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- [00:00]
Michael Batnik
Today's Animal Spirits Talk youk Book is brought to you by Vaneck. Go to Vaneck.com to learn more about their semiconductor ETF, SMH and SMH X. That's Vaneck.com to learn More. Welcome to Animal Spirits, a show about markets, life and investing.
- [00:18]
Ben Carlson
Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing and watching. All opinions expressed by Michael and Ben are solely their own opinion and do.
- [00:27]
Michael Batnik
Not reflect the opinion of Rithulz Wealth Management.
- [00:30]
Ben Carlson
This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. Well, here it is, the whole kit and caboodle, so to speak. Does the fate of the stock market rest on the shoulder of Nvidia and the AI enthusiasm?
- [00:57]
Michael Batnik
It feels like it, but I don't know. I'm sure something else will come up.
- [01:02]
Ben Carlson
I do think how about this? Yes, that's the answer, Ben. The answer is yes.
- [01:06]
Michael Batnik
So I don't know. I've been having lots of conversations in the past couple of weeks. I don't personally.
- [01:11]
Ben Carlson
With yourself or.
- [01:12]
Michael Batnik
Yes, I was talking my own head. I've had a few conversations with people in the tech space talking about AI and like the potential here for it. And I, to be honest, you mentioned on this podcast when we're recording, you don't use a lot of these things a lot yet. Like I dabble in chat, GPT and Perplexity and Claude a little bit. These are the ones I've heard of. But I hear people all the time talk about how they're using them all the time. And I'm not there yet. But listening to people talk about what is potentially coming, I know eventually I'm going to get there. So this is, it's. I don't know, the honeymoon phase, I guess is a good way to explain it. Like it's all theoretical. Most for normal people, not for the tech. For the tech people. I think it's already. They can see it and they're using it. Yes. But I think for me this is the interesting part of the whole thing because I'm thinking about what it's going to do for, you know, our business and, and making my life easier and more efficient and. And that sort of thing. So it's a very. Yes. It's hard to. You ask the question like is it all just being pulled forward or is it going to be great forever?
- [02:12]
Ben Carlson
Who knows Well, I listened to this weekend. I was listening to Bill Gurley and Brad Gerstner for podcast and they had Satya Nadella on the CEO of Microsoft. Did you listen to that, Ben?
- [02:21]
Michael Batnik
No, I did not. I'm too busy listening to sports podcasts like an idiot instead of listening to CEOs like you.
- [02:26]
Ben Carlson
Yeah. And I gotta be honest, fascinating, Obviously extremely successful guy, doesn't begin to scratch your surface, but I understood very little of what they were talking about. Right.
- [02:38]
Michael Batnik
They're talking about, like, that's how I felt. I listening to Patrick O'Shaughnessy's a couple weeks ago.
- [02:43]
Ben Carlson
Okay, so with, with Modest Proposal and the guy from Sequoia.
- [02:46]
Michael Batnik
Yes. And I felt like, oh no, is he from Benchmark?
- [02:48]
Ben Carlson
I apologize. But either way, same thing all over my head.
- [02:51]
Michael Batnik
All over. Clean over my head.
- [02:52]
Ben Carlson
Yeah, I'm listening and I'm, I'm absorbing very little of it, but I'm trying. So, Ben, to your point, like, there is so much ahead of us and so this is, this is like the hard part. I asked, I asked the guys, like, is it too cute to think that we're in the early innings and yet the stock valuations are fully reflective of the future? And of course we don't know, so. But what we do know is. What do we know, Ben? Very little.
- [03:18]
Michael Batnik
Well, we know that there's people out there that are smarter than us to talk about this. So that's why we brought in Angus Shillington, who's an equity research analyst with Vaneck, and Nick Frosty, who's an associate product manager. Talk about their semiconductor ETF, SMH, which it's been out since the year 2000. Do you think they knew that SMH would be shaking my head when they made this ticker? Probably not, right?
- [03:36]
Ben Carlson
You know, you say semi, I say semi. And who's right?
- [03:39]
Michael Batnik
Semi. Okay.
- [03:40]
Angus Shillington
I don't know.
- [03:40]
Ben Carlson
I don't have a strong opinion. Grandma puts hedge on that one.
- [03:43]
Michael Batnik
Very interesting conversation. We get into all things Nvidia and Broadcom and technology stocks, and this is talk your book. Michael tried to get in to talk his book at the end, but anyway, here's our conversation with Nick and Angus.
- [03:59]
Ben Carlson
Guys, welcome to the show.
- [04:00]
Nick Frost
Thanks for having us.
- [04:01]
Angus Shillington
Thank you. Thanks for having us on.
- [04:03]
Ben Carlson
So there has been a lot of enthusiasm from investors over the past couple of years for access to data centers, GPUs, semiconductors. That has been the driver of the most recent iteration of the bull market. Nvidia is up 160% year to date. Something like that. And I saw a chart this morning from Torson Slack that shows there are more data centers in the US than in all other major countries combined. So we've got 5,381 data centers. I'm not even quite sure what that means, if I'm being honest. You could explain. The next second place is Germany at 521. Why does the United States have such a massive, massive lead over the rest of the world?
- [04:42]
Angus Shillington
I mean, I think comically I would, I would go at that and just simply say, look, the rest of the world doesn't is difficult to count, right? It's Europe. We've really not played technology as well as they possibly could have done. India, just getting fired up. Latin America, not really there. China's huge. I have no idea what that number is, but it's to all intents and purposes US versus China. But India. But China has without doubt been scaling at incredible speed with their own technology. US is the home of technology. It has Silicon Valley, it has the most incredible venture capital industry. And really, I think it really talks to just the global leadership in tech, hardware, tech, software and applications.
- [05:32]
Michael Batnik
I assume in this space you have to be feeling pretty good right now, but this fund that you have, The Vanex Semiconductor ETF SMH, has been around since 2000. So you guys have seen some things in this fund. After the dot com bubble blew up, you know, tech stocks got shellacked and I, I think a lot of people who weren't around then don't realize how bad it was. I don't know, like an 80% crash in the NASDAQ or the NASDAQ 100, something like that. I'm sure semiconductor stocks were taking part of that as well. The current environment obviously fuels a lot better than that. But I'd love to hear your take on like the cyclicality of this industry and maybe how things have evolved this century in this space.
- [06:11]
Angus Shillington
Sure. God, that's a big question. So I would think about cyclicality as product or as modality. Okay, so there's a really interesting narrative or analog when you look at, you know, pre 2000 in the US like we had the Cisco craziness, we had Amazon fired up, did really well, and then at Y2K the whole thing just dumped. Right. And you asked the question what happened? Right. And it's not dissimilar to what we're seeing right now. Difficult to monetize all of this Capex. Right. And it wasn't until 2008, 2009 that we really got fired up and we haven't looked back. And I would put that straight at the feet of the iPhone, ARM semiconductors, they created this sort of monetization piece that really helped this thing take off. I don't think it's dissimilar to where we are in AI right now. But I think if you think about this fund like how it's done over time and Nick will probably get to it at the end, it really followed that route. Right. But the where you want to be in the semiconductor space is in the leader. So the leaders have done exceptionally well over very long periods of time. And that's sort of how I think about. So I don't think about it as cyclical. I think about it as at the leadership layer, very structural.
- [07:38]
Ben Carlson
So the leader is Nvidia, obviously it's 21% of this fund. Of the SMH, it is the only $3 trillion company in the category. Again I mentioned it's up, it was up 160% on the year or something like that. But interestingly if you look at Nvidia relative to either the broader market or relative to like if you just divide Nvidia by smh, that looked like a blow off top a couple weeks back and it has since retrenched. Said differently, its competitors, at least in the short term, seem to be catching up. What is the story within video and the competition surrounding it?
- [08:18]
Angus Shillington
I mean, let me say that we don't typically have these conversations around single stocks, but this is a very, very unique situation where Nvidia can be or could be considered to be the sector up until now. So if you don't understand Nvidia and how it fits in, it's difficult to have a conversation. So we're massive believers in mental models. Right. This was a Charlie Munger thing. I, I can't imagine approaching an investment opportunity without a mental model. So basic thesis, architecture of financial components, competitive dynamics. Here's the issue or the answer to your question, which is for investors. And this is an extremely well known stock. Nvidia has been AI and that is by and large true. 90% market share, massive gross margins. Nick and I went on the record about six months ago saying it's time to diversify out of concentrated Nvidia positions. We love Nvidia. Awesome company. Will continue to be an awesome company. Tough stock, really tough stock because we think or we believe that this space is atomizing and we can sort of drill down into that. But phase one, heavy, heavy, heavy Nvidia. We're in phase two now. We saw that from the Broadcom results late last week, we think that the share price is telling a pretty accurate story. So when we were on the record back in July saying we're probably at a level that you can really start to diversify, that's turned out to be pretty much right. We're at about the same level now. Whereas some of the names that will be beneficiaries from phase two are really in liftoff mode.
- [10:03]
Michael Batnik
So I guess one of the liftoff ones would be Broadcom, which is up, I don't know, 30%. We're recording this in mid December. It's up 35% in the last week or so. It's now in the, what are we calling it? The Quattro Commas Club. $3 trillion company now we've got a handful of those. I feel like this has got to be one of the companies that not a lot of people understand or know. And I know you said you don't spend a lot of time in individual companies, but this is a stock that seems to be on people's radars. Now that it hits this mythical level. Is this one of the companies that is coming up to challenge Nvidia?
- [10:33]
Angus Shillington
Right. I mean I do spend a lot of st time on stocks, right. I, maybe I, I've got that. I didn't get that quite right. You must know every single company in this space in order to make, to make money. I think that, that that's sort of where we're coming from. And we've designed, we've designed funds to play diversified. So again, we'll come back to that later. Look, Nvidia was there first. They were there first with a general purpose solution that was literally awesome. It solved every single problem. They, you know, Jensen had been preempting this for 10 years. They have a software top piece which you know, allows total interoperability. You can build massive clusters, you can plug them in and, and it works super fast, right? So that's great. But the clients, the CSPs, some of the other big players, they're input driven businesses, right? They don't like being tied to one solution or one software platform. And when you look at something like Amazon, how they built out in AWS or how they built out in logistics, they're about crushing cost and they crush cost with their own input. So it makes sense that they will move on and find other solutions. So Broadcom, little in terms of like compared to Nvidia, not as well understood, but hocked on one of the greatest CEOs of all time. Bolt on acquisitions, tuck in acquisitions. These guys are champions in networking, they're champions in asics. And this is where we think the market is starting to fragment.
- [12:17]
Ben Carlson
So. But why six months ago, is this a valuation thing, Is this a competition thing? Because of course, these things are very difficult to time. But why now? Or why six months ago?
- [12:26]
Angus Shillington
Just straight mental models. So we were getting data points, we were sort of analyzing transcripts and numbers. Coming out of TSMC was really our sort of lead point where we were seeing a couple of things. One unit sales were not dramatically higher. So most of this Nvidia run has been margins, it's been pricing power, it's been ASPs. And this crushing gross margin above 70%, it hasn't been radically growing, and I mean radically, not to the same degree growing, the number of units they're selling. So we were sort of like starting to think, right, what is coming down the pike? We can see now, we could see back then inside of Amazon, where they've ramped their silicon teams. They've got a piece of silicon called Trainium, which is, you'll hear a lot about next year, which can do a lot of the stuff that Nvidia chips can do. Businesses like Tesla, you saw them evolve over time. Where they now, you know, inside of Dojo, which is their autonomous driving piece, they build their own chips, right, called the D2, built by TSMC. So running down the same kind of process, we know the customers, we know the architecture, and it's felt to us like this, as this fragmented and stock prices move for a million different reasons. But one of them is better options turn up, right? So we saw better options turn up. We designed the fund that Nick will talk about at the end around this idea. And it kind of was a crazy conversation to be having. Second and third quarter last year, she's first and second quarter last year. All right, what if Nvidia no longer has a trajectory? Where would we want to offer clients a solution next? Right? And so we've been thinking about it for a while. You've got to be ahead of these things. And typically momentum, and especially in Nvidia's case, momentum was driven if you look at the upgrade cycle by blowout earnings. So you've got blowout earnings, numbers went up, you got more blood earnings order later numbers went up. So the step up, step up, step up. We just felt that that just wasn't sustainable, like, so.
- [14:36]
Ben Carlson
So let's say that, let's say that Nvidia, and I would imagine, I'd like to hear Your opinion? I would imagine that this ends. I'm using air quotes because I'm not. Nobody's expecting Nvidia to go away or anything like that. But you know, the, the, the crazy one up and Wednesday ends, you know, a gap down of 15 or whatever, something like that. I would imagine that it's going to come after earnings where either the margins aren't expanding or there's something in it. So let's assume that happens. We don't know when, but it could be this year or in three years. But eventually let's assume that, that, that it will disappoint. Is it possible for the rest of the space to do. Well, if Nvidia suffers, like I guess said differently, will in videos. Will in videos like burnout or whatever bring the entire space down with it? Or will money just move to other growth areas?
- [15:26]
Angus Shillington
I mean, that's a great question and I'm trying to sort of think of a sort of simple way to think about. We don't think that Nvidia crashes, right? Let's separate the company from the share price, right? Let's think the company, we think it's on a long term, very sweet growth trajectory. We've probably seen the easy money grows at a slightly different clip and the laws of economics might. My profit is your margin will kick in. So you maybe see gross margins come down as well. That demands a lower multiple. As we were building this thesis, one of the things that I was really interested in was to look at the dispersion of analyst earnings. I think of that as a really interesting way to consider risk. What's the highest to lowest analyst? Because if they're tight, everyone's got a good idea what's going on. If they blow out, no one's got a clue. And we took the lowest sensible analyst in the market. So somebody who was a tech specialist, we took their earnings two years out, they happened to be the lowest sensible analyst in the market. And then we put a multiple based on what that growth implied prorated to where we were now. And that was a share price that was radically lower. Right. So anger was 50% lower at the time. That is probably the kind of thing that will happen. So the Nvidia business will continue to grow really nicely and this is going to be a great year. They've got a great new product coming down the pike. But the question is what's the multiple and are earnings projections too high?
- [16:58]
Michael Batnik
I'm curious how you take these thoughts on a company like this and translate it into portfolio management in terms of positioning sizes in your, in your fund here, I assume there's some sort of semiconductor index that you're following as a baseline. How do you, how do you change the weights of your, your holdings like this? How does that work in terms of tracking an index?
- [17:16]
Angus Shillington
Or, or you want to take that?
- [17:18]
Nick Frost
Yeah, I can take that. And to take a step back maybe one from that, right. To Angus, to the initial question, like Angus has said this really good and we've talked about this on, on previous conversations that him and I have had. If you look at the space as a whole, maybe from an smh, which is more of a broad based semiconductor exposures, you know, if Nvidia starts to, let's say Norma, that's because that's what it is. It's normalization, hyper growth. They were unbelievable. But they're still a good company. They're just not going to grow at the clip that they were at some point. Right. We don't know what. That doesn't mean they're a bad company. There will be a net winner that moves up. Right. And starts to take the place in the portfolio for that. So then to kind of shift to your question, it's like these are passive products, right? These are, these are passively managed. We follow a set of indexes for that from market vector for SMH, that's looking for the 25 largest, most liquid names in the industry. Right. So you're really getting kind of the gold standard in broad semiconductor exposure. And it's a team of winners. Because if you look at the portfolio and look at the top holdings, Nvidia drives tsmc, TSMC is driving asml. Right. And it just kind of moves down the curve and just naturally that's, you know, how the passive product works. So to maybe answer your question, you know, we're not making calls. 20% is the max weight that we allow in SMH and it gets rebalanced on a, on a quarterly basis. So we're going back, it'll. Nvidia obviously over the last couple of years has gone over 20%.
- [18:39]
Michael Batnik
Other than that, besides that 20% threshold, is it basically just market cap weighted?
- [18:43]
Nick Frost
Yes. Correct.
- [18:44]
Michael Batnik
Okay.
- [18:45]
Nick Frost
Yeah. We have liquidity, things like that they have to qualify for just to make sure that the experience for the client is right. But yeah, 20% and then it's market weighted pro rata down from there. There's Rick, diversification rules, things like that, where you can't have so much in the top five stocks, et cetera. So it goes pro rata down from.
- [19:02]
Ben Carlson
Those Angus, you've been in this industry, not to date you but you saw the last cycle. So how does this environment compare and contrast to the last one? I guess looking at the dot com.
- [19:16]
Angus Shillington
Bubble, the players have changed. I think that's the first and biggest point. But also silicon now in terms of what it touches, radically more broad, right? So you had it in PCs and desktops back there, you now have it in literally everything, fridges, cars. So I think the just the application of silicon has changed now. Everything silicon touches can now be optimized by AI. So if you think about the sort of the dot com piece you were sort of retrofitting for the Internet, right and you very sort of early adoption things were super slow. Now you've got like optimized hardware, optimized silicon that now will need to be upgraded over time. So if you think about the last big sort of tech move which was move to the cloud, so companies, you know, enterprises taking servers on premises off premise, so sort of rip and replace into the cloud, we're now moving into another period, kind of not dissimilar where your sort of cloud will move to more general purpose and specialized. So as this moves on, right, so here's the interesting point. Well this is actually it. So this is about data, this is about data ownership, this is about processing unstructured pools of data. So what's different this time around is you're going to get a big build out in infrastructure, networking, that kind of stuff. That's probably not going to be done at the enterprise level, that's going to be done at the CSP colossus level. Then you'll plug into that, draw out the foundational models and then run your data through it through inference. So data is much more important than it was last time around. And the bench that needs to be retrofitted and the opportunity driven out of that is just. So when we talk about Nvidia as potentially flattening out, that's in a nutshell. What we think the problem is is with investment positioning right now, which is it feels like in portfolios Nvidia set up to continue to do what it's doing, right. If you watch or read any transcript from an Nvidia call, Jensen will tell you he believes AI is going to be vast. Right. And I'm sure it is. The question is what percentage of Nvidia play in that and what percentage do the other names play in that. And I think that's when we come to portfolio construction around a, an ETF which is like Diversified exposure. That's what we're thinking about. I invest actively. The risk reward dynamics are a little bit different.
- [21:58]
Ben Carlson
One of the different things about this time versus last time is the end user or the end customer. And it seems like right now the hyperscalers have an unlimited Runway. The market is giving them the benefit of the doubt. And so long as the investing class is going to reward them and give them the benefit of the doubt to keep spending, it seems like there's no slowdown in sight. The big question that people are keep asking is like, all right, well what about the return on these investments? Do you think that that's a 2025 story and do you think that the bar is set too high?
- [22:26]
Angus Shillington
The second one, I don't. It's difficult to say. The first one, these guys have unlimited capital, right. So they're running super high cash flow models, right. So whether it's Amazon or Microsoft, raising too much cash inside your balance sheet makes your return structure less optimal, Right. So you want to draw that cash down. But the environment we've been in and the sort of tax structure of acquisitions and the size of acquisition you have to make for those is just not practical. This is kind of a dream for them, which is like, we can deploy this capital, we can depreciate it over time, right. It doesn't impact our shareholder return. So I think they continue to spend like drunken sailors. There's no question around that. The question is what are they spending on? And what we are seeing now, what we have pretty high conviction in is it is more customized specific solutions rather than the general purpose solution that that is in Nvidia. So there's a diversifying it pretty broadly and you can see that in Google, you can see it in Amazon. And I don't think it just doesn't feel like that's priced in. Last point is this is the most overhead stock. I overheld. Wrong. Let me just say it is. It is the most held stock in portfolio. It appears in products that you would expect it to appear in. The problem there is, especially if it's overvalued. It goes from being the most liquid stock one day to the most illiquid stock the next day. If you get a negative surprise, a trapdoor just opens and there are no buyers. So I think that's sort of where we really want to help our investors. And I think this conversation is super helpful and thank you for having us on to understand that there are other options and you can diversify.
- [24:11]
Michael Batnik
If you look at the top 10 holdings in the NASDAQ 100. If you go back to like pre pandemic. So end of 2019, Nvidia wasn't even the top 10 of the NASDAQ 100. How surprised are you by this run that they've been on? Is this completely shocking or is this just something that you thought like, of course this was going to be one of the biggest companies in the world someday.
- [24:28]
Angus Shillington
Once we saw the first blowout numbers, it was pretty clear because we had this sort of, you had the optic of ChatGPT what that was capable of. It was mind blowing. It became very clear very quickly. So it came from nowhere, no question, but it was pretty clear pretty quickly the scale of this opportunity set. So I don't think it's a. It is a stock with a very high revenue, with a very high gross margin and with a very high multiple. You can put it on a different multiple with slightly lower earnings. And the market cap is not what it is today.
- [25:06]
Ben Carlson
This is part of what makes investing so fun and also so difficult is that you can have this dynamic where these companies are creating the next industrial revolution and perhaps what we're experiencing now is going to be larger than the Internet and all that can come to pass. But you don't know really where you are in terms of the stock market cycle. So it does feel early ish. In fact, it feels like the top of the first inning in terms of like where AI is in my life. I'm not using it very often and there's no doubt that all of that is coming. But then you have the companies that are nearing $4 trillion of market cap. How much of this are we pulling forward? And of course that's, you know. No, you don't know. I don't know. Nobody knows. But billions and trillions of dollars are being placed on that bet. So is it, I guess instead of rambling, I'll ask you a question. Is it too cute to say that we're early in the cycle in terms of AI, but the stock market reflects all of, is discounting all of it. Is that too cute?
- [26:12]
Angus Shillington
I think it sort of, it goes back, I mean that. No, no, it's not, is the answer because I think it draws out the debate that is too much market cap in Nvidia. And I think that's kind of what we're talking about right when we think, I mean, go back to the mental model, the Charlie Munger framework, which worked pretty well for him. You never want to be trying to get off the train right at the last Station, that's a disaster. You get stampeded and you want to be getting off the train before you get there. This AI thematic opportunity looks limitless now. I don't want to put a number on it, but it looks limitless right now. Just the applications and diversity. I think you've just got to be really careful how you access it. And when I think about investing, I have a very simple philosophy. We sort of share it somewhat at Vaneck, which is, look, you get a group of companies you think are going to succeed around a theme or a country or whatever, put them over there, right? You make sure you don't have any of the losers and if any of them start to lose, get rid of them. Right? Because it's the drag factor at the bottom of portfolio that really starts to hurt you. So if we put the sort of AI opportunity through that framework, it felt to us like Nvidia would become a drag. And to some extent it already has started.
- [27:38]
Michael Batnik
Nick, I'm curious from your end, if advisors are using this fund to as a piece of their portfolio, how are they looking at a thematic fund like this that's going to be more high octane, I'm guessing, to the upside and the downside. How do, how do they look at this as a carve out in a portfolio management process?
- [27:54]
Angus Shillington
Ben, can I just set that up for Nick and then I'll set it to you. So we've had SMH forever. It's $25 billion. It's this sort of, as Nick said, it's the winners on the winners on the winners. We launched an adjacency called SMH X, which I got to say was not my idea. Right. I had a different idea. It was Nick and his team's idea in origination. The idea was that you would go for fabless semiconductors, which is effectively what Nvidia is. And that is the one I think we feel like is really most interesting. Now, sorry for Nick, is SMH X.
- [28:25]
Ben Carlson
Is that effectively SMH X? Nvidia?
- [28:28]
Nick Frost
No, the opposite. So it's X. So a fabless semiconductor company is going to be the ones like Nvidia, Right. The ones that are designing and selling the chips, but they're not manufacturing anything. Right. So Nvidia outsources all their manufacturing to tsmc. We're looking for essentially the next Nvidia inside of smh. Right. While still including Nvidia. Right. Because it's the same thing where it's a passive product. We're looking for the 22 largest, most liquid, fabless Companies defined by the indexing company, which are going to be companies that are outsourcing all manufacturing, right? So when we look at the space as a whole, in back to, you know, the initial point of, you know, why did we see Nvidia coming? I don't think anybody saw Nvidia coming, but I think the business model of Nvidia, that Fabless business model, allowed for it to happen because they have such higher margins, lower capital expenditure. It allows them to be more innovative, it allows them to invest more in R and D. They were a gaming GPU company for the longest time, right? Like nobody even thought of them outside of that AMD the same thing. So now you've got this company that was able to pivot on a dime, I will say on a dime, right, for the layman, right. But and see the opportunity ahead and scale this business to be one of the largest businesses in history, all because of their business model. And that's kind of. That was the underlying thesis of Fabless semiconductors. SMH is great, you know, largely again the gold standard in semiconductor companies though. All of the winners in the broad space. If you want to look at the AI revolution and you want to say, hey Listen, Nvidia owned 100% of market share for this first inning, right? If you're looking at it on a, you know, a nine inning basis, who knows where we're really at. But they've won 100% of the market share that they have to lose some. Even if they're still a great company, other competitors are going to come in and take some of that market share or just be the next iteration of it, like Broadcom, right? And their Asics chips. The fact that, you know, GPUs are the foundation now, these hyperscalers. And then down the line, when you have other enterprise companies that are building these, they need the Broadcoms of the world, they need the arms of the world, they need these other fabless manufacturers to keep pushing the AI narrative forward. And that's really what our thesis is. Looking at it that way, the way.
- [30:42]
Angus Shillington
We think about it and joke about it internally is that the SMH is the heavy balance sheet stuff, the SMLs, the TSMCs, a lot of equipment stuff and the innovators in these super flexible business models, the guys in the garage are SMHX kind of thing. But when you could walk into one of these businesses, it's crazy if you're only designing software and then Nvidia is a great idea. Everybody gets very rich very quickly, right? If you have heavy balance sheet pieces on that. You're stuck with depreciation and horrible capex where the profits are not there for distribution. So you tend to find in the fabulous business models the best engineers will gravitate there because the optionality is considerable.
- [31:27]
Ben Carlson
What if the next Nvidia isn't publicly traded? We haven't even spoken about OpenAI or Core Weave or XAI or any of these other companies. Is that, do we have enough publicly traded companies to make money?
- [31:38]
Nick Frost
Well, I mean, SMHX, we did that to lower it to 22. We worked with the indexer to make sure that the environment was big enough.
- [31:44]
Ben Carlson
From a lower to 22. What?
- [31:46]
Nick Frost
22 names. Okay, 22. Yes, 22 constituents. So SMH is 25, SMHX is 22. I think if, all things considered, if we stayed the same as we are now, you might run into that. But I think we don't even know what's going to. You've got grok, right? Not AI grok or not X's grok, but the, the chip grok that is going to be specific to AI solutions. Right? That's just one example. There's going to be, I think, a lot of newcomers to the space. At what point do they go public? I don't, I'm not an expert on IPOs, obviously we haven't had as many of them lately. That could be an issue. But I think if the market is right and there is, you know, the AI evolution continues, I don't foresee that being an issue. But when we work with the indexer, we really try to make sure that we pick a number of constituents to make, you know, to make it feasible for the long term. Right, because we're launching long term products here. We're not trying to, to catch fads. So we want to make sure that there's enough, enough constituents out there that the market share is big enough that the, the liquidity is there, et cetera, et cetera.
- [32:49]
Ben Carlson
But can there be another? Like, doesn't, doesn't it cost so much money to run these companies? Like, aren't these very capital intensive? Just like financial capital?
- [33:00]
Angus Shillington
So when you think about tsmc, right, what did TSMC do? I mean, bananas, they achieved global domination in making other people's chips.
- [33:08]
Michael Batnik
Right.
- [33:08]
Angus Shillington
And how did they do that? They did it with exceptional customer service. They did it with insane execution. They had some tax help, they're in Taiwan, there's an ecosystem and they've beaten everyone, right? They've literally beaten everybody. Okay, so. But they still have to Continue to invest. So heavy, heavy balance sheets. But they have a right because they have leadership and you just can't compete with them. They have a right to a 50% gross margin, right? So sort of slightly talks to Michael, your question just now, which is like, are there enough companies now? If the company has a moat and a leadership, especially a tech leadership, they can catch inflections, difficult to see how they're going to get xed out, right. There's a question I had in my mind about asml. Intel's a hellscape. But as sort of Nick said, you want to be in a sort of portfolio of the winners, right? And the ones that have win, you understand why they won, you understand how to value them. So that when. And this is sort of the smh, the SMH piece, which is if for some reason, for example, ASML no longer has this sort of tech leadership, one of the other large companies in that portfolio probably will, right? So it's sort of six or one, half a dozen, the other they trade off against each other. So if you put that to one side and then think about the other piece, which is this innovative, fabulous piece, you don't need any capital. I mean, you need very, very little capital. You can be VC funded, right? The piece that gets difficult is how you fund working capital to go into mass production. That's where you need, you probably need to be public. So there is no end to what can be done at the sort of more granular level. And that's sort of what we're starting to see now. And that was, as I said, what the Broadcom numbers kind of told us.
- [34:56]
Michael Batnik
I suppose intel is a good example of why you eventually try to look for those other winners, right? Because not saying Nvidia is going to become intel, but how many people would have thought intel was going to end up with this fate 15, 20 years ago?
- [35:08]
Angus Shillington
It was sort of. It's been pretty obvious for a while. Intel is a disaster area. Right. So there was an inflection point. So Pat Gelsinger was one of the early guys. They had that sort of dissisk conversation.
- [35:20]
Michael Batnik
So was only. Sorry it was only the paranoid survive. Was that like the, the end of them? Basically, like they had all these great sayings and books and like all this stuff like look at what we did and.
- [35:29]
Angus Shillington
Right. But they missed their culture, allowed them, gave them permission to miss mobile. I mean, I swear to God they had, you know, their, their x86 no longer has a moat. X86 is the, basically the arm. It's the sort of operating piece on top of of of CPUs. Right? And they thought that would go on forever and it didn't. Right. So then they sort of tried to play optimization. So profits went up, but the business just declined and degraded. Then they get Pat back in and he sells the board on this idea. And the only guy and he had an idea. And I swear to God, Nick and I were on the record on a video like a month ago saying there is a narrow path forward for intel, right? They got to do what we think they're going to do. They got to burn the ships and then they fired the only guy who could do it. But what comes next is could. It's potentially crazy.
- [36:19]
Ben Carlson
Do you think there's any value in intel if you're so courageous and bold, or is it just an absolute avoid?
- [36:28]
Angus Shillington
Yeah.
- [36:28]
Ben Carlson
In the stock. You probably don't want to be searching for value in these names, but no. Okay, all right.
- [36:34]
Angus Shillington
I mean, if you put it in the sort of unicorn space, I mean, here's what I think is going to happen to Intel. All right? So the board fire Pat, right? Which is a, whatever. He's a technology guy and he's got his faults, but he's the only guy he could execute, right? And the executing means build the foundry business. And they have some really cool technology and they potentially have some technology inflections specifically that could knock out asml, right? And that's sort of one of the issues that's going with ASML right now. They got two lines, they got backside power, they got, you know, all around gates. These are great technologies that Pat elevated, right? So they got a shot, but without him, you can't do it. So what happens next? So the board then goes, pat, you're done. They also say, products x86 is our focus. X86 has got nothing. Right? Literally, it's got nothing. Right? So the board just struck out twice.
- [37:27]
Ben Carlson
Is it impossible for them to be acquired? The enterprise value is $120 billion.
- [37:31]
Angus Shillington
That's where I'm going. Hold on. So, right. Who is this important to? Right? Because this was existential for Pat. It was existential for intel, but you got to remember it was existential for the United States of America, right? If you think about, right, risk man, but 101 risk management, right? Right now you've got everything in Taiwan at tsmc. You've got the Taiwanese government saying to tsmc, you're not moving, right. The leading edge stuff to Arizona. You can make like, you know, speaking parts for like electric dogs. But you're not making the cutting edge stuff, right? We want, we want this here, right. So they're proactively keeping it onshore. So if you're Apple or Nvidia, you're there, right. You would love a second source, right. And put this into context. So in 2021, right. According to the Department of Commerce, I think the chip shortage post pandemic cost the United States minus 1% of GDP huge number. But that stuff was very low end. That was like fridges and cars and all that kind of stuff. Think about it, that's like a ten foot swell. Think about the tsunami if you lose Taiwan. Now I'm not saying it's going to happen. I think it's very, very unlikely. But if you're on the board of Apple or you're on the board of the United States of America and your military chips are all being made out of there, you don't want that to happen under any circumstances and you don't want to react after it has happened. You've got to fire up that intel foundry. So I am a huge believer in the sort of Manhattan Project outcome for intel, which that thing gets taken in house and if you think about how that fits into the incoming administration's sort.
- [39:18]
Ben Carlson
Of philosophy, right, the treasury is going to buy Intel.
- [39:22]
Angus Shillington
I don't know where it would end up and I can't. I'm not. You listen to me, I'm Irish, I can't vote. Right. I haven't spent any time studying it. But I do know that this fits very neatly into maga. It fits very neatly into national security, it fits very neatly into innovation, AI, everything. You know, if you, if you took the foundry inside, right, and, and you didn't give it to like a elected representative, you give it to Elon or, or David Sachs and say, build this into a Manhattan Project, I think you've got something super interesting. Now I don't think minorities ever get to participate in that. So what's the takeout value? I don't know. But that is a really, this is existential for the US they cannot not have a leading edge manufacturer of semiconductors. So I think about intel as a pair, a risk pair with tsmc, which we have a pretty sizable position in. All right. Yeah. And that to me is always the risk to TSMC that I'm sort of thinking about in that mind map. There needs to be a second producer and right now there isn't.
- [40:32]
Ben Carlson
I guess. Last question for me before I let you get out of here. I'm asking this Selfishly, because I own the stock. Google is on fire. Over the last five trading days, there's been news coming out of there. What's the story? Is this getting rerated higher as a potential serious player in AI?
- [40:48]
Angus Shillington
I'm a tech hardware guy, so.
- [40:50]
Ben Carlson
Got it. Okay. One guy.
- [40:52]
Angus Shillington
I'm a Sammy's guy, so I gotta dodge that one. But I think it's being unbundled and that's unlocked. It looks pretty interesting.
- [40:59]
Ben Carlson
Well, they did raise their YouTube TV price by $10 a month, so maybe that's it.
- [41:03]
Angus Shillington
I mean, they've got crazy moats. And again, this is sort of what we're talking about is like if you get a portfolio of like semiconductor hardware companies and you build moats around them and that you can't compete with them and you're just compounding these huge margins, return on capital, employed. And you also own the sort of the innovators, you've kind of got it buttoned up to the extent you probably don't need to take the Nvidia risk. That's sort of where we're coming from.
- [41:29]
Ben Carlson
Okay. Bold. I like it. Gentlemen, really appreciate the time. Thank you for coming on.
- [41:34]
Nick Frost
Yeah, no problem. Thanks for having us.
- [41:38]
Michael Batnik
Okay, thank you to Nick and Angus. Remember, check out vaneck.com to learn more about SMH and SMH. Email us animalspiritscompoundnews.com See you next time.