%. We all think that Amazon is taking over the world. Yes, they have like, what, 50% market share or whatnot of e-commerce, but when it comes to total retail, it’s just so different in the States. And it’s actually a lot more fragmented than probably most people think, compared to China where they have the big three, and that’s just how to do commerce.

Stig Brodersen (01:07:30):
I think it’s only a question of time before we start seeing this in the west. It probably already has happened I just haven’t seen it yet. Because it’s just so impactful because we just have these universal principles and perhaps it is easier to do in China, which is probably also why you’re seeing it there first, than in the west. But yeah, I wouldn’t be surprised at all if that’s what we’re going to see.

Stig Brodersen (01:07:50):
Before we round this show off, I just want to get a quick handoff to some of our friends over at the Acquirers Podcast. They did a wonderful, I think it was two or three-hour podcast episode, about Pinduoduo. It’s not so much in terms of having as an investment case, but more like, what’s the story? How was it formed? More about the founder. How he’s been mentored by the biggest tycoons in China. Even was a part of one of the charity dinners with Warren Buffett’s when he was 26.

Stig Brodersen (01:08:15):
You can talk about, he’s been mentored by some pretty bigshot people, and so a lot of interesting things in that episode, and I’ll make sure to link to that.

Stig Brodersen (01:08:23):
Before we round off the show, as always, Hari, Toby, I’d like to give you the opportunity to tell the audience where they can learn more about you.

Tobias Carlisle (01:08:32):
I run an ETF called The Acquirers Fund, the ticker is ZIG. I’m the Antiarc. It’s very deep value and I tend to be short some of the frothier names, so if you’ve got to be exposure to Arc, you should take a look at ZIG, maybe there’s some sort of hitch there. And I run a small and microfund with the ticker as DEEP there, it’s all US-based. And I’ve written some books, my most recent one is The Acquirer’s Multiple, which came out in 2007, and it’s available in Amazon. I’m always around on Twitter @Greenbackd, G-R-E-E-N-B-A-C-K-D.

Stig Brodersen (01:09:03):
Thank you, Toby. Always great to have you. Hari, where can the audience learn more about you?

Hari Ramachandra (01:09:08):
You can always reach out to me on Twitter @harirama is my handle, and my blog bixbusiness.com. Look forward to hearing your comments and engaging with you all.

Stig Brodersen (01:09:21):
All right, guys, so that was all that we have for this week’s episode of The Investors Podcast. Make sure to subscribe to our podcast on Apple Podcast, Spotify. We are also starting to pump out a lot of content on YouTube, so make sure to subscribe to that too. Hari, Toby, thank you so much for making time for us here today.

Tobias Carlisle (01:09:38):
Thanks, fellas. Good to see you both.

Outro (01:09:40):
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