Predicting the Next Rule Breaker Buyout

0:20I'm Rick Munarriz and today I'm joined by fellow analysts Karl Thiel and Jason Hall with bold predictions for what we believe could be the next rule breaker to get bought out. We'll also take a look at a whole new stock quote game. But first, Tesla taps the regenerative brakes on its generative AI supercomputer. Late last week, it was reported that Tesla was scrapping its Dojo supercomputer team, which Elon Musk confirmed over the weekend, putting an end to at least this chapter of its in-house AR hardware dream. Let's look at both sides of the story, dueling fool style. Jason will bring a bullish spin to the story, but Carl, let's start with you and the bear den.

0:55Yeah, it was almost exactly two years ago that a Morgan Stanley analyst suggested that Tesla's Dojo supercomputer could add a half trillion, that's with a T, dollars to the company's valuation. Now it's dead. And as I'm sure Jason is going to discuss, the stock has been going up since that announcement. Bulls are obviously hoping that less spending means better capital management. But not so long ago, Bulls believed that this project would give Tesla critical advantages. So look, not only was this supposed to allow the company to leverage all that data coming in from cars on the highway for better training, but it was a bet on other future possibilities that they could leverage.

1:40Dojo was going to save money because it would require the company to buy fewer incremental NVIDIA GPUs. Moreover, it was supposed to be better. The D1 chip that was the sort of core of Dojo wasn't just a general purpose GPU. It had a massive parallel design, but it was application specific. It was supposed to cut training times. It was, in fact, supposed to be kind of a triple winner for them. It was supposed to be better in performance. It was supposed to be cheaper to make. And it was supposed to be much cheaper for them to own, not only because it was going to be more efficient, but also, obviously, you weren't paying NVIDIA and paying for their profits.

2:20And, you know, a lot of this sort of vision of the future came directly from Elon Musk, and it was, you know, pretty much just accepted by the analyst community. The company and many analysts believe that Dojo could serve as the foundation for other future network services businesses, like managing the hub of a robo-taxi fleet or logistics and delivery fleets. It could handle vehicle infotainment. They even thought maybe they could rent out compute sort of AWS style to other businesses that were trying to do AI training. And, of course, if you believe that a big part of Tesla's future is humanoid robots, you're probably counting on Dojo again for fast, efficient training of them.

3:04But the thing that kind of gets me, I guess, about this announcement is that, yeah, it was announced, as you referred to, Rick, it was announced simultaneously with the Dojo team kind of leaving. So specifically, leader Peter Bannon said he was leaving the company with about 20 other engineers, several of whom went and created a new startup called Density AI. Supposedly, Density is going to be coming out of stealth mode relatively soon, so we don't know a whole lot about it, but from what little we do know, it sounds an awful lot, at least to me, like it's going to do kind of what Dojo was supposed to do, just not under Elon Musk.

3:46And that mass defection certainly isn't the only high-profile departure from a Musk-led company. I mean, we had, just to pick one, Milan Kovac, I guess it was earlier this year, left Optimus, which is their robot effort. So who's to say the defection stop here? I would put it to you this way. You know, you can value this company on its business, which is cars and a little bit of solar, which is kind of another troubled area. Or you can value it on all the future pixie dust. And I'm not against assigning value to future potential that is not here today. But if the pixie dust keeps getting blown away, you should probably sit up and take notice.

4:31Yeah. So addition by subtraction, or in your case, Carl, it's subtraction by addition by subtraction. Now let's turn to Jason for a more upbeat take.

4:40Rick Munarriz:All right. So let's start with the analyst note a couple of years ago. I think we have to be careful because we've seen a lot of squinty math from analysts over Tesla over the past decade about future bets. Let's just cast that aside and talk about what investors have been asking for from Tesla and Elon Musk for a while now, and that's to refocus. We're seeing that. I think this is Tesla and Musk making the capital discipline decision that it needs to make going forward. If it's going to achieve that vision for a company that can transcend just automaking and become, as Musk has called it before, a vertically integrated energy and transportation company, and now energy transportation and automation giant.

5:22Rick Munarriz:If you're talking about robotics and you're talking about autonomous transportation, we have to face facts, Bulls. The auto business is tough right now. And then there's the changes to federal regulations and incentives that are compounding the business environment for selling cars to all of the incentives that generate cash flows that Tesla is about to lose. Now, Tesla has a strong balance sheet. It's got about$30 billion of net cash, only about$6 billion of debt, and that's very manageable, but it has a lot of capital priorities and some serious risks to its ability to generate enough cash to pay for it all.

5:54Rick Munarriz:It's a smart place to pull back on cash outlays as an area where the market can actually still meet your technology needs, right? So sure, dojo and building the hardware would be great if you can pull it off. And Carl, you're right. Those defections indicate that there's still an appetite from the people that were involved in it to go and do something in a pure play business that can raise capital and derive funding as a pure play business versus being part of the more of a conglomerate Tesla, where it's going to pull resources from something else. You look at Tesla now, and the company can focus that capital on things that are more likely to generate revenue in the near term, which is the most important thing that Tesla can do right now.

6:36Rick Munarriz:The company had to reimagine how EVs are built to be a commercial success. It doesn't have to do the same thing with compute hardware to achieve those autonomous transportation, the robotics, other artificial intelligence goals. As a result, I think Tesla did something we haven't seen it do in years. It became more focused on fewer priorities, and the ones that it's focused on are more likely to drive revenue and cash flow sooner, versus just being an expense line on the operating statements that might be, to your point, Carl, just pixie dust in the future. Say what you want about Musk and his ability to end up with too many balls in the air.

7:12Rick Munarriz:But when he's more focused, he is uniquely relentless. This move could represent his refocusing on what's most important to Tesla, and that's delivering the products already in development to the market more quickly and prioritizing the company's limited resources to do so. So, just play your hits. I get it, Jason. I can't wait to see if Tesla will regret this move or if it dojoed a bullet. Coming up next, a few stocks we think could be treated to a bended knee proposal. Plants to stick around? Please say I do. As an investor, I'm buried in data and making sense of it all is hard. That's where Claude helps me every day.

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8:52And the eyes have it. Global eye care leader Alcon announced last week that it's buying rule breaker recommendation Star Surgical in an all cash deal to help expand its corrective vision treatment options beyond LASIK. The$1.5 billion acquisition is a 51 % premium to where its shares closed the day before the deal was announced. Buyouts are common, but a bittersweet experience for investors of disruptive growth stocks. Star Surgical joins Skechers and Taskus as rule breakers that have agreed to be bought out in the past couple of months. The short-term premium is nice, but you likely bought in hoping for a much longer runway before taking off.

9:26Who is the next rule breaker that will be prematurely snapped out of our hands? Jason Carl and I have some bold predictions. Jason, let's start with you.

9:35Rick Munarriz:Yeah, so I'll talk about Lululemon. And I think this is maybe a good fun thought experiment, whether or not it's that likely to happen. But I think if we look in the past, companies like Buffalo Wild Wings, Panera Bread, Skechers, as just happened, different circumstances. But there are times where you can see companies that have been long-term winners end up getting acquired. And in a lot of cases, private equity is involved. And I think maybe that's the situation for Lululemon. And what's going on right now for Lulu? In short, it's an incredibly relevant and valuable brand with millions of loyal customers.

10:07Rick Munarriz:And the customer cohort, while stagnating a little in its mature markets in the U.S. and Canada, more recently, it's grown to include more men and internationally is still growing at a decent clip. But the company does face, if not a crossroads, then some challenges to the rate of growth we've seen in the past. It's had some notable flubs here with its tech approach, with the Mirror. We like companies to take those swings and misses, trying to find some optionality. But it does seem like there's just some struggles with the core business in getting to growth. Here's the thing, though. Still really, really cash-generative.

10:40Rick Munarriz:Generated about 12 % in free cash flow margin over the past four quarters. But free cash flow is down about 25 % from its peak a couple years ago, even as revenue is still growing and is at all-time highs. And then, we haven't even talked about tariffs. It faces more profit pressure if President Donald Trump's tariff policies remain for the long term. In other words, this is a really high-profile business that's going to need time to complete the turnaround to reignite growth and the profits that management is promising. That's just hard to do in the quarterly pressure of today's market. Maybe becoming part of a bigger portfolio of brands, probably under private equity, might be the path forward.

11:20Yeah, Jason, so you see this happening, private equity, so Lululemon doesn't have to post, they're sticking their quarterly report card on the refrigerator door. Any thought on a potential buyer from a publicly traded athleisure, apparel, fitness, or lifestyle, or any other kind of company?

11:35Rick Munarriz:You know, it could happen. It could happen. But I think the reality is, if you look across that entire landscape, and you think about the big players, I'll use Nike as just an example, they have their own problems that they're dealing with right now, that buying their way out of it is not the right approach. So I don't think it would be very likely that we would see anybody that would be overlapping with customer base or already kind of in that market that would want to take on that sort of risk right now. I'm going to cheat a little bit and try to fit in two really quickly. One is Biomarin. And this is a company that if it got bought out, it would be bought out a little bit from weakness.

12:12BioMarin is struggling with some competition, some new products, and a diverse but somewhat aging portfolio. That said, they'd fit really nicely into a larger company's portfolio where some costs could be cut. One nice thing about BioMarin is just a lot of the products it makes are actually very unattractive to compete with, even if patents weren't an issue, just because it's very, very small populations and they have close relationships with those populations that would make it honestly difficult for somebody else to come in and take that much share away from them. I think Viking Therapeutics is a really interesting one.

12:59And anybody who follows this space knows that there's been a lot of anticipation around a possible buyout of this company because it makes so much sense and because there's been so much M &A in the obesity GLP-1 segment, Vikings working on its own GLP-1 GIP drug that's ahead of most competitors. So, there's a lot of expectations there. It would certainly fit in for companies that have some spaces in their own pipelines. I'm looking at you, Pfizer in particular. But the only problem is that it's been seen as such a likely buyout candidate that every time another acquisition in the sector is announced, Viking goes down because everybody gets disappointed that it hasn't happened already.

13:44No one really knows what's going on behind the scenes, but I think we can say that management's planning for a scenario where they can go it alone. And they're undoubtedly asking for a lot in whatever private conversations that are happening behind the scenes.

14:01Rick Munarriz:Carl, I'm going to put the screws to you a little bit here and tell you you've got to pick one. Which do you think happens first? Either way, we're probably talking big pharma here that's moving. Is it a big, well-heeled company that buys the, I don't want to say struggling, but company that would be better fit as part of somebody's portfolio? Or would it be somebody that really needs to get more aggressive and goes after Viking and is willing to pay up? Which do you think is going to happen first? I think we're at the part of the cycle where pharma is really looking to plug holes in its pipelines.

14:35That could mean either company, but I think Viking is just a really strong play to be competitive in what's obviously becoming a huge, huge market around obesity. And they get a company into the market with a strong product and some strong follow-ups. So if I have to guess, I'm going to go Viking first. Yeah, well, I'm going to go with Roku for my prediction. There's a pretty impressive turnaround happening at the Pioneer and Leader in TV streaming. But to many growth investors, Roku remains a four-letter word. The stock may be up nearly 60 % over the past 12 months, but the shares are still more than 80 % below their peak set four summers ago.

15:17Headwinds are turning into tailwinds. And if a company wanted to buy Roku at this point and inherit the pole position in the growing market for streaming video operating systems, This train is about to leave the station. Roku has turned its business around over the past two years. It has posted double-digit revenue growth for the last nine quarters and trailing free cash flow in the last eight. It had a much longer streak of red ink, but it turned profitable in its latest quarter earlier than expected. Roku's reach and engagement remains unmatched despite competing against Alphabet, Amazon, and Apple.

15:46Mag7 tightens with greater financial resources. Why wouldn't Microsoft, a$4 trillion company flush with nearly$95 billion in cash, not buy a company with an enterprise value of$10.5 billion that would catapult it over its mag-7 peers in a new frontier that matters to many of its businesses? The clock is ticking on an administration that may not object to the deal. Why wouldn't Comcast, a media company with large but fading cash cows, not make a play? There's never been a better time for a tech, media, or advertising giant to buy a ticket to the top. Yeah. Rick, when I look at that one, a question comes to my mind that a little bit has come to me about Viking Therapeutics as well, which is, it makes sense, so why hasn't it happened yet?

16:28There's certainly been activity around the margins of what Roku does. I'm thinking about Walmart buying Vizio. I'm thinking about Disney and Fubo. Is regulatory oversight, the Department of Justice or the Federal Trade Commission, a major factor here? Yeah, so this is a giant company buying a leader in a much smaller market. So it's even worse than Walmart, Vizio, or Disney Fubo. But I don't think that DOJ FTC oversight is going to be an issue in a case like this, because, again, Roku is a specialist, and it's competing against three other companies that would be competing directly with Microsoft or even Comcast.

17:05So I think the government will say, hey, better competitors. This is actually the kind of combination that would create a new, stronger competitor to some of these giant companies. So I think it won't have much of an issue going through.

17:15Rick Munarriz:I wish somebody would buy Roku just so I could stop beating my head against it, trying to figure it out. And stating the obvious here for all of our bold predictions, never buy a stock solely as a buyout candidate. Make sure you feel you can grow independently wealthy if your stock remains independently healthy. When we get back from the break, we'll third act this like no one's business with a different kind of stock quote game. Stick with us. We're twisting balloon animals into shape. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount plan, and monthly revenue to quota by region.

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18:35Rick Munarriz:That's R-I-P-P-L-I-N-G dot A-I slash F-O-O-L. Sign up for exclusive access today, Rippling.ai slash Fool. Jason and Carl, I know the two of you know your stock quotes, but how well do you know your quotes about stocks? I'm going to read you a quote said by a Rule Breaker CEO. Take it in. There's a clue in there. I'll then give you the name of three company leaders. Let me know which one said it. Ready? Here's the quote. I work under the assumption that we have no idea how to build companies yet. And that 50 years from now, people will look back at the companies of today and they will seem like the black and white footage of the first hockey games.

19:11We have no idea how to build the best companies yet. So who said this? A, Shopify CEO Toby Lutke. B, Meta CEO Mark Zuckerberg. Or C, former Chipotle CEO and current Starbucks CEO Brian Nickel. I think I know it, but Carl, you go first. I do not, but I'm just going to go with Toby Lutke from Shopify.

19:33Rick Munarriz:Yeah, it's the Canadian connection there, I think. Yeah, the hockey was a clue in there. Yeah, yeah. He said this nine years ago. Wow. So we're now 41 years away from what he was talking about. But yeah, Carl, congratulations on the winning for the two of you. Carl and Jason, thank you for playing, slaying, and staying. As always, people on the program may have interest in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers.

20:07Advertisers are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For Carl Thiel, Jason Hall, and the entire Motley Fool team, I'm Rick Minars. Voices carry. Till Tuesday.