Seeking Alpha

The Changing World For Tech Stocks (Video Transcript)

About: Microsoft Corporation (MSFT), Includes: AAPL, AMD, AMZN, AVGO, AVGOP, INTC, NVDA, QCOM, TSM
by: SA Marketplace Roundtable Podcast

Mark Hibben joins us to talk about why he still sees a lot of uncertainty in the markets.

We also discuss the semiconductor sector and the recent moves Taiwan Semiconductor is making, and how that fits into his new paradigm thesis.

We also get into the stock he thinks is best positioned for the current climate, as it seems to be firing on all cylinders in a transforming world.

Editors' Note: This is the transcript of the video we posted last Tuesday. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the video as well as a podcast embedded below if you need any clarification. We hope you enjoy.

Daniel Shvartsman: I’m Daniel Shvartsman, Director of the Seeking Alpha Marketplace. We're continuing our coronavirus and 2020 roundtable series with marketplace authors. Today I’m speaking with Mark Hibben, the author of Rethink Technology. We're talking about the tech sector. He is – he offers balanced expert investing strategies from a technologist perspective.

Listen and subscribe to the Marketplace Roundtable on these podcast platforms:

The conversation with Mark runs from the 26:30-57:00 minute mark on the above podcast.

So, Mark, good morning. How are you?

Mark Hibben: Good morning, Dan. How are you?

DS: I'm doing well. So, we're going to talk about tech, but I wanted to draw a recent roundtable we did where you made the case that we're really going to be going into a U-shaped recovery. So, a longer-term, not quick bounce back, and that was obviously a roundtable before last Friday's jobs report and lots of other data and news, but what are you – any update on your view? And what are you watching for going forward as you're trying to assess this view?

MH: Well, actually, I was even thinking that it might be worse than a U-shaped recovery. I was talking about what I've read, which is a sort of a swish recovery. People have likened it to the Nike symbol where it's a rapid fall and then a very, very long sort of protracted recovery. And you know, I've been thinking an awful lot about the employment situation report that came out for May. Looking at the data, it hasn't really changed my view, I have to say. It's still basically the same. I think there are a lot of things, a lot of caveats with that report. I think the most important is that, it looks at a very, very different data set than the initial claims data that comes out on a weekly basis. The initial claims data is just tabulated data from the state unemployment offices, what they're seeing in the way of initial claims.

The employment situations summary that's put together by the Bureau of Labor Statistics is based on a survey and it's a survey of businesses, as well as individuals. And they admitted that they were having a lot of challenges due to COVID-19. And one of them had to do with a potential misclassification error, which got a lot of media attention. The misclassification error basically is – amounts to people who are unemployed due to COVID-19 restrictions, classifying themselves as still employed, but absent from work. And if they selected that classification in the survey, they would not be counted as unemployed. And the BLS was trying to get people who were out of work due to COVID-19 to list themselves as temporarily unemployed, in which case they would be counted.

So, they said that, that could lead to an error of as much as 3%. So that the unemployment rate rather than being 13% would be 16%. If it was 16%, that would actually be higher than April. So, you know – I think, in all likelihood, the unemployment rate did not decline from April as you know, compared to what they say in the initial release, which was it went from 14.7% in April to 13% in May. So, there's all those caveats and then the other caveat had to do with well, how do you reconcile the data between the insurance, unemployment claims and the situation summary and I think the best reconciliation I saw was in an article by this, this guy in Bloomberg, where he was basically making the point that if you look at the different sectors that the BLS breaks down, all the employment games were in leisure and hospitality and most of the other sectors were still sloughing off jobs.

And if they're in different sectors, then even if there are gains in, in leisure and hospitality that's not going to get – that's not going to help people who may be laid off from state, state and local government offices. And there was a lot of job loss at the state and local level. So that's a way to sort of reconcile the differences between the different data’s that different sectors are seeing different levels of unemployment or job growth. So, all-in-all, his conclusion was the larger economy as a whole still has a long way to go to make up for the job losses and in April and May. So, my take is, I think we're still looking at a pretty long recovery, you know, economies, national economies have a lot of inertia and it takes a long time to get them moving.

DS: So, and I think that jobs report is so interesting because there's so much you know, you've highlighted a few of the things that you have to break apart. There's also what affected the CARES Act tab, etc. What is temporary? This whole year is an exercise in what is temporary what's permanent. The – you made the argument and I think it's not an uncommon one that you expect – your thing that we may see a correction or a pullback of some sort coming to this summer, we're entering into a period now, obviously, we'll have jobs a jobs report again in July. And it's hard to say there's ever a slow news time in 2020, but we're out of earnings season, at least. So, what do you expect it like, as you position yourself, as you're thinking about potentially pulling back, which, by the way, you know, I've personally lightened up some of my positions in the last few days as well. I'm just curious how you're thinking about what could possibly cause us to grind lower or what are you watching for in the weeks to come?

MH: Sure, sure. Well, I have said that I thought there might be a correction in the offing for midsummer. Now, you know, in many ways, it's kind of a safe bet because we’re offering, you know in mid-summer, we have gone to the summer doldrums and a lot of people sell off. I'm not selling. And if I'm wrong about the correction, well, it'll be the most money I've ever made being wrong. You know, because right now my portfolio is going gangbusters, you know, but I do believe it's a little overvalued, at least in the context of a long recovery. And I also think that the market doesn't really think long-term. I mean, I've tried to make the case that these are good stocks to invest in, because in the long run, they're, they're going to come out of any kind of COVID induced recession stronger and bigger than ever. And I think, I can't blame the market for agreeing with me. You know, and certainly, it seems like the market agrees with me with respect to tech stocks.

On the other hand, I think that the market is not factoring in a long recovery that the market is still sort of thinking about tech as a short-term safe haven. And we're already seeing some of that safe haven thinking manifesting itself in, in some of the some of the tech areas weakening after the May jobs report, you know, where I guess the thinking is, well, if the economy is going to recover fast, then I don't need tech for a safe haven and I can move back into other mainstream areas. And, and so I think that's sort of the short-term thinking that's going on in the market. And I think when the market realizes that the recovery is not going to be quick then there probably will be a correction, but if the correction occurs due to just people exiting tech as a safe haven, I'll take it and I'll be a buyer.

DS: Okay, very interesting. There's all the thematic stuff going on, work from home versus the return to reopening as well. In terms of that, that recovery aspect, one of the things you also mentioned was looking at earnings, you saw a lot of uncertainty from companies about second half of the year, whether or not you know, software companies, for example, could look at Q2 and say, well, we're going to have a good Q2 because we are seeing increased demand for our services, but other sorts of companies, whether or not they gave guidance, there's more uncertainty out there. Are you, you know, a few weeks on? Do you have any better sense of how long this uncertainty might last or what the – is it really just wait and see, or is there any way to navigate that from your perspective at this point, or are companies navigating it?

MH: Yeah, I don't get the sense that companies feel any more sure about the future than they did after the first, you know, at the point of the first quarter earnings reports, you know that – most of the companies that I follow were pretty antsy, a lot of them didn't even issue guidance for the second quarter. And all of them seem to see clouds on the horizon for the second half of the year, primarily due to just a general recessionary effect of, you know, people not having as much spendable income people not buying tech goodies the way they might normally be buying. I think Apple was perhaps the most affected by that.

So, I don't yet have any feeling or any sense from any of these companies that they have more visibility. That may change when we get to the second quarter earnings, second calendar quarter earnings, but right now, I don't think that they're feeling any better about the situation than they did a month or two ago.

DS: Which is a reminder that the, you know, and I've been now doing these videos for a couple months and if you want them narrative to progress, but sometimes patience is really necessary to understand what's happening as much as we're all plugged in it takes time to figure that out.

MH: Oh, absolutely. Well, I wouldn't – I, you know, I don't feel much better or even that I have any more clarity as far as what's going to happen in the second half of the year. I mean, I just have my takeaway for what it's worth that yeah, I think it's going to be a longer recovery, but, who knows.

DS: One sector that you spent time on quite a bit or industry, I guess semiconductors, and I'm curious about them, because I think they aren't being talked up as much as for example, the software stocks in the software industry. And it's also interesting to me because they're to me sort of the connective tissue behind a lot of what goes on, on both the hardware and software side. And I'm curious what you're seeing there. You know, there's some things I posed to you in email, we have Taiwan Semiconductor is planning to build the plan in the U.S., trade tensions may be picking up again in China. So, that's one part of the story, but also with this changing demand with the increased demand in software and in work from anywhere sorts of services on the one hand, like you said on the other that ultimately there needs to be a consumer or business driver and there's uncertainty there. What are you seeing or what are you thinking about in the semiconductor sector?

MH: Well, I always want to preface any discussion of semiconductors with just some background, as far as my approach to semiconductors, which is that I tend to shy away from traditional semiconductor, commodity semiconductor companies and includes Intel (INTC), AMD (AMD), and other companies, Broadcom (AVGO), Qualcomm (QCOM), what I always want to look for is companies that are benefiting from what I call the new paradigm, which is that a company like Apple designs its own semiconductors and then has been fabricated by a company like TSM – TSMC, Taiwan Semiconductor Manufacturing Company. And that's where I'm invested in. I just read this morning, another article in Bloomberg. Another report, there have been a number of them about Apple switching their Macintosh line to their own internally designed processors.

The article even claimed that the announcement for that would be made at WWDC, which is coming up towards the end of June. That would be a huge big black letter handwriting on the wall message to investors regarding the future of the mainstream semiconductor companies like Intel and AMD. So, I think in that context, I'm very bullish about that paradigm. I think that's what's going to sort of take over the world. And I think the companies that survive are going to serve, you know, the mainstream commodity semiconductor companies that survive are going to survive by finding useful niches.

NVIDIA (NVDA) is a great example of a semiconductor company that has found a lot of different useful niches for their products. And has been able to thrive as a result, but has really tried to disengage from the commodity role as much as it could and create integrated products of software and hardware, which is an essential characteristic of that new paradigm. And it's been really instrumental to their ability to penetrate the data center market that they had so much software developed for AI, for big data analytics, which the data centers could use and I think it's really made a difference for them.

So, you know, talking about TSM, well, you know, they're instrumental in that whole new paradigm. The new paradigm semiconductor companies are all fabulous. Now, that's a necessary, but not sufficient condition to be a new paradigm company, but it's essential and TSMC has been right there. And even though they're probably going to get hurt by export restrictions on Huawei because Huawei was a big customer for them, maybe second to Apple (AAPL) in terms of mobile device fabrication because Huawei was typically going, was always using the leading edge process that Apple was using. Huawei certainly planned on using the five nanometer process that Apple currently is using for their next generation iPhone.

Everyone knows that's going on. TSMC hasn't announced it, but everyone knows that that's happening. So yeah, TSMC is going to get her by not being able to have Huawei as a customer, but I think in the long run, they're on the right side of the new paradigm trend in semiconductors. They're going to prosper and grow as a result.

DS: You've – I've heard you talk about the new paradigm before and I wanted to, as we're speaking now, it occurred to me.What you're basically spelling out is that more and more power is – market power is going towards the end. OEM is essentially the original equipment manufacturers are gaining more and more market power that they can start to, they can start to dictate. And so unless you're able to specialize or find those niches, you become just a commodity, and you're implying that there's going to be enough supply out there that the advantage that owning your own fabs and being able to produce your own chips is just not going to be there. Is that the right way to think about it as you're trying to differentiate the old school versus the new paradigm companies?

MH: Well, that's part of it for sure. Yeah. There's even talk about Intel ultimately abandoning their fabs, but that's not – that's not the whole story because it's, you know, being new paradigm doesn't just mean that you go – that you're fabulous, that is right, the necessary condition, but not – it's not sufficient. There's more to it than that. It's about integrating hardware and software into an integrated product that you then sell at a much higher margin than you could sell. If you were just making then the traditional commodity semiconductor maker can obtain by just selling commodity semiconductors.

Now, that argument kind of breaks down a lot with Intel because their margins are still very high, but I think ultimately where margins are probably going for Intel or kind of AMD level because AMD is functioning at much lower margins. They're competing very effectively with Intel. I think ultimately Intel can't survive at their current margins. So, it's more about a higher operating margin business where you're able to sell more or less directly to consumers, these integrated hardware software products like NVIDIA sells an inboard graphics cards that that combine their own chips, their own hardware designs, and the software to realize high performance gaming, for instance. So that's a niche for them. That's essentially a new paradigm.

So it's more than just abandoning your own fabs and Intel actually has not indicated at all that they're really interested in abandoning their fabs. They want to keep chugging along at what they believe is the right business model. And I'm not going to say that they're wrong. I don't know that for sure, but that's not where I'm placing my bet.

DS: Got it. Very interesting. It’s, you know, there's the Marc Andressen comment that software is eating the world, and so it's essentially also eating the semiconductor world to a certain degree where you have to be able to go both ways.

MH: Yeah, yeah. I mean, and that's why I've always been a big fan of Apple’s because I thought they were kind of by force of their own inclination, always very interested in unifying the software aspect with the hardware aspect, and that goes way back to the, you know, to the very first Mac. And they've pursued that approach even when it didn't seem to be the right answer throughout the 90s and early 2000s. I think most people in tech, were convinced that the right answer was Wintel in terms of a business model, but ultimately, that fell down and it fell down when mobile devices became so important because mobile devices need to be – have this intimate marriage of hardware and software.

People on mobile devices aren't interested in tinkering with them. They don't care about adding physical capability or hardware to the device. They just want something that works.

DS: Right. Yeah. Yeah. I can't imagine the hassle of installing a new operating system on your phone or what have you.

MH: Right, right. Well, you know, people try that though, for a while. Even Google was trying this approach of having sort of a modular hardware approach to Smartphones where the Smartphone owner could add modules that would add additional hardware capability that absolutely flopped. It went nowhere.

DS: So, to come back to this discussion, the last question I wanted to ask and it might be a semiconductor or somebody else, but what's a company that you just, based on what's happened over the last five months, you know, beyond anything else NASDAQ is still back at all time highs, but just in terms of the acceleration of the digital world, the closing, the reopening everything else going on, what's a company you think that just has an interesting position that you're watching whether or not you own it already?

MH: Well, I do own it and it's not Apple by the way. You know, I'm, always very enthusiastic and bullish about Apple, but I think Apple is more vulnerable to the impact of the pandemic in the sense that they're very sensitive to their hardware sales and device sales. And if you have a global recession, as we have apparently now, I think it's hard to expect that, that they won't be hurt by that. And in terms of hardware sales, I think they will be. The company that I think is the most interesting right now is Microsoft (MSFT). I think Microsoft has everything going for it.

In terms of being perfectly positioned for the post pandemic world. They've got a great work from home suite of applications work from anywhere suite of applications, no one really can touch Office 365 and Microsoft 365. They've got great collaboration tools and teams that that were really heavily featured in their last earnings release. Nadella spent a lot of time talking about teams. They're really pushing teams now. And they've got really what I consider to be the biggest cloud services business in the sector. A lot of people talk about Amazon (AMZN) being bigger than Microsoft. I don't think they really are. I think Microsoft is bigger in cloud services. Certainly, if you look at their most recent annual reports, Microsoft's intelligent cloud revenue was higher than Amazon's AWS. A lot of people don't realize that.

DS: What is the intelligent cloud? Is that more than Azure? Is it - or Azure, is it more than Azure? Or…

MH: It's mostly Azure. It does include some on premises cloud, you know, you know, private cloud services, but I think it still should be included. Yeah. So, you can you can say maybe in terms of public cloud services, AWS has bigger, but I think overall in terms of the server and cloud business, Microsoft is bigger. And when you consider that their cloud business is oriented towards servicing other businesses so that other businesses can create websites and their own cloud based apps and cloud based services. I think Microsoft is just pretty perfectly positioned for the world going forward. You know, especially since they've emphasized so much cloud delivery of their applications, subscription based model for most of their software now, you know, they're in great shape. So, at least they were willing to offer guidance for the next quarter, but even they were a little antsy about second half of the year, even they're concerned about it.

DS: Well, yeah, I think (CEO Satya) Nadella’s quote about two years of transformation seemed to happen in two weeks or whatever it was.

MH: Right, right. He was definitely very, very bullish on that aspect of the pandemic impact that it was accelerating what he calls the digital transformation. Well, what's the digital transformation? Yeah, sometimes, Nadella – I really, I really admire Nadella, I think he is one of the most intelligent guys in tech, but sometimes he uses terminology that I'm really not sure what it means. So, but whatever the digital transformation is, I agree that it's certainly going to be accelerated.

DS: Well, and it's interesting when you point out that they still have some caution is, I think software's has been a very hot sector and seems to be slowing down just a little bit in the last week or so, but it's still part of the economy. Ultimately somebody still needs to be growing their business to be able to purchase more software. I think that's a reminder that as exciting as it is, we're still subject to a general macro climate, which goes back to where we started and what sort of recovery are we going to see in the coming months?

MH: Yeah, but I think balancing that is that, is my belief that work from home is going to become a thing that it's going to continue. People are discovering and businesses are discovering that their employees can be productive working from home and that the collaboration tools are very effective in bringing people together so that they don't need to be physically co-located. So, I think that that trend is going to continue, and I think that takes the pressure off a lot of other areas that people are concerned about of infrastructure and transportation and even climate change.

You know, when people were experiencing lockdowns in places like China, all of a sudden the smog disappeared, you know. So, yeah, there's some silver lining to this cloud. And I think part of the silver lining is that our workforce can be more geographically distributed and then unified through our telecommunications infrastructure. And I think that's all great.

DS: Right. Absolutely. I don't know if – I imagine you actually have had the chance to work from home as well.

MH: I work from home now. Almost exclusively.

DS: Yeah, I mean, I've worked from home the last, you know, eight years or so. And I've always found it an advantage as much as anything else, but then when you see people shifting to that life and talking about staying home, and how they get cabin fever or anything else it at least casts a light I mean on how weird I must be that this doesn't and hasn't bothered me over the years that I don't like being alone.

MH: Well, I think, yeah, it hasn't bothered me either, but I think there is probably some adjustment that they have to make, and I think that'll happen. I mean, you know, once you get used to the idea that you really have more freedom than you have working a nine to five. You can flex your schedule lot more. If you have to go run to the store, or pick up the kids from school you can take care of all those things.

DS: Yeah, I do think it takes some discipline as far as not letting your work run. It's very easy to work longer hours when you're at home because it's right there, for example.

MH: All too easy sometimes. Yeah.

DS: Yeah. So, it's definitely – you're right. It's definitely an adjustment. It's – and it's, you know, there's definitely benefits to being in a room with somebody, but it doesn't there are more than one way to get at the same end result I think.

MH: Sure.

DS: Okay, I've been speaking with Mark Hibben of Rethink Technology. Mark before we wrap, any disclosures in any of these stocks that we mentioned today?

MH: Okay, yeah. I own Microsoft, I’m long Microsoft, long Apple, long TSM. Did we mention anything else? Long NVIDIA, yeah I did mention NVIDIA.

DS: And you mentioned Google, which I do have a position in as well. So…

MH: Yeah, I don't have a position in Google, but yeah, I did mention them.

DS: Okay, great. Well, thank you so much, Mark. There's been a lot of fun best of luck to you in the markets and working from home and hopefully get to see more of your work on Seeking Alpha in the coming weeks.

MH: Sure. Thanks a lot. And yeah, I enjoyed the interview a lot. It was great. Hopefully we can keep doing these on Seeking Alpha.

DS: Yeah, I hope so. I think it's a fun format.

MH: Yeah, absolutely.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Daniel Shvartsman is long GOOG.
Mark Hibben is long AAPL, MSFT, NVDA, and TSM.
Nothing on this video should be taken as investment advice.