Prof G Markets: Carvana and Corporate Governance, Hollywood vs. Microsoft, and Oddity’s IPO

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1:29Welcome to Prof G Markets. Today, we're discussing Carvana and corporate governance and Microsoft's latest AI announcements. Here with the news is PropG media analyst Ed Elson. Ed, what is the good word? I'm excited for my vacation, Scott. T-minus four days now. Another vacation? First one, man. Where are you going? What? Jesus, how much vacation? Literally, your life is vacation interrupted by fits of work. Where are you going? No, no. I'm going to Mykonos. Oh, we talked about this. That's right. That's right. Yeah, you're going to, it's a ton of fun. That's a long way for you. It's worth it.

2:03And you're going with buddies? Mm-hmm. Going with five of my mates. Same squad. Did the same thing last year. We're just running the whole thing back. I can't wait. Six young men rolling into a club in Mykonos. There's a word for that. No. It's a recipe for success. If I could do a Greek accent, I'd do it. But I hope you have reservations. And anyways, take us to the headlines. you Greek-partying young man.

2:37Senators Kirsten Gillibrand and Josh Hawley introduced a bipartisan bill to ban federal government officials from owning and trading individual stocks. The ban would apply to senior members of the legislative and executive branches, as well as their immediate family. A US district judge ruled that cryptocurrency company Ripple did not violate securities law when it sold its XRP token on public exchanges. Cryptocurrency prices rose significantly on that news. Netflix added 6 million subscribers in the second quarter, triple what analysts expected. That's thanks to the company's crackdown on password sharing and its new ad-supported tier.

3:15Still, revenue came in weaker than expected, and the stock fell 9%. Goldman Sachs reported that profits fell 58 % year-over-year in the second quarter. That's its worst quarterly profit drop since 2020 at the start of the pandemic. And finally, beauty AI company Oddity made its public debut. And as predicted on our show last week, the shares got a pop. The stock rose more than 35%. That's on top of the fact that they were repriced higher before the IPO. Scott, reactions? So let's start with a bipartisan bill to ban federal government officials from owning and trading individual stocks. It is insane that this isn't already a law.

3:58There's a massive amount of research that the majority of these representatives and Congress people are privy to that basically says one thing. To believe you can beat the market is irrational, dumb, illusory, what have you. And I believe the majority of them know that unless you have inside information. The fact that these guys go into private hearings, security, national security hearings with defense contractors, and these people get to decide the budgets, right, of a$700 billion, this is just one sector, in military spending. And they know before anybody who's having their spending increased, who's getting spending cut.

4:42If Northrop's about to get a contract for four more Trident-class submarines, which will take revenues up$30 billion, and then they can go trade on those stocks. And there's some guidelines right now saying if you do it, it's bad, no, no, but they pay a small fee. And what do you know, the Speaker of the House, or former Speaker of the House, Nancy Pelosi, her and her husband, have just a remarkable track record of picking stocks. And this is not only just incredibly wrong, it attacks people's belief and faith in the markets. And our robust markets, where there is a decent association with rule of fair play, are the result that American companies can raise more capital than companies in other countries.

5:25It's the reason why Americans who, when they retire, hopefully have some financial security because our markets tend to go up and to the right. And when we let our elected representatives who have access to insider information trade stocks, it literally cements the notion that they are doing something the rest of us can't do. and any representative who fights this legislation is saying i want to continue to trade on insider information because it shouldn't matter that they only get to invest in mutual funds it shouldn't matter unless they believe they can beat the market which means one of two things they're stupid or they acknowledge they have access to insider information so this is this is overdue what's the difference here really if say you're a big executive at a big bank a big investment bank you're overseeing massive M &A transactions.

6:15You have, you know, maybe not better insider information to the senators, but I'm sure some of these executives do have more consequential insider information. But they're allowed to trade stocks. And the way that we regulate that is that we just keep track of their stock picks and we prosecute when there's evidence that they are engaging in insider trading. So why not use that same approach for senators? So, Ed, I think your premise is flawed, and that is having worked at Morgan Stanley and now working a lot with Goldman Sachs and different investment banks, very few of them are ever allowed to trade stocks.

6:51David Solomon and Jamie Dimon do not trade stocks, Ed, just for that reason. They know it. They're contaminated. The moment when I'm on a call with someone on board, if they say you're about to get inside information, it means you are no longer allowed to trade in those stocks. One of my stalemates of Morgan Stanley went to prison for insider trading. He was feeding information to his cousin in Singapore in his late 80s. So I'd be shocked anywhere, anywhere if you sign up to be an analyst in the M &A group of an investment bank that you are ever allowed to buy and sell a stock. You can go into blind trust.

7:25You can go into ETFs. So right now, there are fewer restrictions on elected representatives who have access to more insider information than anyone in investment banks. If you're working on a deal, the fastest blue line path to prison would be to trade on insider information. And that's true of the law firms. That's true of the PR firms helping them with comms. You get a talking to saying you are now privy to material non-public information, and you can go to jail if you trade on this information. This is overdue, and anyone who raises their hand and tries to get in the way of this is saying, no, I like insider trading, and I want to keep doing it.

8:02Let's talk about the U.S. district judge that ruled a cryptocurrency company, Ripple, did not violate securities law. And we saw, I think we've seen Ripple just rip up. I know that Coinbase, I think, has doubled in the last couple months. And Jason Stavvers, our editor-in-chief, reminded us that it almost means nothing. And it's really interesting because we have a tendency, whenever we hear a judge is ruled, that's the headline. That's the news alert from CNN. And what Jason reminded us was a district ruling, a district judge ruling means almost nothing. And that this could just as easily be overturned as it was ruled.

8:37So it's a signal, but it's a faint signal. And you and I were talking about this, saying that everyone has seen this as some sort of unlock or liberation of crypto. And you had a different view. What are your thoughts around this? Well, the reason that they shouldn't be celebrating is because if you look at the ruling, the ruling just doesn't make any sense. Basically, according to the judge, half of those XRP tokens that were sold were securities and the other half weren't. And the ones that weren't securities are apparently the ones that were sold to retail investors on crypto exchanges. and strangely the ones that were securities i.e the ones that should have securities regulations and disclosures are the ones that were sold to institutional investors i.e the people who need regulations the least so it just doesn't make any sense i mean they're basically saying okay you're an experienced investor you're a vc we're going to give you the protections that you need so that you can validate yes this is a security but if you're just some kid who heard about the xrp token on, say, Reddit, then it's not a security.

9:41There's no regulation. There are no protections. Just throw your money at the wall and see what happens. I think it's a bad ruling. And, you know, if I were to make a prediction, it'll be that the court of appeals will reverse the decision. And eventually, if this goes on any longer, I could see this going to the Supreme Court. Jesus Christ. You're already in Mykonos doing edibles and trying to talk about the markets, said. Let's move on. Goldman reported profits fell 58 % year on year. This is some of the exit costs of getting out of the consumer business. Their trading volume is down. Dealmaking is down.

10:13In sum, Goldman is, they're great at trading, but they're primarily known as the premier dealmakers. And so when IPOs and M &A is down, their earnings are going to get hit hard. They kind of took a very conservative accounting approach and threw a lot of losses at this quarter to try and get it all out. And that appears to have worked. I think the stock's actually up today. I mean, there's some things here management has to take responsibility for, specifically what looks like an expensive foray into the consumer world. So that's the bad news. The good news is they're smart enough to get out. The other stuff that is really sort of outside of their control is just what is a cyclical decline in dealmaking where they get a lot of fees.

10:50In terms of AI company oddity, we made this prediction and it was an easy prediction. And I want to be clear, I bought stock in the IPO yesterday. There's very few companies in the shoot who are growing 30, 40, 60 % a year and also profitable. A, it feels like it's a great company and there aren't that many lined up. And because there's a lag between when you decide to go public and getting public, a lot of this is not their fault in the sense that there's just so much appetite and money on the sidelines ready for a good company and there just aren't that many queued up on stage, if you will. Are you viewing that as sort of a momentum trade or a long-term investment?

11:29Because a lot of what you said around the combination of beauty and technology and the leveraging AI, and it's one of the first big consumer IPOs, that sounds sort of momentum-based. Are you going to hold for a while? Well, is it a trade or is it a hold, right? So it's not what I call fully valued right now, but whenever you buy a stock and you could recognize a 45 % gain in 24 hours, there's a reasonable temptation to sell and just take the gain or at least maybe take some off the table. I think I'm a holder here because I think I'm super excited. They're about to launch or going to launch in 2025, an acne brand.

12:08And I think if you look at the ability to absorb with machine learning several million photographs and figure out the right treatment, I just, to me, that sounds really powerful. And when I look at the beauty industry, there really aren't what I call a lot of hot growth brands right now. Leal Makiage is a really strong brand. It's a strong company. They just got raised a shit ton of capital. They could probably go buy some small beauty related tech startups. And I think the momentum here is going to take the stock higher. I think this is a company that could be a$10 billion market cap beauty brand and be a reasonable, not a competitor, but a threat to L 'Oreal and Estee Lauder who traded much larger market cap.

12:49So I'm probably a holder here. If it were to like double in the next 30 days, I might think about taking my initial investment off the table and playing with the house's money. One mistake I make, but I continue to make it, is I almost always hold a stock for longer than a year because it just pains me to pay short-term capital gains on a trade. And quite frankly, sometimes that doesn't work out. Letting the tax tail wag the dog is not a good idea, but I can't help it because if I'm in something six or seven months, I just can't help but think, well, if I just hold on another five, I get a 10 % pop in the stock price because I'm going to pay 22.8 as opposed to 37.

13:28And if you talk to great investors, usually where they've had really big wins is, I bought$400 ,000 worth of Apple stock in 2010, and I think it's worth$8 or$10 million now. And any one year, it did okay. In some years, it was down. But holding a stock, there's nothing that creates wealth, like one, inheriting it. But two, if you're not smart enough to inherit money, buying a good company and holding onto it for a decade. So I have a bias towards just holding on. And to be clear, it's hurt me a couple of times. I invested in the IPO of Lemonade. It went to 200. Now I think it's at 20 or 23. When it was at 200, I probably should have said, okay, as great a company as it is, this makes no sense.

14:15And I did sell down, but I didn't sell, you know, I didn't sell all of it. I still own a bunch of it because I like the management team and I like the company. Netflix, other than TikTok, is the biggest beneficiary of the writer's strike. My understanding is somewhere between two-thirds and 80 % of their content production marches on. I think they have 10 ,000 people in Madrid making content. So thank you, WGA, said the Economic Bureau of Spain. Thank you, says TikTok. And Netflix, just by tightening up password sharing, added 6 million subscribers. They're adding people. They're adding 6 million subscribers.

14:53And the writers, in my opinion, in the union, and I've been saying this a lot, should absolutely partner with the studios and Netflix and go really hard at the biggest pile of money. And that is Microsoft, which added$155 billion in one trading day. And basically say, look, we are really gonna seriously get in the way of your ability to charge a subscription fee because you are crawling our content everywhere. And we represent almost every content creator in the world. And this is the moment. And I was at this moment in 2008 with the New York Times when we were so fascinated with Google that we let them crawl our data and debase our amazing content for pennies on the dollar.

15:34We should have all gotten together. The New Houses, the Murdochs, the Salzburgers, the people who own the FT, and said, we're gonna present one unified front to Google and to Microsoft and the other search guys, and we're gonna extract fair value for the fact that we are painting their house every millisecond. And that is what's happening the same moment here. the biggest pile of money is tech as it relates to ai and that's who the wga and sag and after and the studio should go after we'll be right back after a quick break with a look at carl vana

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18:01We're back with Prof G Markets. Shares in the troubled used car retailer Carvana soared after the company said it had reached a deal to restructure its debt. The agreement will eliminate 83 % of Carvana's 2025 and 2027 unsecured note maturities, and it will reduce its total debt by more than$1.2 billion. dollars. Shares rose 43 % on the announcement. Carvana also made headlines during the pandemic as its stock more than quintupled. 2022, however, was a disaster year. Inflation and rising interest rates suppressed demand for used cars, and the stock shed all of its gains, down 98 % from its peak.

18:40The company was also hit with several lawsuits. One came from a couple of shareholders who alleged that the Garcia family, which controls the company, had engaged in a pump-and-dump scheme. That suit claims the family inflated sales numbers and quietly sold the stock. But the debt restructuring is promising to investors. So is their latest earnings report, which beat estimates with a$105 million net loss. The company is also issuing$350 million in new stock. And year to date, Carvana is up, get this, 1 ,000%. It's still well off its pandemic high, but these gains put the stock back at 2019 levels.

19:17Scott, Carvana was a huge name a couple of years ago. What do you think of this news? The markets are bipolar, and this really speaks to what is the core competence of a great investor, and that is your ability to disassociate, specifically trying to ignore your emotions. Because when Carvana is on the way up and it's the future and used car prices are skyrocketing and everybody's going to buy cars through Carvana, everybody piles into the stock and takes it to just unsustainable levels that assume that it's going to sell every car in the world. And then they have some governance problems and governance matters.

19:50One of the reasons that our stocks and our markets traded a higher multiple is that we do have greater regulatory scrutiny. And generally speaking, we have better governance. Most boards take their role very seriously. And this transaction with his dad, it just really stank. You just heard about it and you thought, okay, another reason not to like this company. And investors will ignore poor corporate governance when the stock skyrocketing. They're like, whatever, you know, I'll ignore it. All right. If you get straight A's, I don't mind that you're vaping on weekends with your friends. When you start getting B's and C's, I'm going to start paying attention to the fact that your clothes smell like nicotine.

20:23Anyways, God, that was a good analogy. I'm proud of that. I just made that up. And everything, when you look at a company or investment, has to be set against valuation. At some point, almost any stock is overvalued. NVIDIA is an amazing company in the hottest sector in the world. And guess what? But its current valuation indicates or assumes that it's going to sell every semiconductor and every GPU in the world. So it's probably overvalued. At the same time, when Carvana was trading at cash, they do sell cars. They are an important company. And they took down costs. They reduced costs. Their revenues were up 24 % year on year, but their cost of sales decreased 29%.

21:03Their SG &A declines 37%. So in some, they've cut costs faster than the revenue declines. which adds up to a decline in loss. And the loss did narrow from 438 million to 105. So the market looks at this company and says it's a big player. They're making hard decisions that are moving them towards profitability. And it had been over punished when in March of 2021, when it hit its peak, its enterprise value to sales was 4.8. Now it's 1.1. And by the way, that EV to sales ratio is about the same for Ford and GM who are in the ugly business of manufacturing. It's actually cheaper than CarMax right now.

21:42So the tick up is really the notion that, okay, at some point, every company, no matter how much you love it, is a sell. And again, with almost every company at some point, it's a buy unless it's going to zero. And Carvana does feel like it adds enterprise value there. Yeah. I mean, so you bring up this idea of corporate governance and just some history on Carvana. So Carvana was spun out of another used car company called DriveTime. And it turns out that DriveTime is run by the founder of Carvana's dad, this guy named Ernie Garcia. And just a side note, that guy, Ernie Garcia, was guilty of bank fraud in the 90s.

22:18But let's just ignore that for now. Mia, our research lead, looked through the filings and she found some very sketchy information as it relates to DriveTime. So first off, Carvana buys cars and leases office space and sells warranties on behalf of DriveTime. And the filings don't disclose anything about whether Carvana could have gotten better prices on those services somewhere else in the market. There was also a shareholder lawsuit that alleged Carvana paid$400 million to DriveTime, which was at the time equivalent to a third of Carvana's gross profit. And then probably most alarmingly, there's this quote in the annual report that says, quote, the interests of the Garcia parties may not in all cases be aligned with our stockholders' interests.

23:04Meanwhile, the Garcia's have basically total control of the company because they have a dual-class shareholder structure. So you mentioned the idea of the markets being bipolar. Is there a line in terms of sketchiness, bad fiduciary obligations, just the fact that they have this strange parental relationship, literally a parental relationship with drive time? Is there a line at which you're like, okay i totally need to stay away from this company and everyone else should as well i wouldn't invest i mean this is a trade it might be it might have just gotten so cheap that you might have looked at it and said well the company isn't going away and it has more cash at one point i bet it was trading for cash but here's the thing this type of conflict all right selling having a relationship with a company controlled by your father that is uncomfortable that in and among itself, though, isn't illegal.

24:00And there are certain situations where conflict benefits the company. Maybe they were getting a sweetheart deal. Maybe it was the best type of relationship in the industry, given the options. However, however, the board, what this indicates is they have a shitty board that doesn't understand the term fiduciary. Fiduciary is a wonderful word. It means that once you have your deal set, once you know you're getting this many options, investing once a year for four years and you get a certain annual fee to serve as a director, you are now doing nothing but serving other parties' interests. You are representing shareholders.

24:35You are representing the Commonwealth. You are representing employees. You are representing the community. Here's the thing. It's okay to have related party transactions as long as a special committee of the board and the company can show that this is a good relationship with market economics. That's okay. As long as you've done the work and said, this is a great relationship, we benefit from the personal relationship and the services we are buying from them and the money we are paying are market rates. That's fine. It doesn't appear they've done that here. So this thing stinks. That's not to say it won't go up another thousand percent or then down 90 percent, but in general, as someone who likes to think of themselves, not as a corporate governance expert, but someone who appreciates how important it is, good corporate governance matters.

25:21I hate dual-class shareholder companies. They started with media companies. Now they've perverted almost all technology companies. And to be fair, Audity has dual-class shareholder. I think the brother and the sister who started the company now control it. I hate when you separate ownership from authority. The Salzburgers control 2 % of the shares of the New York Times, and yet they control the company. Are they going to make decisions? Are they great fiduciaries for the other 90 % when they get to control the company, but they only own 2 % of the company. It's important when you're on a board to be, you know, occasionally be the, I don't know, the unpopular one.

25:57And I was at a board meeting this morning and the companies, like a lot of companies taking its revenues down by a certain percent and was taking its expenses down by call it 0.3X of the revenue, a fraction of the revenue decline. I'm like, those don't foot to each other. And I realized this is painful. I realized you're a young CEO that's never had to create, you know, make a bad decision between bad decisions. But as it relates to layoffs, you only want to do it once. So you should go deeper than you want, because you don't want to do this twice. And, you know, I'm setting myself up as the hero right now, but your job is to say very uncomfortable things.