Andrew Freedman - TMT Talk!
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Bill: This episode features Andrew Freedman. My informal endorsement of Andrew is he has been a heck of a guy to get to interact with. We've done some Twitter Spaces together with the Twitter CFO, Ned Segal. Andrews got a ton of hustle and a newborn baby at home. In short, he's exactly the kind of person that I'm looking to help promote himself. Not just that, I think he drops a lot of educational knowledge. So, hopefully this podcast is a win-win-win for everyone involved. The formal sales pitch for Andrew is he runs a business within Hedgeye, which is an independent investment research firm covering 10 fundamental and industry sectors, macroeconomics and policy. Andrew is a managing director there. He is the Communication Sector Head at Hedgeye. He also holds Senior Analyst responsibilities on the Healthcare Team, where he specializes in information technology.
This is a fun telecom tech and media discussion. I hope you enjoy, I hope it's educational in case you need to hear it. As always, none of this is financial advice. All of the information contained in this program is for entertainment purposes only. Please consult your financial advisor before making investment decisions and do your own due diligence. Happy to be joined by Andrew Freedman today of Hedgeye fame. Andrew, how you doing, man?
Andrew: Doing well. Thanks for having me on.
Bill: Thanks for coming on. Benefit of doing the pod is I get to ask people, like yourself to send me information that they want me to look at, and you sent me some examples of what you do for Hedgeye, and I got to admit, man, I think that that is a heck of a product.
Andrew: Thanks. I appreciate it. A lot of work goes into it. So, I appreciate that feedback.
Bill: I'm pretty proud of the podcast and then I'm looking at your TV production that you guys have over there. I'm looking at a couple expert interviews of you interviewing experts. You've got the Hedgeye TV behind, like symbol on it.
Andrew: Yeah.
Bill: It looks very professional. I got to step my game up.
Andrew: Yeah. Hedgeye has been around for over a decade. I've been here for eight years. A big part of it early on was democratizing research and creating this mass market media business on top of the core institutional research business. Keith and the management team at Hedgeye invested heavily pretty early on, and building out that studio infrastructure, and making a push to video. It took a long time to gain traction. But I think as with many digital media type businesses, the last 18 months have been transformational in that respect. A lot of those investments have really paid off in a world where we're not really interfacing in real life that often, and the studio has been a great asset, and it's something that-- We do all of our research reports through it, we host to your point, speaker calls on it. It's a great asset to have. It's a great way to communicate with people and drive engagement.
Bill: I have never talked to Keith. Keith, if you listen to this, first of all, thank you for being in my corner in the Robinhood debacle. I appreciate you for that. But I've always listened to Keith talk, and I know he's got his quadrant things, and I'm always like, "This dude is either real smart or selling some stuff that's disprovable," and I didn't know which, but then you and I were talking, and you're like, "The quadrant stuff really works." It's been interesting to get to know you and interesting to talk to you a little bit about it. I think the way that Keith goes about selling his business is understandable to me. When I got to see behind the scenes of it, I was actually quite impressed.
The other thing that I didn't know is I didn't know that-- and this may be stupid, but I just didn't know it. I always thought of Hedgeye is a macro firm just because of all the quadrant talk. But the information that you do is obviously very sector specific. But the video of the expert call, I was like, "Wow, I had no idea that Hedgeye offers this kind of thing."
Andrew: Yeah. We were founded as a macro research shop and still quarter what we do is the macro, but we have over 10 different verticals, all the different sectors, tech, industrials, finance. Keith leads the macro research team. Yeah, not everybody does macro and that's okay. It's not for everybody. A lot of us are born and trained as fundamental research analysts. I was CFA, went to finance, economics major and undergrad, I understand that. But there're elements within the macro process that I think to be really additive, when it comes to idea generation on the fundamental side.
The quads, they work so well and you can hate it all you want, or you can be skeptical all you want, man. But I've got to tell you, time and time again, the growth and inflation and policy model that they've developed, and the way that they analyze macroeconomic conditions, and rates have changed within the economy, it works and it helps calling different kind of environments in a world that's increasingly factor driven and flows driven, where sometimes things go up for reasons that make fundamentalists scratch their head and go down.
But if you understand the macro, you can be like, "All right, well, growth inflation is slowing, so beta is going to get hit." It's risk off and I'm oversimplifying it. But that's the concept and if you can navigate the quadrants effectively, then from a portfolio perspective, and that's how I communicate the ideas in my space on the position monitor, I think you can increase your hit rate, be right more than you're wrong, and help time your positions, because you know how these stocks are going to perform on a back testing basis with a pretty high degree of accuracy.
Then on the fundamental side, we've been bolting on the sectors for some time. Like I said, I've been here for eight years. I started off in the healthcare sector, cutting my teeth in the healthcare T space, and then have the opportunity several years ago to take over the comm space, which I did a land grab and called it everything internet, media, cable, telecom, which is-- [crosstalk]
Bill: Good for you.
Andrew: Yeah. So, that's been a lot of fun. Yeah, it's a fundamental research process. We do a lot of comm expert interviews, what everyone call it. Expert is a dirty word these days, but you get the point.
Bill: No. You are having interviews with people that actually know something. For instance, the one that you sent me was a discussion about television manufacturers and how that fits within Roku's- [crosstalk]
Andrew: TV supplies.
Bill: -distribution strategy and that's a quality of discussion that is not just out there and I can tell how you're adding value through having it.
Andrew: Yeah, no, and I do appreciate that. Part of its process driven, a lot of people have access to these platforms like-- [crosstalk]
Bill: They'll be careful, one sponsors me now.
Andrew: They're Stream by Mosaic, right?
Bill: Yeah.
Andrew: So, there is that one, I won't mention the other one for that reason. But the point is--
Bill: It's all right. They know about Tegus, Stream does about Tegus. We are complementary products over here. I got love for Tegus too. They just don't give me stuff.
Andrew: Yes. Those have been great but I think building your own network is really helpful because the reality is that, I have a pretty good understanding of fundamentals and how to make stock calls. I also know a lot about the industry but there's a lot that I don't know. So, I'm always trying to learn and so being able to speak to somebody who's an operator or whose knowledge base is just far more deeper than I could ever get. It can be really additive, and just connecting the dots, and helping out model these companies in the future, and understanding how they're trending in the shorter term.
Bill: Are you comfortable giving people a high-level overview of the quads or should I just refer them to a Keith podcast?
Andrew: No, I can do that. I think it's up to you. Keith would probably be happy to come on the pod if you [crosstalk] have him on.
Bill: Yeah. Someday, I may have him.
Andrew: Yeah, I am happy to.
Bill: Just so people know what we're talking about because not everybody nerds out on podcasts and finance stuff all day.
Andrew: Sure.
Bill: They're probably like, "What are these quads these guys are talking about?"
Andrew: I think I'll address this, it's a four-quadrant model, within each quadrant it's based off of growth and the way growth and inflation is trending. Within quad one, you have growth accelerating and inflation decelerating just like the best macro regime to be in, because you're creating real value in the economy. Quad 2 is growth accelerating and inflation accelerating which is what we were in coming out of the pandemic going into the first half of last year. That's an environment that we haven't historically been in the last decade or so because it's been slower growth. We have this whole reflation trade is probably the best way to describe it.
In that environment, most everything goes up except for Telecom, but high beta, high short interest stocks do really well. Legacy media companies that have been left for dead. See their businesses reaccelerate in that environment, inflation's positive.
Bill: Why is that, does advertising comes back to them?
Andrew: Yep, advertising comes back. It's also an environment that the deep value typically works. I think we saw that play out pretty well. So, if you're able to make quad 2 call, which they did in November of last year-- 2022, now. In November of 2020, going into the first half of 2021-- [crosstalk]
Bill: Huh, that was a good time to make that call.
Andrew: Yeah. It worked really well. I was sitting there from a fundamental standpoint and thinking things were just going bonkers. So, I'd started making short calls because I thought that they would-- probably growth will start to slow down a little bit and valuations got a little wonky. But if you were able to make long calls like our retail analysts made a great call on GameStop at alongside, and you could disagree with him all you want, but he made that the end of 2020 going into 2021 and you got paid. Then quad 3-- [crosstalk]
Bill: Now, did he have short squeeze type stuff going on in his call or did he just say, I kind of like it as a reopening play and its deep value?
Andrew: Yeah. There was a fundamental reason behind it. It was really cheap, cheap for a reason. But short interest is definitely a part of it. Because the quads can tell you what kind of style factors are going to work. In quad 2, you want to be long, high, short interest. So in that sense-- [crosstalk]
Bill: That actually makes sense to me.
Andrew: Yep. And then quad 4, you want to be high, short interest. You want to be short leverage, high debt companies, the shitcos, the ones with the weaker operators because they go down a lot. So, that's ripped off--
Bill: Dude, you know what's crazy? Let me fork this real quick.
Andrew: Yeah.
Bill: Something that in my head right now is, I know that everybody's focused on inflation and I realized that there's supply chain stuff. But the idea of hiding in some of these crappier businesses, because they're at lower multiples right now as commodities, specifically, I'm not saying it can't work, but man, do I think people need to have very specific and detailed knowledge about the asset. It's just that scares me.
Andrew: Yeah. I can't speak to like, I'm very sector focused, right?
Bill: Yeah.
Andrew: I can't really speak to other industries. But the concept of cyclicals looking really expensive and really cheap at the wrong times is pretty classic. Yeah, everyone's obsessed with commodity inflation. We had a pretty successful long commodities call at the firm, really successful at work. Now, we have a peak inflation call. So, things were starting to slow down.
Bill: Oh, did you guys call that?
Andrew: Yeah. They've made that call and for the peak starting last quarter-- [crosstalk]
Bill: Interesting.
Andrew: Yeah, and making the added consensus call, but be long-- [crosstalk]
Bill: That's what my gut says, too. I think people are too worried about inflation. But things that are found to look wrong in retrospect, but I don't know. It just feels like it's top of mine. The other thing is everyone's dunking on growth right now and that just doesn't feel like it's going to see some well.
Andrew: It doesn't feel right. Yeah, no, it will turn. There'll be a turn. But it's been an interesting environment and to say that it was a bubble, it was a bubble, right? Unprecedent monetary policy, unprecedent fiscal stimulus, everybody staying at home, people trying to wreck, like, tell themselves a narrative and justify the valuations that they're seeing in some of these smaller cap mid tech growth companies that were profitless, digital transformation, all these things. But if it smells like a bubble and it looks like a bubble, chances are it is a bubble. All the trading dynamics that we saw over the last 12 to 18 months all support that. You can study every single bubble or mania going back to the dawn of time, and sometimes they look a little different, but a lot of times they look the same.
There are companies that are better companies post-pandemic than pre-pandemic for sure. They're good businesses. But I think the issue is that a lot of good businesses were out there masquerading as great companies and getting valuations that they didn't deserve, and there were a lot of crappy businesses that were obviously crappy getting bid up to multiples that they didn't deserve. So, it's easier to identify the crappier companies, it's hard to identify the good companies that are masquerading as great companies. That's where industry level knowledge comes into play because then you can really create a lot of value on long side or short side, in this case the short side.
But yeah, man, I think it's liquidity is drying up, growth is going to slow, recomping stimulus, and that's been the reason why I'm so negative at least in the digital advertising space last year with Pinterest and Snapchat on the short side, because it just was obvious that things were going to fall out of bed. We haven't been perfect. Twitter has been an absolute disaster for us. I feel less bad about it because the way that we communicate ideas is through a long-short framework, and we have a position monitor. So, I can't just say like, would the right call have been, say, short everything? Sure. But in reality, if you're running long short, you can't just be 100% short everything. So, trying to balance relative calls with my outlook and say, look, short Pinterest, stay long Twitter, be long Facebook, or Google, and short Pinterest and Snapchat against that to hedge yourself. But I think that the industry outlook is pretty dire and that multiples are going to come down because estimates are too high and revenue growth is going to slow, and that's not going to be good for anybody. So, then how do you play that, right?
Bill: Yeah.
Andrew: That's kind of the game that I'm trying to figure out and help people out with.
Bill: Yeah, that makes sense. Now, I want to talk a little bit about you because I was unaware when we spoke earlier. You are affiliated with Hedgeye, but you actually run your own research siloed business within there, right?
Andrew: Yeah.
Bill: It's your little baby, yeah?
Andrew: Yeah, absolutely. I don't work as hard as I do. Maybe I would, if it wasn't that way. But it's definitely a situation of what I put into it, I get out of it. The way that Hedgeye is structured and it's a revenue share model. Maybe it's like use an analogy. I know you're familiar with Formula 1, but I think it's works. Probably many of your listeners are familiar with it. You have Formula 1, which is the league, it's the brands, it's the overarching component and within that you have different teams, 10 teams, two drivers. Then within that, each team is part of Formula 1, they're all incentivized economically to move the sport forward because there's that revenue share component that's paid back as part of it. Those cash team payments are 60% to 70% of EBITDA. That's a framework to think about.
But if the sport becomes more competitive, they grow their audience, they get more sponsorships, it all flows through better economics to the sport and the team. All the teams agreed to a governing document for how things are operating. In that sense, Hedgeye is somewhat similar. All the individual sectors and sector heads are like the teams. Each sector head, I'm not going to can call myself a Formula 1 driver, but you get the point, right? I'm operating that business. We sell research subscriptions. Hard dollars-- mostly get paid through hard dollars. There is a CSA component we get paid off of trading commissions but really the bread and butters subscriptions. We don't do banking, we don't do trading. [crosstalk]
Bill: What's the CSA component?
Andrew: If a large mutual fund complex generates dollars through trading activities, right?
Bill: Yeah.
Andrew: There's a pool of money that becomes available, and they vote on it, it gets allocated, or if there's some firm that is generating some type of credits or commission pools through trading activity, then that becomes available to pay for other third parties. It's not purely hard dollars in the sense, but it's pretty close. But either way, we don't have a trading desk, we don't do bank. We don't get paid, we don't have asset management or AUM to back ourselves up on, which is why I care so much about the quality of work that we do, and maybe we come off as being a little combative sometimes in our calls because at the end of the day, people are paying us to be right for the right reasons. If you're managing money, you can be wrong and still make money. You can be long beta or you could get lucky and still get make money.
If I'm wrong on the thesis but the stock price works, then I'm just lucky. Then therefore, from a research perspective, you're not going to really pay me to add value. It really becomes more alpha oriented. Then I guess the only other thing I'd say, just going back to the Hedgeye structure and the business, yeah, whatever revenue I bring in, I pay a percentage back to Hedgeye. In return to that I get access to a sales team infrastructure. The media, the production studio, and then everything after that goes to pay myself whoever works for me, research and data expenses. So, there's definitely a gross to net component here that I'm sure many of you are familiar with.
I have a P&L to manage, a business to grow, expectations of me managing a business within a business, and then figuring out how to maintain that and grow it because there are only so many seats. There're only so many sectors and my spaces. There's a lot of smart people competing in my space. If I were to just stop working or not do well, then that increases the probability that puts my seat at risk or I don't get paid, because my revenues will suffer, and my costs will go up, and I'll have no P&L. In that case, either scenario isn't good. Sometimes, you have people that you want to switch teams internally, go work for another team because it doesn't work out, or maybe choose an entirely different sport altogether, that certainly happens. You have different types of people on the analyst side, you have rockstar young guns, you've more better wily veterans, all through different style and process. But at the end of the day, we all do work together. It's a competitive place but there's a high loyalty of trust amongst each other. I do consider everyone I work with teammates and we do have our best interests in mind.
If we do have a setback or you stumble, they'll be there to support you. They're not going to show you the door. A lot of that comes from the top down in the way Keith manages the organization. Keith is hockey coach. He's competitive but he also understands what it takes to coach a successful team, and that filters through the rest of the organization. It's not for everybody but I personally wouldn't want to be anywhere else. I feel very fortunate, like, the support and autonomy that I was given as a young analyst, basically, no sell side equity research experience, just hunger, and passion, and drive, and then having that being able to run with that, and giving this type of responsibility and promoting early, I've been very happy with and I think it's worked out for Hedgeye too, and it's also worked out for other analysts within the firm, too. Hedgeye has a history of that. It's been a really fun ride and it continues to be a great ride that we're on. But that's how we're structured, which is why, I take so much pride in my work and maybe get sometimes defensive on it, because-- [crosstalk]
Bill: Well, who doesn't get defensive about their work?
Andrew: Yeah.
Bill: Anyone that doesn't get defensive, doesn't care enough in my humble opinion.
Andrew: Yeah. But anyway, that's how we operate in a nutshell.
Bill: Let's talk Twitter, if you don't mind.
Andrew: Sure. No, God.
Bill: Part of why I enjoy having conversations rather than just being on Twitter is, I can contextualize how you saw being long Twitter. What about Snapchat versus Twitter competitively? Were you saying, "Okay, I don't like where Snap is over the next 12 months versus where Twitter is and "Why was Twitter of all the assets to remain long? I know why I like the story. I'm just curious to hear you articulate, like, what you saw between those two?
Andrew: Sure. It's performance advertising, it's the Holy Grail, it's the fastest part of the market. When you look at Snapchat going back to the fall, it wasn't necessarily that I thought that the business was a bad business relative to Twitter. It was just that I thought expectations were way too high, consensus estimates were way too high based on my industry modeling. I thought that it just had the biggest potential for downside negative surprise and the valuation to come in. Along the same lines, if you look at some of the drivers of the business for Snapchat and Pinterest over the last 12 months, a lot of it's been driven by the boost of engagement and coming out of the pandemic, a lot of share gains. Going into the back half of 2020 until 2021, Snapchat and Pinterest were the shiny objects because you had the Facebook boycott, and the big spike in engagement.
They sold a really good story to agencies, and they took a lot of shares, and then it just became a situation of, "Well, you're coming up against difficult comps, you're no longer the shiny object." TikTok is starting to monetize. You're losing share of engagement, and we also have these data privacy issues that are coming down the pike because you're a smaller scale platform, you're probably not going to be able to manage that as well. You put it all together and you come to the conclusion that this isn't sustainable. So, from a multiple perspective, probably had further to fall and estimates had further to fall compared to Twitter.
Then from the Twitter perspective, it's always been a case of, and this has been the thesis for a while, and it still hasn't really proven itself out. But can you turn it around. There's more idiosyncratic event driven type ways to think about Twitter that make it a little bit more attractive if you're interested in that type of a call. But to say that, they're still exposed to brand advertising mostly, which I thought last year would have been a good thing because brand advertising got hit so hard in 2020 that I thought that they would outperform. Well, peers and I think it will show that occurring in Q4 results in Q1 guidance, but it still hasn't translated to any type of multiple expansion, and they've just gotten and taken down with the rest of the group because it's really just a relative play.
From here, Twitter's just all about, can they get direct response advertising off the ground, can become more shoppable? It's a really competitive industry. I do have structural concerns about it whether or not the platform is just conducive to that.
Bill: What do you mean? Sorry.
Andrew: Yeah, no worries. Yeah, Instagram's inherently shoppable, Pinterest is inherently shoppable, there's a high degree of commercial intent. The use case is a little bit more conducive to shopping and conversion. Twitter is not really a content native platform in the sense that you're feeding people ads and you're shopping or you would on Pinterest. The ad loads a little bit higher and the nature of the discourse on Twitter is much different in that people are looking there to engage in conversation. Its more event based. So, the engagement trends that Twitter sees relative to others, it's more episodic, and non-trending. In that case, if you're trying to attract always on performance at dollars, it makes it a much tougher sell to do because you basically have to time your flights more in line with these major events. [crosstalk]
Bill: Huh. So, I like to sell football pads or maybe Budweiser is a better example. During the Super Bowl, I'm going to have some, I don’t know or golfclubs are probably more concrete. During the Masters buy PING golfclubs here, whatever. But once the Masters is over, I need to find the next event, and my salespeople need to find the next appropriate DR campaign to run next to that event. Is that what you are saying?
Andrew: Yeah. No, that's fair. Historically, though, that's always been brand advertising, right?
Bill: Yeah.
Andrew: That's rebroadcasting content, generating buzz around the event, whether it's the Olympics, or the Masters, or the NFL, Super Bowl-- [crosstalk]
Bill: But I'm saying a click that then leads you direct to commerce because when Bubba Watson won the Masters, I bought those PING clubs. I'm just trying to think if those are the types of DR, you almost need to get it while it's live.
Andrew: Yep, and that's the opportunity. Then what Twitter needs to do is they need to lean more heavily into that click but you need to have the reporting and measurement in order to be able to measure that conversion. The issue is that, Twitter's ad tech historically hasn't been that great. A lot of advertisers don't have the pixel installed or the capabilities to accurately measure that type of conversion event. I still think a lot of low hanging fruit. But to really, really get a lot of SMBs on platform and to really grow their share of advertisers beyond just the large ones and to become a truly direct response platform, they need to be able to keep people using the platform that it's not that our daily users that are not just coming on, because there's a conversation going on around the Masters or because there's some type of event. They want to be able to feed you that ad every single day and know that you're seeing it because it increases your probability of conversion and then it helps retargeting and the list goes on and on. That's the opportunity and the risk and whether or not-- [crosstalk]
Bill: Sorry, but this is why-
Andrew: No, it’s okay.
Bill: -I think they skew. If you look at ad loads, at least for me and I know Compound248 has sampled this, too, he's got a more statistical approach than mine. But it's crypto and sports gambling. It makes sense, because every single day the markets open or at least maybe it's 24/7 with crypto, you can get the Webull clicked to install this right now, where-- [crosstalk]
Andrew: And think about most engaged demographic on Twitter. It's a perfect fit.
Bill: It makes me nervous for them a little bit because if this is a crypto bubble, how does that hit the P&L--? [crosstalk]
Andrew: You've heard Ned last in Q1 last year throwing out little data nuggets about how much crypto has been boosting everything when things are going through the roof with all these wallet services. Then likewise, going into the Super Bowl, sorry, the NFL season start, you had all the sports book launches as well. Yeah, ad load is higher. They're trying to experiment with ways to drive engagement whether it's through carousel ads that drive higher clicks per ad. Now, they're starting to experiment with advertisements within comments. That all is immediately creative. The question becomes just whether or not it turns off users ultimately. So, it's always a delicate balance between the two, but Twitter has been very difficult to love.
The reality is that if you're looking for a business at scale that has much better ad tech data, incremental margins cash flow, it's never going to be Facebook, it's never going to be Google. That's always the argument. But it's the same debate that-- investors are having the same debate that advertising agencies are having. If I have a $100, where do I allocate that in digital? It's the same thing. It's mostly Facebook and Google because they work, right?
Bill: Yeah.
Andrew: And that translates directly to fundamentals. Until you believe that either Twitter can grow its share of engagement or really improve its targeting and ad tech, it's going to be harder for them to really significantly grow their share of digital advertising dollars, whereas going forward, now, historically, they've lost share. Just not losing share anymore in turn and maybe gaining 10 basis points a year is going to be positive and creative. But then the question becomes, well, now estimates have come all the way up to the long-term targets, and so how much upside is there, and then the industry is slowing down. It just becomes a very precarious set up for somebody that is long and strong Twitter, but even though, it impacts the industry broadly.
Bill: Yeah, it's an interesting asset, especially since there's a lot of combative discussion. I would think as a brand putting yourself right in the middle of combative discussion is not ideal. That said, that's what that business does best is brand advertising. So, it's just an interesting observation more than anything.
Andrew: Yeah. Well, look, those brands cut bait when the discourse on Twitter becomes really negative.
Bill: Yeah.
Andrew: They won't be there during the capital riots and what happened post-COVID in the summer. George Floyd, they just stopped spending on Twitter, because they just don't want their brand around that.
Bill: Yeah.
Andrew: You're spot on there. That's why, last year in the summer was so good because we're reopening, people were seeing each other in person, and a lot of good vibes were going around. So, it's a good time to be brand advertiser and get in front of people.
Bill: Yeah. Nice to have two and a half good months sandwiched in 18 months of shit.
Andrew: Yeah.
Bill: [laughs]
Andrew: Seriously.
Bill: At least from a life perspective. Did you see the Alicia Keys ad that she ran in the Spaces that she did?
Andrew: I did. I saw it, I didn't really dig into it too much.
Bill: It was interesting.
Andrew: I know it got a lot of traction, a lot of views.
Bill: It was interesting, man. If you opened up the ad, and this I think was a problem because you did have to click on the ad. But once you clicked on the ad, you could preview the song. It was like a partnership with Spotify. Then she did a Space with Jay-Z, where they discussed the album and she ranked her albums, and the Jigga man ranked his, and they talked about music and stuff like that.
Andrew: Yep.
Bill: That's a pretty cool example of the dream of how the platform could work.
Andrew: For sure.
Bill: But one off examples are insufficient at this stage.
Andrew: Yeah, you need to scale it. That's been the issue, the execution counterpoint. Super follows great. It's not rolled out to scale. How well does that really monetize their benefit? I think they're doing the right thing and that they have to iterate faster experiment, get feedback, AB test, the whole nine yards. That's the name of the game. I think Spaces, and podcasting, and integration with Spotify potentially is very interesting. If you can expand audio formats, build out the ad network, the opportunity is real. They just need to get after it at some type of scale and take a big swing. Maybe under the new CEO, they can actually do that. Time will tell. But so far, they haven't really taken the bull by the horns I would say, and really roll something out in a big way. It's been more these smaller pieces, which don't get me wrong with all these smaller platform changes is a rising tide of engage-- [crosstalk]
Bill: Yeah.
Andrew: It all helps. They'll feed off of each other and that's what's important. But in terms of monetization, they haven't really done anything that is going to unlock a tremendous amount of incremental revenue.
Bill: Yeah.
Andrew: And that's what I'm waiting for. That's why Space is potentially interesting. Some of these other new user initiatives are interesting as well.
Bill: As somebody who takes pride on being accurate and you're running a long short, how would you describe research recommendation service? Is that a fair way to characterize what you do?
Andrew: Independent research firm? If you really want to boil it down, it's called the sell side. It feels like a dirty word, just given the way that we think about the world.
Bill: I guess the only reason I don't associate you with the sell side is I associate you a little bit more with price accuracy. The sell side I don’t-- [crosstalk]
Andrew: Well, sell side gets paid what for corporate access a lot of the ways.
Bill: Yeah.
Andrew: Or order flow or banking. There's lots of conflicts. For us, being an independent firm, we're trying to exploit that. We do research, we make actionable investment recommendations. Things that-- and we talk about catalysts and price a lot, but the goal, the name of the game here is to make an investment recommendation and get paid on it and then have it work. So, in that sense, I guess, maybe we aren't the sell side, because-- [crosstalk]
Bill: Yeah, that's why I'm a tweener in my mind.
Andrew: Yeah. We take a very buy side mentality to what we do. Maybe it's just an element of brainwashing over the years to do it because we don't really run asset that we don't run money. But I think about it in terms of, if we were to run money. I think about my ideas and when the stock is going against me, I feel the pain.
Bill: Yeah.
Andrew: You just don't actively trade on it. But I think I have that type of mentality, and so, in that sense, a lot of our clients and people that subscribe get a lot of value from that because they can take what we do and they can immediately apply it or not to try to create value. But I'm very performance oriented, where we focus on trying to like I said be right and make good calls, and be right more than we're wrong, right?
Bill: Yes.
Andrew: That's the name of the game.
Bill: Yeah, well, especially if you're selling a research service and you're feeling it in your P&L if you're not right for too long, then you lose the-- [crosstalk].
Andrew: That's the thing too. There's natural skepticism of anyone that's trying to sell you anything and I totally understand that. One of the biggest points of pushback and criticisms that we often get from people initially, until they actually understand what to do is like, "Oh, you don't run money, you don't have any skin in the game." And it's just-- [crosstalk]
Bill: I would say to those people, "Andrew has a young baby at home." That's a lot of skin in the game. [laughs]
Andrew: Yeah, exactly. Yeah, that's not the baby. I've a wife, I have a family. The other thing too is I would argue that it's maybe I have more skin in the game in many ways because like I said, people will only pay me if I'm right. If I'm consistently wrong or produce low quality work that doesn't add any value or their perception of value, then they're not going to pay me, and then my business goes down, and I have no P&L, and I don't get paid. It's just like that simple. I have to be right. It forces you to think differently, it forces you to be creative when it comes to data, it forces you to be a little bit more diligent, and the buy side is inherently time constraint especially for PMs. I feel on my side, too.
But the other thing, too is that, from this seat, I can look at it from a little bit more of a fresh perspective and tend to spend a little bit more time with ideas, and not have all those inherent biases associated with having a live position on where maybe the analysts pitched it to their PM, and it's going down, and the analysts are saying. "Buy more, buy more, buy more," and then you're sitting there with an 8% position, and I'm coming out and saying, "Short it," that's a really tough dynamic to be in for my see and then from the analyst perspective with the relationship with the PM. Because then the PM's like, "Well, he's saying short it, you're telling me to buy it, who's wrong?"
I've been in situations before where there's a lot of mutual respect within our client base. Everyone has an ego in this business, but we try to put it aside and just try to come to the right answers as fast as we possibly can. The most fun conversations-- Now, they're fun for me. When I was younger, they were terrifying.
Bill: [laughs]
Andrew: When you're going up against a senior analyst and the PM, and your PM's like, "So, you're saying this and you're saying this, and you're both looking at the same thing, ready? Fight."
Bill: Yeah.
Andrew: Or, "Come to figure it out. The baited out come to the right answer." It is fun. Yeah, I don't want to go too off topic there but-- [crosstalk]
Bill: No, I like it.
Andrew: Yeah. To your point, though, we're trying to provide actionable investment recommendations to our clients, help people become smarter, faster, and hopefully that all translates to making money at the end of the day [crosstalk].
Bill: Yeah. No doubt. Speaking of places where there may be some combative energy, you are not the biggest cable fan.
Andrew: [laughs] Not inherently. It's interesting. I don't want to have my identity tied to some type of secular view, or long, or short. When you become the Netflix bear and the Roku bull, or the cable bear, you're inherently putting yourself in almost a lose-lose situation at some point. Because you can be right but then especially when you're public and Bill you recently-- your rise in the public sphere has been awesome in the last 18 months. When you do everything in public and you make your investment ideas public, it creates this-- Maybe anxiety or bias. Your ideas become your identity. Then if you're wrong it makes it much harder to pivot because it's really harder to fail in public than fail not in public and just be able to cut bait on your idea and move on to the next one.
When you say that, I'm not the biggest fan of cable, yeah, I'm not, but I think that doesn't mean that I wouldn't be in the right environment. I was a big Roku bull and I still have a long bias. I should have pivoted short but at least we punted it. You know what I mean?
Bill: Oh, did you?
Andrew: Yeah. We wrote it initially up to 360 in December and then we put it from the best idea, actual idea down to the bench, and then I was like-- Because I didn't understand valuation, the valuation framework was just beyond me.
Bill: What were people doing at that point? I've spent the last three or four weeks thinking about it a lot. I'm still not sure where I'm at on it but I was trying to reconstruct what people were seeing at higher like 400?
Andrew: It's really hard because my valuation approach is, first of all, that's the last thing I do. I care more about the trends of the business like, is it accelerating, decelerating, like, where the fundamentals are doing? Because that's going to translate ultimately to what the price does in value. But back then with Roku, people were just extrapolating-- I, honestly, I'm not even sure. I think going back to-- [crosstalk]
Bill: Yeah. Well, it might have been a bubble earlier.
Andrew: It might have been a bubble. What were people doing with AMC, what were people doing with some of these other names? A lot of things didn't make sense then. When a lot of things don't make sense, I just tend to not do anything and just wait. The way that I've always thought about Roku simplistically is the same way that people think about Netflix long term. How many accounts, how many subsequently get, what's the ARPU going to look like, what's that revenue mean, what's the margin profile and then multiplying and pay for that, and whatever year, and then what do I discount that back by?
For Roku, I've always thought basic framework, hundred million active accounts, $100 ARPU is $10 billion in revenue, 35% EBITDA margin, $10.5 billion in EBITDA, five years from now trading at 20 times seems reasonable to me, that's a $70 billion EV. That's what I'm playing for long term. Then what does that translate to in the stock price? There's been some dilution, but it was somewhere between $300, $400 a share, like Ballpark. Then I'm sitting there, I'm like, "All right, well, even if I'm right on my fundamental view long term, price is bad." I'm basically pulling forward, all these stocks are pulling forward fundamentals that they're going to be putting up five years from now today, and stocks are discounting mechanisms.
Bill: Yeah.
Andrew: Even if I'm right, I'm still going to be wrong on the price. I think that's what a lot of people missed. Maybe some more like the traders or the people that got newer to this game, and learning how stocks work, and investing works, and value works. So, I think people got too excited clearly into a slowdown. I fucked up Roku because we tried to get long again in July, August, because I had some data that looked maybe accounts weren't going to be as bad and they missed, and then I was like, "Ah, let's just wait," because Q4, they had a really good upfronts. Q4 is going to be better. Then, double down on the work and I was like, "Yeah, maybe over 12 to 18 months long term, this thing's going to look good. I can get 50% upside. The next few months are going to be choppy."
Then we did our themes call, realized that the industry was going to totally rollover, and then the reported earnings, and they were disappointing, and I couldn't figure out the guidance, like the guidance based on my model just didn't make sense to me. In that scenario, plus the YouTube debate, I was just like, "This is done." We just moved on at $300 and I'm just waiting. Cheap gets cheaper when growth is slowing. When growth is accelerating expensive gets more expensive. So, I'm just waiting for the fundamentals of the business at the bottom and seeing where that is, and then make an assessment from there what to do.
Bill: Cheap gets cheaper when growth is slowing, and expensive gets more expensive when growth is accelerating, that's what you just said?
Andrew: Yep.
Bill: Huh.
Andrew: It's not a crazy concept.
Bill: No. I'm just thinking about why it would be intuitively makes sense because I like to internalize these things.
Andrew: Yeah, I can help you out if you want to try it.
Bill: Yeah.
Andrew: This is part of just how I think about investing in stock prices. I fully understand valuations and opinion and everyone has their different approach. Neither one is better than the other. I just want to say that upfront, but so much of a-- One thing we've learned coming out of the pandemic is how much of a company's or stock price's value is based on its terminal value, right?
Bill: Yeah.
Andrew: The next three to five years it doesn't matter as much as what the perpetuity value is. That's not really surprising because anyone that's built like a DCF, you know how big the terminal value is to your ultimate equity value, and you know how sensitive it is to all the inputs around interest rates and growth. When growth is accelerating, what does the street do? what do investors do? Estimates start going higher. They start to extrapolate that growth into perpetuity. Terminal growth rates go up and then in the case of COVID, interest rates were also dropping like a rock. We had this digital pull forward transformation, everyone was raising estimates, tons of stimulus, people got really excited, terminal growth rate assumptions go way up, interest rates are way down, and so, multiples go through the roof, these companies are beating estimates, so, estimates continue to go higher, and higher, and higher, and it's like an accordion.
Then as soon as growth slows and then you have momentum. Just you have momentum as they're beating. Then growth slows and then it's the opposite effect. It's classic momentum, but there's a fundamental basis and there's also a behavioral component to it as well, which is why, if you look through some of the decks that I sent you, we have the process slide and we have that slide that's at the very beginning, It's a normal distribution curve but it's like-- [crosstalk]
Bill: Yeah. The fundamental idea generation slide?
Andrew: Yeah. It's basically expectations gap. There's the behavioral component, but there's with short interest, sell side, and sentiment. Then there's also the fundamental component. If I can identify situations where consensus is wrong, and they're going to be estimates, and growth is accelerating, that's the Holy Grail, because I'm going to get paid on estimates going higher, and the multiple expanding, and vice versa, right?
Bill: Yeah.
Andrew: That's why Roku worked really well from us initially and we got lucky with the pandemic, I guess, in some ways. But fundamentally that's the view. That same thing can be said for like legacy media companies, melting ice cubes, GARP, the list goes on and on. That's just how I think about value and what drives stock prices.
Bill: No, it makes a ton of sense. it's funny because I think before I understood not saying that I do understand, but before I had more than elementary understanding of how the game works, I read contrarian investment strategies or some statistical books, and it's like, "Well, this should be the strategy that you always run." I don't believe that anymore. I do fundamentally believe that you buy businesses at below what you think or at undemanding expectations that I believe is an evergreen strategy. But within that, I do think that there are some tactical allocations that work in certain environments and don't in others. That said, I got caught offside last year, so, what do I know?
Andrew: It's going to happen. Everyone has their own process. As an investor, just in life in investing, you have to find your true north, and find out what works for you, and what you're comfortable with, and stick with it. If what you're doing is consistently wrong-
Bill: Yeah. Then you got to change.
Andrew: -you got to change. There's no point, then you're just struggling with cognitive dissidence. You're just ignoring reality and then that doesn't help anybody.
Bill: Yeah.
Andrew: But I think there is value in always asking yourself like, "What am I missing work, where could I be wrong?" Then asking yourself, "Why is the stock doing what I'm doing? What do I think my own expectations are?" The name of the game, as you said, it's just buying fundamentally mispriced assets. I think that coming from a classical training, looking at Buffett, trained up on all those concepts, the idea of like, you want to buy something low and sell at highs, that's what investing is. I think being able to identify those periods and then inflection points within those periods are as much harder to do, and that's why for our process and Hedgeye is founded on this, and I've adapted the fundamental view is like, something can look cheap but if growth is going to slow and they miss estimates, then if you think it's cheap, you're probably wrong. Because estimates are going to get cut by 10%. The street's not baking that in.
Being very acute to the modeling and what consensus is and I know people harp on the pod shops all the time because they're just trying to figure out a five-cent EPS miss and try to arb that to some extent. For me, it's more or less just being mindful of space, time, valuation, expectations, rate of change on the growth, and how these businesses are ultimately doing, and what's baked in. I can go both ways in that scenario. Having a long-short framework allows you to do that. When you're along only your mentality is little bit different, because your threshold for what you think like--
I've had situations where I'm short a name and people that are long, they're telling them this, and I think it's a great short, and they say, "Well, it's cheap, and yeah, I'm not really sure that's going to matter, because I have a three to five [unintelligible [00:48:45]." I respect that.
Bill: Well, you sound like me on Altice before I got cut in half. How was that? That was fun for me.
Andrew: Yeah.
Bill: [laughs]
Andrew: Well, I don't lose.
Bill: Let's not get diverted because I want you to finish your sentence but that's exactly the conversation that we would have had, had we had that conversation.
Andrew: Yeah. Then, going into the year, I was like, "Well, they're going to become a cash taxpayer. Free cash flow estimates are way too high." They've been underinvesting in the business for so long that, and then all the due diligence I was doing on the ground was like, "Look, these businesses, it's showing up in customer satisfaction," and they're getting their lunch eaten by Verizon. It took a while for that to actually to get the catalyst, part of it was macro related. But the point is that, that was a situation where I think that was a very rare opportunity on the short, where you actually have a situation where a business is over earning, investors are valuing it based off of a number that's structurally too high, because they need to invest more. Therefore, my definition of risk either long or short is the permanent loss of capital. I'm not saying you permanently lost 50%. If you're still invested, I really do hope you make it back. [crosstalk]
Bill: I actually [crosswalk] out.
Andrew: Okay.
Bill: Because I read Hempton and I think that I'm going to learn from people smarter than me, and one of Hempton's-- one of my favorite essays of his was watching people blow up buying levered entities that underperform and buying more into it. I think the stock was at $19.50 or something, when I sold. I was just like, "You know what? I'm going to get out, and I'm going to get rational and I'm not--" [crosstalk]
Andrew: Just move on. Yeah, it's one of those situations where you just have to cut bait, move on, and-- [crosstalk]
Bill: Or, not. I know, I had to. That I know for a fact. I have not regretted the sale and obviously, the stock on the $25 maybe we'd be having a different conversation, but I think it's allowed me to be more rational about what I saw that I dismiss. There is a lot of them. I had a lot of cognitive bias in that. I think some of it was from past success and I think some of it was just from wanting to see what I wanted to see. You talk about the expert interviews and whatnot. I really do legit Stream, and they really are integral to my research process. That's not just bullshit that I read but I do think that when you read those transcripts, many of them appear to me to be people asking questions that they want to get the answers for. I read a lot of those with bias in them.
Even despite the bias, the expert was like, "I think they've cut to the bone." I remember reading that interview, and dismissing it as priced in, and I should have been like, "Holy shit. Here is an expert interview, which I believe skew bias heavily on the distribution curve." This guy will not confirm what this analyst is asking him. Why am I just dismissing this and why is there not a better use of my capital somewhere else? That should have been when I look back at things that I really overlooked. That was my version of I think what you saw. But you saw it 10 different ways and I only saw one.
Andrew: Well, in all fairness, we shorted it in I think December of 2019. It underperformed but it was a wild ride between then and now and then. It is interesting how you can look back in retrospect, and there's usually always one moment, and it's usually the key decision-making point where you're like, "Yeah, I knew that. I should have known better, but I didn't do anything."
Bill: Yeah.
Andrew: Yeah. In the case of Altice, they're doing everything now, they're investing in fiber. I was just looking at some of the local town forums, they got eviscerated by every single local government that they were involved with coming out of the pandemic because the network quality issues and also how they handled all the hurricanes. From a perception issue, it is a big deal. They're also getting overbilled by fiber and it really just had to be a situation that they had to change something. And now, they're rolling fiber out everywhere. Everyone's like, "Oh, yeah, they're rolling out fiber, they're rolling out fiber" [unintelligible [00:52:54] I just saw it the other day.
Now, here's the thing. Is fiber more valuable than coax? Maybe. But is fiber more valuable than coax when you're just fiber going against fiber? That's the whole concept of maintenance versus growth CapEx, where if you go back and look at what Cablevision was investing, Suddenlink was investing in terms of their capitalization rates or capital intensity rather. Now, granted, the Dolans are probably spending too much. But the point is still the same that they really cut their CapEx and stop investing in the business in highly competitive markets and that led to market share losses. Now, they're playing catch up. So, it'd been great if they did the fiber push several years ago, and they were selling a fiber story. But the problem was that they're really, really slow in rolling out fiber. That's the only way that you can really generate the high ROI from fiber investments is if you move very quickly.
Bill: Yeah. And then you get the scale advantage and then no one can come and overbuild you because it doesn't make sense and then you're--
Andrew: Yep.
Bill: Yeah. Then just it's one of these positive flywheels not to overuse the term, but you can start to get aggressive on pricing, because you got capacity that's least on.
Andrew: Yeah. But now the issue is, well, okay if frontiers rolling out fiber, they're already competing against FIOS, so, then what is their ability to raise price? They're accelerating all these capital investments, where are they going to realize the incremental return from those investments? I think that's the big question to be had. [crosstalk]
Bill: Yeah. My understanding to plug Stream again is that they're currently running two systems. Maybe once the fiber is fully installed, then they can cut off the legacy cable system and whatever.
Andrew: Yeah. You have to decommission the old network in order to be-- [crosstalk]
Bill: Yeah. What a pain in the ass.
Andrew: Otherwise, you have to basically support every single customer, and just like network effects work for you when you're scaling up. They also work against you when they're declining. The more and more people that leave the coax network to go to fiber, the less incentivized you are to maintain that and the worse the network becomes, and so, then-- [crosstalk]
Bill: Yeah, but people are still on it.
Andrew: Yeah. You got to support it. It's a pain in the ass.
Bill: But you don't want to and then people are bitching because you service sucks.
Andrew: Do you force conversion, right? Do you give them promotions to try to entice them to convert over? It's really tough transition to make when you're going from cable to fiber, and competing in a market that's pretty dense, well, in the case of Cablevision, but also increasingly competitive. Again, the question is, is this just deferred CapEx that's catching up with them and we'll see if they'll be able to get back to growth in 2023. It's possible. They're doing all the right things by investing but it's hard to get any type of conviction until you actually see the turn of the business.
Bill: Yeah. I agree with that. The one thing that I've always liked about the story they sold is through and through they've always said that they are a fiber organization at their core. The belief internally is fiber is the end state. I tend to agree with that but that is an insufficient insight to drive an investment decision on.
Andrew: They say that, but I really think that if you go back and look at when they tried to acquire Cablevision, and all the issues that were brought to light by regulators and policymakers, because they saw how terrible of an operator Altice was in Europe, and they were terrified that the same things were going to happen. But Altice sold a really great story and they promised to invest in fiber. They made all these promises. They promised to keep News12 intact. They did all these things. Then we slowly find out is that and they did this in Europe, too is that they break their promises or they slow roll whatever they're doing. They can say that, yes, fiber is the future, but if that's really the case, then you know that you should have been more aggressive in rolling out fiber than you actually were, instead just plowing back hundreds of millions of dollars a year to buy back your own stock that's undervalued. So, there's that great capital allocation opportunity, like, just miss allocation of capital where that's Altice, it's just not great operators for that reason. We'll see. We'll start and see what happens with that one.
Bill: Yeah. Speaking of capital allocation decisions that I do not yet understand, I look at Roku, and I asked myself, "Why is there no--? Or, I shouldn't say no because that's hyperbolic. But "Why is the International piece of this puzzle so hard and have they waited too long to get into the international scene?"
Andrew: It's a great question. Part of the reason why the international puzzle's so hard is because if there's just no precedent. It's really purely speculation. Can't really say it's going to work out with a high degree of confidence. I think there's a couple things going on here. Roku clearly had a very early lead in North America and the US. They did not have to spend a [unintelligible [00:57:53] of advertising dollars to grow their brand. They did their first brand campaign last year. All their acquisition has been organic [ [crosstalk].
Bill: Like Tesla.
Andrew: Yeah. It's been really good because they were early and so, they were the first streaming player in the market. They have that position and they were also able to--- Anthony Wood had a lot of foresight when he struck those agreements with TCL and Hisense back, I think, in 2015, 2016, if I'm right, going into the really big smart TV upgrade cycle. They rode that wave when smart TVs shipments were still 20% of total shipments. Now, they're at 90%. Those Chinese OEMs took a lot of market share. So, very, very smart, no decision making.
When it comes to the international piece, there's a couple of things. One, from a streaming standpoint, the market is much further behind anywhere else behind North America. If you look at the number of streaming services per household, it's higher in the US. Historically, there hasn't really been a tremendous amount of demand for these aggregation services. That's changing because Disney is launching internationally, HBO Max is launching internationally, Paramount+. There's going to be more I think more natural demand for the services.
The other thing is that the Pay TV ecosystem, XUS were earlier on there. Broadcast is still very sticky, people consume a lot more linear.
Bill: Costs them a lot less down there.
Andrew: Yeah.
Bill: Well, around the rest of the world. Forget about down and out. All of it just seems to be a better consumer structure in a bundled offering.
Andrew: Yes. You know what also makes it challenging for Roku is that, the markets are fragmented. If you're going to tackle any market, especially in their space like North America, the US is great. But then, where do all these internet companies tackle then? They go to the UK, they go to Germany, they start with English speaking countries first, and then move on to non-English speaking, but still large markets like Germany. Then they typically go to like LATAM and APAC is always last. Netflix set the course in that respect.
It's more fragmented, which means that they have to go out in each market and negotiate distribution deals with all the different content partners on a local basis. Get all that local content on platform because they don't have it, then it's not going to scale. It's not going to be attractive. They have to go and work with local retailers, and each of these markets to get shelf space to help do promotion, get promotional activities set up. Then from a supply chain standpoint, they have to work with all the OEMs and they have to configure their TVs for each individual market, which has different broadcast requirements. In some cases, different hardware specs. So, it is just a much more difficult market to go after to try to scale.
Early in Mexico, they're actually no fun fact. They were banned in Mexico for a little bit of time, because the Mexican government thought that they were basically ripping off other streaming services. Like, it was a platform for copyright. It was a threat to their local content publishers. They got that fixed but I thought that was an interesting dynamic. But the point is that, international is a different animal. It's harder to target and scale. Whether the consumer use cases there is also a little bit different as well. So, that's from the consumer side. However, from a TV side, the question is not necessarily, is somebody going to go out and buy a Roku TV or Roku device? The question is, is somebody going to go out and buy a TV?
Bill: Yeah.
Andrew: It's similar to-- you've done work on Sirius service-- You're a Liberty guy, you know Sirius. Sirius goes out-- [crosstalk]
Bill: It's like a cockroach. I would have expected Spotify to crush it a long time ago but at the end of the day, the car distribution matters a lot.
Andrew: Exactly. Well, that's the point. Roku is in a little bit of a different situation, and that they're not paying for exclusivity, and there's not this upfront sack component yet. Maybe, there will be. But they're getting sold into the channel. As long as these large TV OEMs continue to take market share, then Roku gets sold in along with that. I know from RC, you look at Roku, you say, "Well, what's really special about it, what's their competitive advantage, is their operating system really that much better, and why is the consumer going to choose it and get that?" But what really drives a TV purchase decision in most cases is really price. The lower price models drive the most amount of volume. You could sit there and look and say, "Okay, I got my $2,000, LG OLED or have my $2,000 Samsung, and I have my Apple TV." The reality is that maybe that's 10% of consumers less.
Bill: Yeah.
Andrew: The vast majority of TVs sold are smaller TVs, the Roku TVs. As long as people are buying TVs, and TCL can secure shelf space, and be the lower cost operator or provider in that space, and provide a good value to consumers, then people will buy the TVs, maybe not knowing what Roku is, but they'll still be on the Roku platform. That's the opportunity, because it's not necessarily like, "Okay, I'm going to subscribe to Netflix, I'm going to subscribe to HBO Max, I'm going to subscribe to Paramount." You could be a Roku user on the platform and monetize without having to have a really strong affinity to the Roku brand. That being said, people still really do like Roku. They score well-- [crosstalk]
Bill: It works nicely.
Andrew: Yeah.
Bill: I have a very nice OLED. I think it's OLED LG. I'm pretty sure it's an LG. I don't know. McMurtrie, I've recommended it to him and he likes it, too, and he likes movies. So, anyone that-- [crosstalk]
Andrew: I have an LG OLED. I just got a C series. It's good-- [crosstalk].
Bill: Dude, it's insane. McMurtrie, he had been trying to get me to watch Into the Spidey Verse and I watched it on the TV and I was just mind blown. It was awesome.
Andrew: It's so good.
Bill: Yeah.
Andrew: But that's webOS, right? [crosstalk]
Bill: Well, I was just going to tell you, I don't run on their OS. I run Roku on it because it's just easier.
Andrew: Yeah. It is easier. That's part of the case as well. People think that devices and player sales are going to go to zero. TVs are just now that they're smarter, just going to completely cannibalize player sales. That is true to some extent. But a lot of people prefer a Fire Stick or Roku device. A survey ran in 2019. It was about 65% of all smart TVs, they were using either a Roku device or a Fire Stick instead of the native operating system that comes with the TV. I think I've had Samsung Tizen, it was awful-- It was an awful experience. The LG webOS is okay, but it's still clunky glitchy-- [crosstalk]
Bill: Yeah. It is a little clunky.
Andrew: Yeah. There's something not right. That's Roku's advantage in many ways. The brilliance and its simplicity, which a lot of people look at and say that they just don't innovate. But it's the channels the way its setup, the way the remote fits in your hand. Surveys upon surveys just show that the biggest advantage, like, the remote is so important, it's overall [crosstalk] experience.
Bill: Huh. It's nice ergonomic handle like my Cutco knives?
Andrew: [laughs] Exactly. Yeah. And then there's also a network effect potentially, right?
Bill: That's interesting. It is a net scandal. I haven’t like [crosstalk] thought of it.
Andrew: Yeah. [laughs] You have your Roku on all your TVs across your entire household. Everyone's dealing with the same type of experience, all your subscriptions are in one place, your logins are there, you don't have to fiddle with going from your Fire TV to your Roku TV, and there's still ubiquity in both design, functionality, and also access to content. As it stands today, the Roku, the setting up of the Roku remote to your soundbar, your TV is very seamless. They have the Roku powered program that makes it, so that they can integrate really well. It's like the Spotify play in terms of ubiquity being really important, because it's a distribution platform like anything else. Then like the biggest question becomes content, and are they going to potentially lose any apps, right?
Bill: Yeah. Or, the ability to participate in the economics of the large-- [crosstalk]
Andrew: Yes, which they don't really anyway.
Bill: Yeah, I know. It's part of what I get concerned about because if we're going to a world that's more and more consolidated on the content provider side, how long is the long tail of niche content?
Andrew: Yeah, and it's very similar to the rise of cable and Pay TV. I know you're a cable fan and a lot of people listening are like, "It's not unlike what happened like that." With all the different channels, the broadcaster's rolling everything up, the balance of power between distribution and content providers. I think that we're in an environment where the power has been with distributors when it comes to CTV and streaming because all these media companies need scale, and they need it fast. Roku still has 40% to 50% of all streaming hours happens on Roku devices, and they have 55 million active accounts. Most of those are in US and North America. So, they're unavoidable.
If you're a media company looking or an AVOD service looking to scale or you need access to it, the question becomes five years from now, 10 years from now, will they have the same type of leverage? I think what we've seen time and time again with these App store type models or any type of mature market like, return on capital naturally just declines. These streaming companies will look to get more profitable, will probably come at the cost of economics of Roku to some extent at some point in the future. I just don't think we're there yet. The reality is that, by the time we get there, Roku's business could be 3x, 4x what it is today. So, is that thesis going to really matter to you now or is that something that you have to worry about much further down the road? I think that's more of the situation. But the content piece is definitely the most interesting part of the equation.
Bill: Yeah, that makes sense. I had something that was moderately smart to say and then I totally blanked out when I tried to say it. But oh, well. Oh, I think it's hard to argue that they haven't benefited from the incentive of Viacom, release Paramount+. Everybody's releasing their own app to prove to their investors that they can make it in a streaming world and that clearly benefits Roku in the short-term. I am super fascinated by ViacomCBS and the NBCU assets. I had Xfinity. I actually liked the cable box and if they didn't charge me, I would be a cable box user but I hate the rental fee. But even on Comcast, Xfinity cable box, Peacock didn't work well.
Andrew: No. I think there's a couple things there. Well, you remember Flex? Remember Xfinity Flex and everyone thought that-- [crosstalk]
Bill: I have Xfinity beta now, which is a dogshit product. If I fast forward, I can't even see the commercials that I'm skipping. I have to guess when to press play and I can't rewind live TV, it's as if I have gone back in time. But I refuse to pay them any more money.
Andrew: Yeah, it's tough. Because that's all-high margin, all that equipment gets depreciated to zero, and then it just becomes gravy, and then that's ultimately probably going to go away.
Bill: Well, mine's just an app. I guarantee and I don't invest $1 in it. It's all just pure margin.
Andrew: Yeah. That comes down to just Pay TV, the future of pay TV and people actually watching it or not. The beta app is crap. But then again, if for most people, like, you're not, you don't care. If you want Pay TV, you're probably going to subscribe every six months. So, YouTube TV or Hulu with live TV, if you really, really want sports or you care. Yeah, then Comcast, and I'm getting a little off track here. But with Comcast, they're starting to get into smart TVs [crosstalk], they are trying to launch that which is I think I get it. But the play would have been to buy Roku five years ago. But imagine being a Comcast investor and seeing them buy Roku, maybe it would have been an issue back then because it would have been small. It's clearly a risk for them long term if they get disintermediate on the video side.
Bill: I think they already have. I think they've just been outflanked in a lot of different ways there. Now, it's a matter of squeezing as much juice as you possibly can.
Andrew: Yeah. Broadband, video, they made so many investments next one on the video side and it's a pretty good product.
Bill: I think it's a fantastic product.
Andrew: Yeah.
Bill: You know what I don't understand, man, the thing that I've said, and I guess it's a function of business model, and maybe I'm an idiot, and I know that it's all the truck rolls and the free cash flow associated with the CPs garbage and video, but if they had just given away Xfinity and not been so tied to the rental box fee, could they have potentially built out what Roku has?
Andrew: It's the innovators dilemma, right?
Bill: Yeah.
Andrew: As your investor base, would you have been okay with them taking the EBITDA hit?
Bill: Well, it's Brian's company?
Andrew: Yeah, it's true. Well, I think there's a level of arrogance probably there as well. Are they going to be willing to invest in something early on that they think could be fundamentally disrupt or just continue on just doing the same? The case of legacy media, maybe with the exception of Disney, who has started to pivot a little bit earlier and getting things structured, but it's not they've been bleeding Edge when it comes to tech and getting ahead of where the consumer is. Yeah, they can still do the same thing. The future of Pay TV, let's say, it just goes away. They're still going to be value where they can do a similar type of model with Roku, where they sell streaming subscriptions. There's distribution there or they partner with the vMVPD because eventually, they're not going to take a loss on pay TV. Charter, Comcast, I don't know, maybe you know them better than I do.
Bill: No, I don't think that.
Andrew: They'll never take negative margins on video. Video's becoming less and less part key to the bundle as they come go more to MVNOs and wireless. As that scales and they have this other part of the bundle to anchor on, then the economics in theory of that business on the wireless side get better as it scales, and video gets worse, then they're going to be less tied to video, less wanting to pass through your higher programming expenses. I think that there'll be a day where you just exit. It'll just be a wholesale exit, and maybe they just do a partnership with YouTube TV, Hulu with live TV people that want it. Similar to what Frontier's doing or had Verizon-- [crosstalk]
Bill: What does Frontier do? I'm not familiar.
Andrew: Frontier basically exited the business. They're on this whole fiber campaign-- [crosstalk]
Bill: That I knew. I just don't know-- [crosstalk]
Andrew: Coming out of bankruptcy. Yeah, because they don't really have them. They basically said, they're de-prioritizing video or basically exiting. They cut a lot of the fat. It's really just more like a skinny plan. Then they said, "We're partnering with YouTube TV and if you want it" and I'm sure within that agreement, maybe fiber gets or-- Frontier gets some type of finder's fee, or some type of revenue share off that, and it helps in that you have this great fiber asset symmetrical one to two up and down, and then you can have this bandwidth heavy streaming service on top of it that scales. I think that's an interesting way to think about the future.
Then, within Roku, they still probably become the platform within that. Do they get disintermediated somehow and get TiVoed? You've got to watch it. You always got to watch it. That's why I was so concerned about YouTube. Because if they lost YouTube, then that could have been set precedent for losing other services.
Bill: Yeah.
Andrew: Because even though they don't directly monetize YouTube, it's still a large percentage of streaming hours, and they can't risk not having it on the platform.
Bill: Yeah.
Andrew: That's why I was very concerned because it would have threatened their entire competitive positioning or that part of the thesis, it would have invalidated it to some extent. But they figured it out. I'm not sure if it was a good deal or a bad deal, probably not that. It probably was neutral or slightly negative frankly for Roku, but we'll never know.
Bill: Yeah. That's an interesting way to frame it. It's funny to watch my kids interact with YouTube. It's like they don't even have a relationship with some of the-- Nickelodeon, for instance, they don't have any relationship with that. They've got some relationship with some creators and whatnot, but it's bizarre, man. I don't know. I'm definitely this is a boomer comment but I'm like, "Why don't you guys just put on some professional production?" They don't want to. They want to watch a bunch of like-
Andrew: It's all short one--[crosstalk]
Bill: -kids reality TV. It makes no sense.
Andrew: I know. YouTube's crap. It's just the way it is. It's going to be interesting. They're just so dominant. For Roku, the question just becomes like, "How well can they monetize the Roku channel from here?"
Bill: Yeah.
Andrew: Because that's they have third party Inventory, but the Roku channel is like their own and exclusive, and that's where they own the inventory to get the highest margins on it. Can they push that, can they scale that? I think they've done a really good job at growing it, and there's a lot of investor skepticism out there, whether or not that can be the next big thing. I think the skepticism is right. But the point to our earlier conversation around process and valuation, at some point, just like Roku is way too expensive at 500, it's going to be too cheap. I would make the case that within that same valuation framework that I rolled out before around active accounts, ARPU, I could easily make the case that if Roku never grew again.
Maybe grow ARPU by another 20%, maybe. But just keep active accounts flat, and just focus on that, and driving a good experience, and cash flow optimization, then I would say that the stocks probably worth what it is today. You probably don't make a lot of money from here, but the present value of the future growth opportunity is next to zero. We can debate internationally all we want but if it's not priced into the stock, then who cares? It's all upside. Maybe the Roku channel becomes the next big thing. It's quite possible. Management has a great track record of execution. They're going through a tough time now. Part of its cyclical, part of it's a little bit secular. But I think the valuation down here is becoming really interesting.
Again, to that extent, the fundamentals of the business are not going to turn until probably the second quarter of this year. In that situation, Q1 estimates are probably too high for accounts. Same thing with Q2. So, it can look cheap, but if they're going to miss, that's going to be a problem. Rather wait for that clearing event. It's possible that they miss and the stock goes up. If they miss and the stock goes up, then that's probably a sign-- [crosstalk]
Bill: Yeah, then you should buy.
Andrew: You should buy. Then you can say that, the back half is going to inflect positively, the supply chain issues resolve, and you have easier comp dynamics, and the multiples coming into historic or not historic, but you are on all-time low. There's a lot of interesting things to still like about Roku, even though, it's been part of this COVID bubble basket that's burst. Now, it's an Ark stock. So, I'm sure that there's a lot of people just hunting those as shorts. I think Roku is the number one holding. But I'm not sure the long-term bull cases necessarily totally debunked at this point.
Bill: I have found the channel to be quite good. I do think they need to work on, I'm going to use Spotify's term here. I don't know what Roku calls it but their dynamic ad insertion, I have re-found arrested development through my research and I'm a happy watcher. But then it'll cut to an ad out of nowhere. I'm like, "Come on, at least cut where the show--" It seems a natural show to be like, "This is where a marker would be if this were on linear. Just throw a commercial in there."
Andrew: Yeah.
Bill: But they don't do it that way. Sometimes, mid-sentence, it'll just go to an ad, and I'm like, "What are you doing?"
Andrew: Well, that's because it's digital, right?
Bill: Yeah.
Andrew: YouTube's the same way. It's just the way digital ad insertion works. It's not very content focused. That's part of it, too, is the TV buying experience is traditionally very network based. You know what content your ads are going to be placed against. Roku is different in that respect because they're really trying to create it at scale. So, there's definitely opportunity for them to improve their ad tech. [crosstalk]
Bill: Yeah, just riffing on that real quick.
Andrew: Yeah.
Bill: If you sign a deal with them, you don't know where it's going to get pleased necessarily. It can get thrown on the tennis channel for all you know.
Andrew: Yep, and that's been a big--[crosstalk]
Bill: They just promise you the demographic.
Andrew: Well, in genre. You can do genre-based targeting, you can know what channel it's going to be on, you can know your demo, but you don't know actually what type of content is getting placed on. That's a big part of it, it's just the way that the agreements are structured with the content companies. Peacock TV, or HBO Max, or Paramount Plus. They reserve the rights to be able to do that type of level of targeting. So, that makes it a little bit more difficult for TV buyers that are natural. They're used to that. At the same time, Roku offers incremental reach, unduplicated audience, and they also have really good targeting capabilities. There're offsets there that make it more attractive potentially relative to linear. That's one thing to consider.
The other point I would make on data side is, they do have ACR tech. Auto Content Recognition-- Auto Content Recognition that's built into the TV sets. They can see everything that you're doing on the TV. They can know that Bill Brewster's watching Netflix, and what they're watching on Netflix, he's watching Ozark. Then based on that they can infer what your interests are to help serve you ads or what type of consumer you are. That's valuable because that helps so many reasons, but primarily targeting purposes. That's another advantage where traditional network advertising, it's more like brand focused. It's just birdshot and going after like a certain demo. Roku also has the Nielsen integration. They first strike a partnership with Nielsen really helped with measurement purposes and get a lot of TV buyers more comfortable. There's a lot of other things [crosstalk].
Bill: Didn't they buy that asset now?
Andrew: I think they bought the ACR tech. I think they also bought dynamic ad insertion tech.
Bill: I thought they had bought something from Nielsen.
Andrew: They did. No, they did a Nielsen deal. Yeah, I think they did one or two Nielsen deals. It was smaller. I think they're wanting to have an ownership over their ACR Tech was first and foremost, because that was something that is pretty critical to have.
Bill: Yeah, that makes sense why you would want-- [crosstalk]
Andrew: I'm pretty sure Vizio has their own proprietary like ACR tech, too. So, having that for Roku would be important.
Bill: You know an insight that I found super interesting when I was watching your stuff is that, 45% of TVs sold are through Walmart, 25% through Best Buy, and 5% on Amazon.
Andrew: Yeah.
Bill: I'm pretty sure that those numbers are right. Do your own due diligence, folks, but directionally, I'm right. I thought your comment to that person was really interesting, where you said, "Yeah, Walmart probably doesn't care as much about whether or not your Roku, Android, or I think maybe you were arguing that Fire," or maybe your first inclination was that Fire was something that Walmart wanted to keep out. But then eventually you guys settled on-- It's probably more important to drive down costs and just turn TV velocity for Walmart than anything, which didn’t Walmart end up partnering with Fire, or am I wrong on that?
Andrew: No, I don’t think so, they didn't partner.
Bill: No, they didn't. Okay. All right, sorry.
Andrew: I'm pretty they'll never be a situation where at Walmart you'll see Amazon devices.
Bill: Onn is Walmart's TV, right?
Andrew: It's their house brand.
Bill: Is that still a Roku TV?
Andrew: Yes.
Bill: Yeah.
Andrew: Yes. Last time I checked, [crosstalk] I don’t know if it's changed in last three weeks. Yeah, at that time, I'm pretty sure. They're powering that. So, strategically Roku is an important partner. They've also been dabbling a little bit more with Android, they're also selling the Comcast branded TVs as well. A lot of the debate amongst the buy side has been, "Well, are you paying Walmart a revenue share? It's not going to destroy the business model. Are you paying for access?" My debate, my pushback has always been even if they are, we probably wouldn't know, I don't think it's going to destroy the business. But if they have to give up a revenue share in exchange for additional scalar exclusivity, then I think it makes sense.
Going back to that whole SiriusXM equation, if they paid TCL a 5% take on every single TV sold, yes, it would hurt their gross margins. But if it means that they get access to a lot more market for them, that in my opinion is probably worth it, and that's worked for Sirius, although Sirius is a subscription-based business, Roku is more a platform.
Bill: Yeah, but it rhymes, man. If the deal to me was, you cut Walmart a little bit of a commission for a TV sold, build it into your hardware losses, and then you keep your platform economics. I would probably do that deal that way.
Andrew: Well, that's why historically, Roku is not really in Best Buy. Because that's the Best Buy business model is that you pay for space. Amazon has actually been really aggressive in terms of trying to find their share, the channel, and paying for placement, because they've been boxed out historically, because of Google. Because Google makes all their content partners choose between Android. You can't use a fork version of Android. So, there's no large-scale TV OEM that's ever going to say like, "Yeah, I'm going to adopt Fire TV if it means that I can't also use traditional Android operating system." If you're a Samsung or if you're using-- That goes Samsung by example.
But if you're any type of global, OEM that has any type of relationship with Android, it's a corporate deal. It's not just one side of the house. That applies to the entire organization and basically makes Amazon, you can't partner with it. Then that helps Roku indirectly, but also helps Google, Android. Then, again, Walmart with their Onn branded device buying to compete effectively against Amazon makes Roku interesting. Then people still like to buy their TVs, and see their TVs, and go to the store and buy it. It's a big traffic driver for these guys, too. So, that's another part of it as well.
Bill: Yeah. No, it makes sense. I don't know. It remains in my too hard pile. I obviously have more questions to answer, but I do fundamentally like the product, and I do think I understand how the Roku channel can continue to grow. I like how you can search for anything, and then it's a pretty seamless subscription. If you search for Dexter, it's a pretty seamless click on Dexter's new season. I haven't done that because I didn't like how that pivoted, whatever.
Andrew: Yeah. Discovery is key. It's very similar to Spotify in that respect.
Bill: Yeah.
Andrew: It's a platform, its distribution. The economics look pretty good now. I think they'll continue to be the case. But there's a very strong group of bears and strong group of bulls on the name. If you've timed it right, both have made a lot of money.
Bill: Yeah.
Andrew: I think that's going to continue to be the case, we see with any type of growth stock or company that's early on in its adoption.
Bill: Nice. Well, I appreciate you dropping some of your knowledge here. I hope that people appreciate it as well. How's fatherhood been?
Andrew: It's been good, man. It's definitely thrown me for a little loop. I'm trying to figure it out. I had everything with work and life pretty well balanced. I still haven't quite figured out my morning routine and when I can get stuff done. I think the reality is that, I just have to embrace the chaos and the uncertainty, and just realize that I'm never going to get any type of certainty. Things are always going to just be all over the place and try to figure out how to wing it. So, that's where I'm at.
But Cole's healthy, my wife's healthy, we're very fortunate, and I'm looking forward to the next phase here as we go forward. [crosstalk] Everyone's been super nice, and supportive, and reaching out on Twitter, and giving their advice. Elliot Turner, he sent me a book, which I really appreciated. It was really helpful.
Bill: Elliot's the man.
Andrew: Yeah, he's great. Yeah. Bill, thank you so much for having me on. It's been really awesome to see everything that you're doing, and the investments that you've made, and the podcast, and just growing your reach. It's been really awesome to see. So, I'm glad that you're finding success.
Bill: Thanks, man. I don't know, I obviously enjoy doing it. I don't know that I love the responsibility that I'm willingly taking, but I think it's made me a lot better. There's some stuff that's come up and I've just been like, "That can't happen." For instance, yesterday on Value: After Hours, we were talking a name and I didn't have my numbers in front of me, and I was like, "That can't happen again." If people are listening to me, I'm asking for people's ear. I need to be a little bit better, but-- [crosstalk]
Andrew: Tighter. Yeah.
Bill: Yeah. Because it's no longer just something that's fun. People actually care about it and come to which is fun to build. So, we'll see where it goes.
Andrew: Yeah, man. No, it's been good.
Bill: I appreciate you being a guest and I hope you will be one again. In the meantime, I hope somebody subs to your stuff, man. I like you, I like that you're an entrepreneur, and I like what you're offering, and thank you for giving me a peek behind the curtain, so, I could have an informed conversation with you about it.
Andrew: Yeah, Bill. Thanks. I really do appreciate that.
Bill: All right, man. Take care.
Andrew: All right. Take care.
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