Value Options: Micron, the AI Boom, and the Hidden Opportunities in Deep Value Stocks

During their recent episode of the Acquirers Podcast, Travis and Carlisle discussed:

• Micron Stock Valuation: Why Cheap Earnings Can Be Misleading

• AI Stocks vs. the Dot-Com Bubble: Are Investors Paying Too Much?

• MGM and VICI Properties: Finding Deep Value in Beaten-Down Stocks

• Nvidia’s AI Chip Dominance: Can Custom Chips Threaten Its Valuation?

• Deep Value Investing: Why Quality Stocks and BDCs Could Be Undervalued

TRANSCRIPT

[Tobias] This is the Value Options Letter podcast. I’m Tobias Carlisle, joined as always by Tim Travis. How are you, Tim?

[Tim] I’m good. I’m hoping my sunburn has faded a little bit. I’m in the Cardinalston in Hawaii and went to the beach with my daughters the first day and just got fried.

And then my youngest daughter was calling me like a lobster the whole trip. So it was not ideal, but a wonderful time. Well, welcome back to an ugly market.

Oh God. Yeah. Yeah.

How are you feeling? It’s been, I mean, it’s been a pretty miserable, I’d say 50 days, you know, it’s, it’s Toby, it’s a, it’s one of those where a lot of things just don’t make a lot of sense. And there’s a lot of overreactions and, you know, business values, I feel like are very detached from stock prices right now.

And I think we could go over some fun examples of that. And we were kind of mentioning, you know, what it feels like. And to me, I felt this type of detachment from kind of the index and fundamentals for a few times.

I was thinking like 2011, I remember the European financial crisis. There was a lot of kind of overreactions there, particularly with the financial sector. I mean, there were stocks, the big banks were trading at, you know, true fractions of tangible book value and even quality ones like bank of America.

I remember Buffett bought into bank of America and it barely even moved the stock. I mean, it did initially, and then it kind of like retread. And then I just remember, I believe it was in October too.

It was like, or September maybe. And then it was like, there was something that happened. It might’ve been Draghi saying, we’ll do whatever it takes.

And the market shifted and it was just a torrid end of the year for a lot of the value stuff. And also like kind of 2021 when you had the memes and then, you know, those things kind of crashed in the next year, kind of just that kind of vibe, Toby, to me.

[Tobias] There’s a couple of things going on in the macro backdrop that are worth mentioning. One is that long run rates seem to be just continually jacking up. And that increase impacts the businesses of small and micro and value cyclical stocks, because they’ve got, their debt’s not as well termed out.

They tend to carry a little bit more debt. The businesses are a little bit more cyclical. And so they feel the pain first and they fall fastest.

They also recover first and fastest on the other side because they’re sort of the little bellwethers in the market. The other thing is energy is just another cost for most businesses moving stuff around. And that shows up as a, just an additional cost and energy oils back to a hundred bucks trading around a hundred dollars might be a little bit south of that, but it’s like, it’s near enough to that.

It doesn’t matter. So it’s been a, it’s been a tougher year for anything that is small value cyclical. And really that in this market, that’s anything, that’s not the biggest 10 companies in the market that are sort of AI or AI CapEx beneficiaries, either the hyperscale as a semis or something that’s benefiting from the buildup.

So it’s been a, it’s been a frustrating market. If you’re not holding those, but even anybody holding those names is if you’re holding the S and P 500, you’re underperforming those names, everything’s sort of underperforming a handful of, of names, which not a super healthy market. It may be justified in that instance, but I think that I did this little analysis where I was looking at the proof that what has been quite predictive of good returns in the market has been profitability.

And that makes sense. And highly, highly profitable companies tend to do very well, but that’s that as a factor by itself in 2000, that factor topped out at seven times book value. So book value is not a great measure.

I understand, but maybe more so as these companies become more sort of capital intensive, but now they’re at 11 times book value. So we’re well through the peak of the 2000 among those highly profitable businesses that are represented and that are doing quite well in this market. So I don’t know what the right price for those companies is, but 11 times book value is, is pretty stretched.

You’ve got to be right on the business. You’ve got to be right on the forward growth. And, and we seem to be very optimistic about that, but I think they’ve been pretty consistently wrong in the past.

Micron Stock Valuation: Why Cheap Earnings Can Be Misleading

[Tim] Oh yeah. I mean, it’s, it’s, I mean, you look at like Micron for instance. So like you said, I mean, so earnings are growing very rapidly.

I mean, this is a period of extreme earnings growth, but then you also have the dichotomy where free cash flows are down. So you have, I think the hyperscalers are spending like $600 billion. And I think that the deflate, depreciation, oh my gosh, it’s been a long day.

The depreciation might be like one fifth or one sixth of that. So, so it, they’re not taking nearly as big of a hit to earnings as, as they are to, to free cashflow. And so what ultimately will matter is what’s the ROI, you know, on that CapEx.

And I know Michael Burry had his thoughts on depreciation of the GPUs and whatnot. But like Micron’s kind of an interesting company because you have a, it’s an oligopoly. There’s, you know, two or three major suppliers.

So that reduced competition really changed the dynamics of the business. And the margins are just insane. I mean, they’re, they’re, they’re sold out for, I think like two years.

And, but then you have like the headlines, well, China is starting to get into that game and why wouldn’t they, right? Like, I mean, why wouldn’t they, if you’re China?

[Tobias] It’s capitalism, baby.

[Tim] I mean, I mean, it’s something, you know, it’s government, government sponsored capitalism, right? And, and so, I mean, that, that could have a huge, huge impact. I mean, nobody wants to be paying these prices for, for those memory and it’s impacting everything.

It’s impacting iPhone sales and, and all of these different areas. And, and I understand Micron’s, I mean, I’m looking at right now, it’s trading at 5.41 forward earnings. It’s very cheap.

If you, you know, believe the earnings are sustainable.

[Tobias] Yeah. You’ve got to normalise those earnings. I mean, they’ve been traditionally, they’ve been very cyclical.

Micron’s been one of those companies that pops into the deep value screens all the time because the earnings are so high relative to a low market valuation because folks know that they’re cyclical and they, they go up and down. We may be in a brand new world where they’re no longer cyclical. I don’t know.

Maybe the demand is, is out so far that they’re secular for a while. Maybe they’re still cyclical. I have, I really have no idea whether the nature of that business has changed.

[Tim] I think that, I think, I don’t think that nature has changed that much. I mean, it’s just how long the cycle goes. But one thought that I have that’s interesting is, okay, I love Claude.

I love it. It’s fantastic. It’s a fantastic product.

And I don’t use ChatGPT that much, but I’ve heard really good things. I’m sure it’s fine. But you have like the advent of Muse and Muse, I mean, for business guys or girls, like Claude, I think obviously takes the cake over something like Muse.

But I do think if you, if you have so many options for, for, you know, these AI products, I mean, what, what is the pricing power of the business? I mean, it just seems like they can really, it just, you’re spending so much money. You need profitability to, to justify that at some point, because you’re just spending, you know, equity and, and, and debt as well.

So it’s, it’s just interesting if you get, I think Steve Eisman’s kind of made this point. If, if you got people losing confidence in open AI and, and anthrop, anthrop, anthropic, I always want to say anthropology and anthropic, then, then those future orders, like, you know, Oracle’s massive order book, and a lot of these companies have massive order books might come into question a little bit. So, you know, those are a few of the things, but ultimately, like, I think the hyperscalers are, are still decent values.

I thought Meta was dirt cheap for a while. And I mean, I like my Mark Zuckerberg strategy on, on, on Muse and how he’s putting it out there. I mean, what a home run.

And it seems like it’s going to keep getting better.

AI Stocks vs. the Dot-Com Bubble: Are Investors Paying Too Much?

[Tobias] Yeah. I couldn’t agree more. I’m, I love Claude and I use a, I use a ChatGPT and Claude and I have the other, I have a few open as well.

I use Grok, I use Gemini and I have Muse there as well. So I have like a variety of, I’m not as familiar with Muse and Grok and Gemini, but I use open, I use ChatGPT and Claude like all day long. And they’re clearly very powerful tools.

And I’m, I’m still really only scratching the surface, but I’m getting, I’m using for more and more repetitive, systematic tasks that need to be done all the time. And it’s very good at doing those, giving you a report. Claude particularly learns, like you can plug it into various different software packages and use it as the, where previously I had to go and do it.

Now it just does it automatically. It’s incredible from that perspective, but I still don’t pay that much for it. Maybe that just indicates that they can charge a lot more, but it feels like there aren’t a lot of people using it that way.

There’s still like 95% of people don’t use it at all, use the paid versions. They use the free versions. It probably indicates there’s a lot of, their runway is huge.

They’re going to do very well for a long period of time. But I think that the analogy is the early 2000s, late 1990s, early 2000s, the dot-com was clearly game changing for everybody. The internet’s been an incredible burn, but we did get a little bit ahead of ourselves in the first instance.

And we saw that collapse. And then it really took 10 or 15 years for it to become properly integrated into business everywhere. And then we’re now seeing like the dot-com or last five years or so, we’ve seen the impact of the dot-coms as good businesses.

And I think that we’re going to see the same thing with these companies. I think they’re a little bit ahead of themselves in the short instance. I think that it raises some interesting questions though, as an investor, there’s a great line from Morgan Household’s book where he opens the book, where he tells that story about somebody having a similar, Buffett’s famously never invested in technology, but he’s done pretty well.

And he’s been able to do that by investing in things that don’t change. And so there’s a lot of things out there that are like that, that really they’re not going to be impacted by AI at all. You got anything in the book that won’t be impacted by AI?

MGM and VICI Properties: Finding Deep Value in Beaten-Down Stocks

[Tim] Well, I mean, I think most of us are going to be impacted at some level, but I’ll tell you an interesting one. So on the value options letter, we just released a trade idea on MGM. So MGM was being acquired by People’s Inc, which is Barry Diller’s company.

And they’re the largest shareholder. They own about 27%. And I forget if it was 45 or $48, it was somewhere between 45 and 48 was the acquisition price of MGM.

And I had owned MGM in the past and I sold it into that acquisition because I thought it was fairly priced. And I thought there were some risks. You never know the regulatory environment there.

And the rates went up. And so I think debt costs to finance the acquisition probably got a little overwhelming. And then you combine that, Toby, with just the true misery on consumer spending stocks.

I mean, if you look at all of them, so that stock’s trading at like 28 and change right now. And this all happened in September. The deal blew up in September and then the stock dropped all the way to like it’s at $29, $28.

[Tobias] Where was the bid?

[Tim] It was like 45 or 46. And it was pretty far down in the process. And I mean, what’s interesting is Caesars, I mean, I believe that deal’s approved with Fertitta.

And Caesars has a lot more hair in my opinion, as far as the balance sheet than MGM. MGM generates a tonne of free cash flow and they’ve got Macau. Macau’s been down a little bit.

They also have the development coming in Japan that, I mean, I think it’s going to be like the first casino ever in Japan. I might be wrong on that, but I’m maybe the first of that scale or something like that. So yeah, that’s one where I think you look at it and it’s like, yes, okay, AI has some impact on that and the proliferation of online gambling.

MGM plays that with that MGM and they have another internet suite. But yeah, I think that you look at those and I mean, Vegas stuff’s gotten crushed. I mean, Vici, who we talked about, that’s trading at 10 times cash flow.

So think about this. Just think about you’re buying a company, you’re buying a real estate investment trust with 100% occupancy. And the lease terms are like 40 years and your tenants are Caesars Palace and MGM, and now they’re diversifying into other stuff, but concentration risk is a thing.

And you’re buying it at 10 times cash flow and you’re getting an 8% dividend that’s gone up. It keeps going up. They just raised it again.

It’s just really interesting. I mean, you think of people buying like rental properties and the type of cap rates you’ll get on that and the headaches that can come with it versus buying something like that. I mean, to me, that’s such an obvious undervaluation.

I think if the CEO, I almost want to reach out to him. I think if the CEO said, okay, this is stupid, the best utilisation of cash is to buy back stock. I think you see that stock trade up to 28 again.

It’s illogical.

[Tobias] What do you make of all of that weakness in consumer discretionary? Because I’ve noticed you can see it in restaurants. You can see it across the board in anything that’s consumer facing.

Clearly people are being squeezed. What was the 3.7? Was the print?

[Tim] 3.7. And it’s all the real stuff that matters and people are feeling it. And yeah, employment’s good and wages are definitely up. People are making more money than you’d think.

Nominally.

[Tobias] Nominally, exactly.

[Tim] But quality of living and stuff like that, I don’t think it’s that high. I think that people are disillusioned. I mean, this war is not popular.

I mean, it’s not popular with conservatives even. And I would view myself as conservative. And it’s extremely frustrating because what is the outcome that solves it?

It just seems like Ukraine, where it’s just a total quagmire that is going to last and there’s no solution that’s going to make things better in the short run, at least. It’s kind of a dreary time for the American economy outside of AI.

[Tobias] What’s the comp, do you think? Is it the 1970s when we had, I think that was an Iran conflict as well with energy prices like rocking up?

[Tim] That’s an interesting analogy. I mean, you and me, we’re not around in the- Before my time, I’ve already read about it. We have read about it.

That’s an interesting comparison. And then you think about like what, you know, you have your parents or something like that, that’ll be like, well, do you know what I was paying for a mortgage in the 1980s? And it’s crazy, or a business loan, like 15% and stuff like that.

So they’re like, well, 7% or 8% mortgage isn’t terrible. I mean, it is pretty terrible for this generation. And housing prices just haven’t dropped to a level where it makes a lot of sense yet.

[Tobias] That was Volcker trying to get inflation under control, jacking up rates like that.

[Tim] You know what’s interesting?

[Tobias] That was the nifty-fifty too, where there was a handful of stocks that were just, you could buy them at any price and you’re going to be okay.

[Tim] Yeah. Yeah. So that, I mean, that’s kind of, there’s some similarities in that too.

But what’s interesting is that the CPI was so bad today and the 10 years actually, the yield’s gone down. Bonds have actually rallied a little bit today. I think that’s interesting.

[Tobias] Is that- Expectations, maybe they’re expecting even worse.

[Tim] Wow. Yeah. I mean, I think possibly, or possibly also they’re thinking, okay, they might hike sooner.

And then ultimately that kind of drives things down more quickly and how that impacts long-term rates could be something like that too. It’s above our pay grade, I guess. Yeah.

It’s a tough game to play that one. It is. We’ll leave that to Drunken Miller and those guys.

George Soros.

[Tobias] So that’s one of the nice things about being a value guy though. You don’t really have to worry so much about the macro. I think that it’s good to keep an eye on it because clearly there are some banks are affected, insurance companies are affected, banks are affected.

It explains why small and micro and cyclicals can sell off. Might tell you why micron looks cheap when it may not in fact be cheap if you normalise those earnings. But that’s been a criticism of just about everything that’s a beneficiary that has previously been pretty cyclical.

I mean, even Nvidia has been pretty cyclical in the past.

Nvidia’s AI Chip Dominance: Can Custom Chips Threaten Its Valuation?

[Tim] It has. I mean, it’s a pretty different business now, but there you go, Toby. Look, all of the hyperscalers are building their own chips now.

So they’re using Broadcom and they’re designing their own chips that are different, but they utilise less energy. And so they’re more energy efficient. And I mean, that’s interesting.

So I guess if you look at Nvidia from a PE standpoint, it looks fairly cheap once again on the ETH part of it. But I mean, that’s a pretty challenging competitive threat out there. I would think long term.

I mean, these companies are developing very viable TPUs and chips. So Amazon, Google, Microsoft has them. I don’t know.

I believe Apple is doing it. I’m not sure on Apple.

[Tobias] Could be great for the consumer if all of that comes through because you’re competing AIs that are pretty close. I mean, that was the… I was in China last year, in April last year, and one of the things that we were told by the VCs there was that they viewed the American AI.

And this is 18 months ago now. So this is old technology, but they were clearly thinking about the future there as well. They could see that everything was leapfrogging.

At the time, the American version of open AI was ahead of everything else. But DeepSeek, which is the free Chinese version, was sort of just behind it. And I wonder, for most people, do they really need the bleeding edge, expensive AI to achieve most of the things that they want to get done?

Or can they do it with a cheaper version that’s just a generation or two behind, that gives you 95% or 90% of the performance? I think that’s probably the case. There’ll be people who just use an older version off the shelf, don’t pay much for it, does most of the stuff you need, and it’s the people who…

A handful of people need the really bleeding edge stuff, and they’re probably going to pay for it. Great for a consumer, hard for a business to make a whole lot of money with that. It’s like when the hard drive makers first started coming out, they just leapfrogged each other so fast, they’d be a winner for a little while, but something else would come through, like basically an uninvestable sector, unless you really, really knew what you were doing.

And I think it’s just easier to avoid that stuff. You’re a value guy, you don’t have to be playing in all of it. It does make it painful, though, when there’s a little bit of a mania going on and everybody’s in those businesses.

[Tim] Think of Yahoo. Yahoo was the top dog, right? And then Google started just eating them up.

Remember what Yahoo’s market share got down to? The company just could not perform. I don’t see this as being that different.

Let’s say the market starts picking winners. Let’s just say, okay, we’re going to write off one of these, and we’re going to focus on a few of these, and the Chinese cheaper versions or whatever. You’re not going to be able to raise capital at the same levels, you’re not going to be able to spend at the same level, so you could really fall behind the arms race.

It’s just a really challenging time. I don’t think that companies like Amazon or Microsoft can really afford to sit around and let Muse just gobble up the consumer part of it. I mean, Amazon’s not letting…

I mean, why wouldn’t they do that themselves? I can’t imagine that they wouldn’t. Unless it competes with their customers, I mean, that’s something to think about at AWS.

I mean, maybe like Anthropic and OpenAI, they spend a lot of money with Amazon, but who knows?

Deep Value Investing: Why Quality Stocks and BDCs Could Be Undervalued

[Tobias] So, what do you think, given the overvaluation of the very top end of the market? I think that there’s some really interesting stuff around this and bargains around the deep value stuff particularly. Even quality has been a little bit beaten up over that.

There’s some names, it’s just been shocking to go through and see. I always say on Twitter, I retweet these charts when I see them and they come out, and I just say every single one of them has an idiosyncratic problem. Nike’s got a problem.

Nike’s off 80% over the last five years, Lululemon. They’ve all got specific problems, but it’s sort of across the board that for a long time, quality was sort of… The thesis in the market was that they were bond proxies, so you could bid these things to the moon.

It didn’t really matter what you paid as long as the quality was there. They would never sell companies. And now they’ve, I mean, quite a few of them just escaped.

[Tim] Dates play an impact, right? Because a lot of those are dividend yielding. Anything that…

All the dividend stuff’s gotten crushed. Utilities has gotten crushed. Real estate’s gotten crushed.

Quality like Pepsi, quality like McDonald’s has really sold off hard and are trading at some of the cheaper valuations you’ve seen. I think there’s real opportunity there for the long-term investors. This is not a market where it’s like there’s not opportunities to make money.

It’s just a market where there’s so much fear over kind of the short term. Like, okay, well, what if they miss the next quarter? It’s just the momentum is so bad for the majority of stocks.

I think 80% of stocks are down over 10% total. And we were talking a little bit earlier. So I follow the business development companies, and I have a long history following the banks as well.

And so there’s a dichotomy there where bank credit quality is good. It’s really good, actually. The valuations are way higher.

I mean, you have Citi trading at a pretty large premium to tangible book value now. And that’s historically been the laggard. And a lot of them are trading at two, three times book value.

And then you have these business development companies, like I’ll give an example, like MSDL, which I own. And Toby, it’s trading at like 67 cents on the dollar. And you look at their nonperforming loans that are like 1.8% at fair value. And the average is like 1% since 2004, according to an index. But even in the worst year, which was 2009, credit losses were like 6.9%. And so what’s priced in right now for MSDL is that all of their loans would have to only recover like 74 cents on the dollar. So you think of that from like, let’s say a 50% recovery, right?

I mean, the amount of defaults are far beyond a great recession, depression scenario. And that’s priced into the stock and these are adjustable rate loans. So they actually do a little better when there’s higher rates.

Yes, higher rates are going to pressure some of the underlying companies, but they can adjust that. But I mean, that’s a hell of an opportunity. You get like a 13% yield.

And I think the fear is, well, they’re just covering their dividend. So maybe they cut it, but that doesn’t change the discounts and net asset values. So there’s a lot that kind of stuff that for the value investor, if you can stomach it and just…

I would love, Toby, to be in the type of career where I could just buy a lot of this stuff and then look back in five years. Because I’m very, very confident in how that would look.

[Tobias] I don’t know that you need to wait that long. I think that the cycles are turning faster than they have ever before. I think 18 months is like a really long time in the market now.

I’m sure 18 months time will look back and a lot of this will have been reverted, normalised. It’s just the markets seem to be… I think the markets swing faster to the extremes, but they also swing faster to the median.

So we’ll see interesting times ahead.

[Tim] We will.

[Tobias] Yeah, absolutely. We’ll be back this time, same channel, same time next week. Any final words?

[Tim] No, no. Appreciate it. Looking forward to next week.

Hopefully we see some action and maybe a little better sentiment next week. It’s been a kind of a dreary few ones, so it can’t get much worse, God willing.

[Tobias] Good stuff. See you then.

[Tim] See you guys.