Episode #485: Dan Niles on Big Tech Stocks and the AI Revolution
Guest: Dan Niles is the Founder and Portfolio Manager of the Satori Fund, a US focused, technology biased, large capitalization, long-short equity fund.
Date Recorded: 5/31/2023 | Run-Time: 1:10:00
Summary: In today’s episode, Dan shares how his macro outlook is impacting his valuation of the big tech names. And of course, he gives his thoughts about how AI will either help or hurt some those same companies. He also spends time discussing timeless topics like the art of shorting, the importance of cutting your losses, and why he believes the most important trait for an investor is having emotional control.
As we wind down, Dan shares some risks he thinks the market may be overlooking as we head into the second half of the year.
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Links from the Episode:
- 1:55 – Welcome to our guest, Dan Niles
- 3:05 – Dan’s career and history as an investor
- 8:45 – Celebrating his sell-side research success over 20 years
- 11:03 – Overview of his hedge fund & investment framework
- 15:05 – The art of short selling
- 19:39 – A walk around the investing landscape as it exists today
- 32:59 – Valuations do not always lead to peaks
- 35:11 – Current opportunities and risks in the market
- 50:57 – Investment views he holds that his peers do not believe in
- 57:15 – Sell discipline
- 59:33 – Dan’s most memorable investment
- 1:05:53 – Learn more about Dan; Twitter; DanNiles.com
Transcript:
Welcome Message:
Welcome to The Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer:
Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb:
What’s up everybody? We got another fun episode today. Our guest is Dan Niles, portfolio manager of the Satori Fund, a US focused, technology bias, large cap, long short equity fund. Today’s episode, Dan shares how his macro outlook is impacting his valuation of the big tech names. He shares some ideas. And of course, he gives his thoughts about how AI will either help or hurt some of those same companies. He also spends time discussing timeless topics like the art of shorting, the importance of cutting your losses, and why he believes the most important trait for an investor is having emotional control. As we wind down, Dan shares some risks he thinks the market may be overlooking, as we head into the second half of this year. Please enjoy this episode with Dan Niles. Dan, welcome to the show.
Dan:
Thanks for having me on, Meb. Appreciate it.
Meb:
Where do we find you today?
Dan:
You find me in the Seattle area, so enjoying another beautiful day out here.
Meb:
For the listeners not watching this on YouTube, Dan’s got Golden Gate Bridge in the background. He just can’t let go of that California vibe. When I first moved to LA, I had one of the world’s best 415 phone numbers and I must have kept it for three or four years, didn’t want to let go of it. And it reminds me of, I was checking out at the supermarket the other day, and they say one of the best hacks if you don’t have a rewards card or whatever, they say just use your local area code plus 8675309. And almost in every state, somebody has the famous song that they put in as their requested phone number.
Dan:
Oh!
Meb:
So listeners, try it out and see if it works. Anyway man, it’s good to have you. You have a pretty fun background. There’s a couple names in there that bring back a lot of fun memories, Lehman, Robbie Stevens. Maybe give us a little bit of your quick career arc origin story?
Dan:
Sure. I mean, I’m an engineer by training, worked at Digital Equipment Corporation in the late ’80s. Started investing sophomore year in college with this girl I knew who I was dating, who is now my wife. And we started investing together when we were both broke. So had a hundred dollars that we were able to scrape up between the two of us that we invested in a Merrill Lynch account where you could buy fractional shares if you couldn’t afford to buy a whole share of a company, and fell in love with it. And so I went on and got my master’s in electrical engineering, but decided I would-
Meb:
What? Wait, hold on, I got to interrupt you. Do you remember any of the names, or any of the original themes that were … was it tech? Was it kind of like your Peter Lynch circle of competence for you? What were you buying and selling?
Dan:
It’s funny because a couple of those lessons I learned, as one in particular, it stuck with me to today and I use it all the time. So the first one I bought was Standard Oil, because my thought was, hey, the world’s going to need more oil in the future. As emerging markets grow they consume a lot more energy. And got lucky and that Standard Oil was bought out very shortly by British Petroleum back then. And so that was great, made a ton of money off of 100 hundred bucks. But for me it was a lot of money back then. And so didn’t learn much from that, other than when I think big picture, that’s good. The second one is where I learned a lot from. So I bought this company called Worlds of Wonder. And so they made the first talking teddy bear, and this is in the eighties, in 1988. And they made this thing-
Meb:
Teddy Ruxpin?
Dan:
Teddy Ruxpin, yeah absolutely. So you do remember. And they made this game called Laser Tag. So they had two of the hottest games on the top 10 list. So I bought it before the Christmas holidays. Was like, how can this go wrong? Went through finals, et cetera, finished those. And then I’m pulling up, get a copy of the Wall Street Journal looking for the ticker symbol. Because back then yeah, that’s the way you had to figure out what your stock was trading at. Couldn’t find it. And I was like, what happened? They went bankrupt over the Christmas holidays. And so you go, well, how’s that possible? Well, they couldn’t manufacture. They were a bunch of product guys but didn’t manufacture, didn’t get it to the stores on time. And so they literally went bankrupt over the holidays. So it taught me that a good product is great, but you need good execution, good management. And that’s something that I brought with me going forward. Because if you think of the tech industry, it isn’t always the best technology that wins, it’s the best execution that wins.
You can think Beta versus VHS, or whatever you want to pick, but there’s a lot of those stories out there. And so I always try to really think about how much do I trust this management team? Especially if it’s a very competitive industry.
Meb:
I don’t think there’s … laser tag would’ve been in my top five most pined for sort of consumer products of the eighties. I mean the Walkman, the Discman would’ve been up there for me. But laser tag, Man, that’s bringing back some memories. All right, so you got started off early. We always tell people, and currently during this last Robinhood generation, I said, “It’s hard to know if having early success is a blessing or a curse, on getting you interested and involved in markets.” It’s good in the sense, you’re like, “Oh my gosh, this is so interesting. I can compound my money.” It’s a little bit of a curse too when we’re young, because you’re like, “Oh my god, I’m so brilliant and this is so easy.” I mean, I remember buying E-trade in the nineties and it went up like 10% in a day and I was like, “Well, why would people put their money in a bank account, or in an index, and it only go up 10% in a year? This goes up 10% in a day. I’m soon going to be George Soros.”
Maybe not the best example anymore, but whatever the, Stevie Cohen or whoever the masters of our industry are. Anyway, so it’s always a little bit. So you kept at it. Okay, so?
Dan:
Yeah, so I kept at it. And when I graduated with my master’s in electrical engineering out of Stanford, I’m like, “You know what, let me try this investing thing, see if I like it, good at it.” And was an investment banker for four years. Didn’t like the part where you’re just basically sucking up to clients, to try to win their business. And what I really enjoyed was the valuation work, because I was focused on mergers and acquisitions. So then switched into sell side research in 1994. And that, for your viewers, that means you’re making recommendations to the Fidelity’s of the world, of this is the stock I think you should buy, this is the one I think you should sell. It’s called sell side research. And did that for a decade, had some really good success with it. And left after 10 years and decided to open my own hedge fund and I’ve been doing that since 2004.
And so that kind of gets you to where we are today. Because what I enjoyed about it was you’re figuring out what do you think the company’s worth, how do you think it’s doing? But then a good portion of your job is trying to convince other people that this is what they should be buying or selling, and that part I didn’t like at all. And so after 10 years of doing it, thankfully had some good success, built up my own nest egg, and then was able to invest my own money for the last 19, to going close to 20 years.
Meb:
So the funny thing about the sell side is one, it’s an incredible training ground. And as far as listeners who haven’t had exposure to sell side research and the depth, I mean some of these reports being 50, 100, 200 pages on industries and companies. But second is that we need to get some more sell side current research analysts on the show, ’cause I love getting deep dives on certain topics. It is a departure as you mentioned, from taking that jump from the research side to the actual implementation, which is a whole ‘nother skillset. But hey, you’ve been doing it for … Dan, you’re going to hit a 20 year track record next year. You survive two decades, Man? We joke all the time about the public funds, and I bet hedge funds is even worse, where the attrition over the course of a decade for public funds is usually around 50%. So you tack on two decades, it’s probably down to less than a quarter of survivors. And for you guys, I imagine the casualty rate is even higher, given the industry. So congratulations. What are you going to do to celebrate?
Dan:
I don’t know. My wife would probably be, “Take a year off.”
Meb:
Yeah, yeah, I like it. Sabbatical, I need one of those. I’ve been promising to do one every year for the last six years.
Dan:
It’ll probably be going to Hawaii to surf for a week. That’s my favorite way to relax if I can.
Meb:
I was joking on Twitter today with Toby Carlisle and Greenbackd, for listeners. And Cliff Asness, they were talking about some of the valuation similarities between markets today and other periods. Kind of late nineties as far as the value spreads. These are the quants talking. And I said, “This feels like it’s got a little bit of a …” And I’m a quant again, so this is my subjective happy hour coffee talk. But I said it is got a little bit of a feel to summer 2005. But I said, “To make the analog complete, we would have to go back to Central America and run around in a pickup truck.” Which is what I did right out of college. So I was an engineer too, and we ran around in a pickup truck. And I said, back then the Q’s were bouncing up 30%. Everyone said, “Okay, this is over. Life is good.”
And then we all know what happened afterwards. But anyway, all right, so you start your own fund. Give us a little overview of what’s the framework? How do you think about the world? Is this a traditional long short equity fund, or are you a macro guy? What do you guys do?
Dan:
So saying you’re a hedge fund is like saying you want to go out for food. It doesn’t tell you anything because you might be a vegetarian, you might be a meat lover like I am, though my cholesterol level doesn’t love that. But for me, what we do with this hedge fund is to the long short equity fund. It’s very conservatively managed. So over 19 plus years, roughly 25% net exposure. So what that means is for roughly every $80 or so that we have on the long side or so, we’ll have 60 some odd percent on the short side. And so the goal is for this fund, and every fund’s different, it’s to run it very conservatively. Have 20, 25% exposure of the market. Try to get a majority of the upside, or the returns over that period of time. But the main thing is, don’t lose money.
And so hopefully what this fund can do, and so last year is a good example of that, and given it’s a private investment vehicle, can’t give you returns. But I can say we were up last year with the market obviously getting beaten up pretty well. And so the idea is during the worst downturns is to hopefully be able to make your client’s money, or at least protect it. And to grow it so that when everything’s falling apart, this actually will give you some solid returns. And so that’s kind of the long and short of it, unintended. And it’s primarily, as you would imagine, it has mostly tech in it. We do all different categories, and all around the world. But as you would imagine, over 50% of the investments are on the tech space, because it’s what I know the best given my background. And we’re kind of agnostic to the stocks, and we’re pretty good on the short side mostly.
And that’s where our real alpha generation comes in. I mean if you think about last year we were net long last year, like we generally are all years. And very low exposure. We made money because our shorts did very, very well, relative to our longs. And then so that offset it, and that’s how we made money last year. And so that’s what we try to do, pick the best in an industry, hopefully short something that’s having issues, and use that against each other. We try not to do what I call relative valuations and things like that where we say, “Well, this one’s more expensive so we’ll short that. And be long, this one’s as cheaper. What we try to do is find fundamental reasons to be long in one stock and short in another one. And especially in tech, as you find out when you’re going through more normal times, there’s definite bifurcation between the winners and the losers.
And you even saw it with this most recent earning season where some of the internet companies like a Google or a Facebook did really well, and then other ones like a Snapchat or Pinterest did really poorly, and you’re seeing share always shift. And that’s the beauty of the tech industry is it’s not static. The winners and losers seem to change around pretty dramatically every decade and there’s very few companies that make it through from one to the other.
Meb:
That’s a very traditional old school like Alfred Winslow Jones. Going back a hundred years of the origins of hedge funds. Maybe not a hundred, but close enough to where it really was about stock picking. Your longs, your best ideas, the shorts are the ones that we expect to go down. Sort of market independent, which last year was a big down year for stocks. Talk to me a little bit about the short side. It historically is a very different skillset for many portfolio managers, as well as analysts. And a lot of people, even short exposed funds have learned that lesson again over this cycle. But if you look at the graveyard of short selling only hedge funds over the past 15 years, I mean we’ve had this just monster S&P period. The number of short selling hedge funds dedicated has just declined every year, to where it was almost extinct.
But it’s a unique skill. And I like to say we’ve had a ton of old school short sellers on this podcast, and I like to say they all have a little bit of a screw loose. And I say that lovingly, you kind of have to. But maybe talk about that balance. The macro, how you think about the portfolio as a whole. And the struggle or opportunity where there’s times when there may be tons of longs and not many shorts, or tons of shorts and not many longs, and how you kind of find a balance there?
Dan:
So as you rightly pointed out, I mean short selling’s really tough because just you think about the math. The most you could ever make on the short side is a hundred percent, the most you can lose is infinite. So right there, the risk reward, it’s really tough with shorts for that reason. And especially in this environment. And this has happened before. In the late nineties this also occurred, except it wasn’t as well organized because now you’ve got Reddit boards, et cetera. But you’ve also got retail investors who have realized that you band together and you can make stocks do anything. GameStop obviously, people are familiar with that. Last year got up to 450 bucks, started around five bucks or so. And so you can really get caught and just get destroyed if you don’t have good risk management. And I think that’s one of the things we try to do on the short side is, we’ll have some very big positions.
We’ve had 15% of the assets in the fund short one single name before. But in that kind of instance we’re short something like an Apple, or Google, or something where we go, we’re not going to walk in tomorrow and find out that they got acquired. So you don’t want to do that in a small cap name like a GameStop et cetera. And so you need to really manage the short positions much more actively than you’d manage the long positions, because the downside’s limited unless the company you think is going to go bankrupt. And so at a certain point you go, “Well I need to cover that short.” And sometimes you go, “Well that short may actually turn out to be a good long.” And so for a lot of our tech positions, some of our best short ideas turned into some of our best long ideas, and vice versa.
And that has more to do with where do you think fundamentals are with the company. Because sometimes it’s as simple as, Facebook’s a great example. Where we were short at the moment it opened for trading on its IPO, and I was fortunate to get written up on that trade. And the stock just continued to collapse if you remember, from the moment they went public. But the reason we were shorted is there was this thing called the smartphone that had shown up and people were starting to access their Facebook accounts through their smartphone. Well Facebook made no money on it, they didn’t have advertising on mobile. So our view was pretty simple. Smartphone adoption we think’s going to be pretty good, and they’re going to have an issue. And then people are going to say, “Oh, this is just a fad. It’s social media, it’s not going to be here to stay.” Et cetera.
And then a quarter or two into it, they did launch their smartphone app and we turned around, covered our short, got long in it, and it’s been a great stock obviously on the long side. But even there you go, well over the course of about a year the stock went down 75%, as TikTok was taking share and Apple made their privacy changes, stock got pummeled. And then back in November after they gave that horrible guide of we’re going to spend an ungodly amount of money on the metaverse, we came out and said publicly, “Hey, we’re buying the stock.” Because they just guided to expense growth. Doesn’t mean they have to spend it, and they can turn around and cut that spending plans whenever they want, which they did by the way two weeks after they gave guidance. And their product called Reels is actually doing quite well against TikTok. And the stock is now got a P/E almost in the single digits, which is half the market valuation.
And so now that great short, dropping that stock, now we turn around and say, “Oh well, this is kind of interesting on the long side.” And Apple’s a case in point, where we tend to trade around that name. And right now we’re logging into their product event, which is going to happen early June. And what we’ll probably end up doing, because we think the numbers have got to get cut some more, the stock tends to run into that. I’m sure we’ll end up selling it and shorting it at that point because of the valuation and where it is. So for our longs and our shorts, a lot of times they’re the same names. And the bigger shorts are the bigger names. Where we go, there’s some fundamental reason not to like an Apple, or a Google, or pick whatever it is.
But we can hopefully match it up against something like a Facebook where we go, “Well you know what? The valuation’s really compelling, and they’re using AI to help their ad placements, and they’re gaining share against TikTok.” And the government obviously is pressuring TikTok, and so we can match that short up against a long in the same industry. And hopefully that enables you to have a really well constructed portfolio. And that’s what we strive for if we can, is each short should stand on its alone, by itself. But if we can match it with a long, that’s even better.
Meb:
What you were just talking about I feel like is really instructive and useful, because most humans get psychologically and emotionally attached to purchases and investments. So somebody buys a stock, they spend all day then looking for confirming evidence of why they’re brilliant. If you’re a Tesla bull, be damned. If you’re going to look for information that’s like, “You know what? Actually my thesis might be wrong.” You’re going to spend all day reading supporting things about Elon Musk, and the new product launches, and how Tesla is going to colonize the moon with space, and on and on. And vice versa with the Tesla bears. Very rarely do you see someone saying, “You know what, I’m going to be agnostic about this investment, and see that there’s times when it potentially could inform on both the long and short side.” I feel like that’s a pretty rare and unique mental dexterity, that most investors, I think they don’t really think about it that way. Does that kind of feel familiar, or does that seem to be the case for you?
Dan:
No, I think that’s a hundred percent true. And I always try to say to people, don’t confuse a great product like Teddy Ruxpin or laser tag with a great company. And I think investors do that all the time, is they confuse the two things. Because those are two very different things you have to think about. And I think, I always like to tell people you may love a stock, but the stocks may not love you back. And so you can’t get emotionally attached. Because especially in technology, I mean you can think about the cell phone industry is a great example of that. Where at one point Nokia had 40% market share, and then Motorola came around with the flip phone. And I remember that was the first one I had. You may remember the Startac?
Meb:
I was a big Razr guy. Man, I think I would go back to the Razr honestly at this point.
Dan:
Yeah, and then the Razr. And then if you remember Motorola then was the hottest stock. And then there was this thing called the Blackberry that came along, which if you remember was affectionately termed the Crackberry, because it was so addictive. And then then Blackberry was the hottest stock. And then this guy pulled something called an iPhone out of his pocket in ’07, and that’s now the hottest thing. And you can think about the internet, same thing. Search, you go Alta Vista, and Lycos, and Yahoo. And now you got this thing, new thing called Google, what’s that? And, “Oh my god, look at that!” And so that’s the great thing about technology, is it keeps evolving, keeps shifting. The winners become the losers. There’s very few companies like Microsoft that have been on top for three decades now, in one way, shape or form. And it creates some great opportunities if you are on top of it.
But to your point, and I think this is really important that you brought up Meb, is that I think the biggest trait to successful investing is emotional control. You have to be able to admit you’re wrong and cut your losses. I try not to ever look at where I bought a stock, or where I shorted a stock, because that has no relevance to whether it’s a good investment. Or cover today, where I actually purchased the thing at. It’s a horrible way to do it and I think a lot of investors make that mistake when they’re investing. And it’s something you should break, where every day you get some new pieces of information you need to think about that and adjust. The one I remember most recently is, I remember Jeff Bezos putting out a tweet, and it was signed off with, “Batten down the hatches.”
And I remember because I was long Amazon at the time and this was a couple of quarters ago. And I remember looking at that going, “I’m dead.” Immediately sold the stock and then shorted it, because I’m like, he’s obviously seeing something in his business. And that’s the thing you want to learn about these CEOs, is when they make economic comments, they’re making it because of something they’re seeing in their own business. And so you have to be emotionally flexible to go, “Well clearly, something’s changed. But can I make money off of that?” And the great thing is, “Hey, I have some other names that I like. So let me get rid of it and short it.” And turned out they did have a problem with their retail business and we made some money on that. So I think you have to have good emotional control, and be able to be very flexible in your thinking. Especially when you’re in an environment like this, where you have so many crosscurrents going on with the bank failures, the interest rate hikes, high inflation.
And then as you pointed out when we started the podcast, the wide divergences you’re seeing in valuations across different sectors. As we’re talking about it, obviously NASDAQ’s up 20%. S&P’s up high single digits, and the Russell’s actually down for the year. And you haven’t seen these kind of spreads between the small caps and the NASDAQ since, you got to go back to I think the late nineties or so to see that. And I just don’t see how this is going to last. Because everybody’s looking at Nvidia and going, “Oh my god, estimates almost doubled for the July quarter when they reported.” And they’re thinking, “Oh, every company’s going to be like that at some point.” And that that’s just not going to be the case. And so it’s going to be a very interesting Q2 reporting season I think, in that regard.
Meb:
Well give us a walk around the investing landscape today. We’re recording this the last day of May. My nuggets start the NBA finals tomorrow, so this will probably be on in two weeks. So listeners, probably this is mid-June when you get it. But summertime, how do you think about the world today? Because you talk a fair amount about macro as well, which we love. But at your core you seem like a stock picker at heart. I don’t know if that’s an accurate characterization. But, so what does the world look like today? You mentioned Nvidia, which is seemingly 90% of the headlines on anything anyone’s talking about.
Dan:
Yeah and it rightfully should be. I mean, you don’t see a mega cap name guide revenues 50% above expectations. I don’t think I’ve ever seen that. The estimates were 7 billion for the July quarter and they guided to 11. I mean, it’s unbelievable. And EPS roughly the implication is that roughly doubles, relative to where people had it in July. But I think you do need to remember the macro picture. And if you’ve only been investing for the last 15 years or so, you have no idea what real investing is. And what I mean by that is, since Lehman failed, you had central banks around the planet, and governments around the planet, stimulating the economy whenever there was a problem. And that’s because inflation was very low, so you could do that. I mean if you think about it, just big picture, if I were to say, “Hey Meb, guarantee you there’s going to be a global pandemic that kills millions of people, shuts down the globe, you’re all trapped inside your house.”
Your first thought wouldn’t be, “Oh, let me run out and buy stocks.” But that’s exactly what you should have done, because the S&P finished up ’20, up 16%. Now why was that? Well, it’s because central banks massively expanded their balance sheets because inflation was so low. Well, if you think about where the world is today, a lot of those trends that kept inflation low for decades is reversing. So China had their first population shrinkage since I think the 1960s, so cheap labor to produce goods is gone. Because of the geopolitical environment people are trying to produce goods in their own countries now, which is much more expensive than outsourcing it to China. So that’s also gone. And then cheap energy is also gone because you have a lot of ESG policies. Which are great for the environment, but what it does do, is it restricts investing in capacity. And these are not renewable resources, so that means cheap commodity prices are also going to be gone.
So things that have been long-term deflationary for decades are now turning inflationary going forward. And then you fast forward to where we are today, we’ve had the fastest rate hikes since the 1980s. What people forget is that takes time to play out. And you’ve also had three of the four biggest bank failures in history in the United States that just happened. And lending standards have gone way up, and that’s also going to take time to play out. And so that’s why for us, we think between now and year end, the stock market declines. And the downside risk is pretty high in my opinion, in the sense that you take peak earnings for the S&P 500 in 2023, at one point middle of last year was about $252. In a normal recession that goes down about 20%, so that gets you to about 200. When CPIs above 3% over the 70 years of history that we have, the multiple on earnings is about 15 times.
So that puts your downside risk if things go really south, at about 3000 on the S&P, and obviously we’re a lot higher than that today. And so that’s to me is the risk reward, in terms of where you’re sitting. Where the tightening and bank failures affect earnings as we go throughout this year. Inflation remains higher than what people think. That’s not a good combination ’cause that basically ties the hands of every central government, central bank around the world as well as government, in terms of how much they can spend to simulate the economy.
Meb:
Yeah. The talk about Nvidia, and I don’t speak specifically to Nvidia, but some of the rhymes and discussions. I think back to my favorite kind of bubble period, the late nineties, early two thousands, and the darling certainly at the time was Intel. And Intel, the description you make earlier, which I think is such a fantastic framework, but almost impossible for most investors. It’s almost like you need a app or a website that would blind the market cap and the price. Because anytime somebody wants to look at a stock, what do they do? They pull up the quote. They look at the market cap and the price, no matter what. And Buffet talks about doing this too, but I think it’s really hard to train yourself to do this. But say, all right, I’m going to look at the fundamentals, I’m going to look at the story, and I’m going to come up with my estimate of what I think the actual market cap slash price of the stock should be. When I do this all the time with my family when we’re talking about other things, not stocks, but talking about other things.
And so because then you get that anchor bias. You’re like, “Oh my God. Well the stock trades for a trillion and clearly it’s a great deal.” But if you were to blind, kind of go about it, it removes that bias. So listeners, if you want to start that website, let me know. It’s like a Tinder for stocks, but no price and market cap info. But a good example is Intel. Late nineties, if you just look at the revenue since the nineties, it’s gone up from 10, 20, 30, 40, 50, 60 billion. On and on, just this beautiful, not very volatile revenue chart for the past 30, 40 years. But then you look at the stock and it’s down over 50%, still from 2000.
And that just goes to show, and just it’s kind of alluding to part of your short book, but the price of an investment relative to the fundamentals is not the same thing. And there can be a pretty long, because they were the darling of the day. I mean, had books out on Intel and everyone wanted it. And here we are 23 years later and it’s still a mile away from the peak.
Dan:
Yeah. And there’s multiple stocks you can say that about. Cisco is another one. Networking obviously a bigger deal today than it was in 2000. Akamai serving webpages, obviously much bigger deal than it was back in 2000. That stock’s down over 50% from there. Sienna obviously again, networking space. Optical, obviously a huge deal for delivering all those videos we like to consume. Stock is down over 50%, revenues are up multiples of what they were in 2000. And so I think the one thing I would say, is that I don’t focus on valuations that much. In the sense that, as you saw with GameStop, or even go back and pick a real name. You saw it with Volkswagen way back when, if you remember, and the short squeeze that was under. And it became I think, very briefly the world’s most valuable company, when they were going through that whole scenario with Ferrari.
But the point being is, valuations though make a huge difference at turning points. So when things roll over and people figure out, “Hey, fundamentals are poor.” Or when they figure out, “Wow, the company’s actually turning around.” With Facebook for example, the stock is up a lot, partly because it got down to such a low P/E level. It was literally in the single digits at one point, at its low point, where you go, “Wow, given its half the market multiple and normally it trades at near the market multiple, that gives me a lot of potential valuation catch up if it’s good. And likewise, when things roll over and they’re bad and they start missing, Tesla’s a good example. The valuation didn’t matter until you saw the top line in unit growth starting to slow a little bit relative to expectations. And then all of a sudden it really mattered. And so that’s the other piece that I try to remind myself, because some of my worst investing mistakes is looking at valuation and saying, “Okay, well that makes no sense.”
And as that famous saying by John Maynard Keynes is, “The market can stay irrational longer than you can stay solvent.” It’s something I try to remember, especially when you’re looking at shorts.
Meb:
Well, tell us a little bit about, and whether you’re comfortable saying names or not, but it could be themes or general topics, about what are the opportunities you’re seeing today? As well as the landmines perhaps, or things to be cautious about?
Dan:
Well I think the big one is, if you think about the macro, and you think about tech in particular, tech companies are the biggest spenders on technology inside IT spending. It’s about mid-teens. The second biggest spender though is financial services companies. And you saw three of the four biggest bankruptcies in history and all of these companies are now trying to make sure they stay in business. And they’re cutting back on spending because of that. And so the impact of those failures, bank failures, and companies really trying to control expenses, you’re going to start to feel that as you go through this year. And financial services companies are 11, 12% of total IT spend. And then all the fed tightening and bank lending standards going up is going to restrict capital even more. And so I think with Nvidia, you look at that if you’re a tech investor and you go, “Oh my god, that’s huge.”
And today as we’re doing this webcast, Hewlett Packard reported, Enterprises, as well as HPQ. And both stocks are down because both stocks had issues with their top line. And so investors are figuring out, well Nvidia may be a special case that you can’t apply it to everything in technology. And I think that’s going to be become more apparent as we go through this year. And so that bifurcation is something I’m really paying a lot of attention to. There’s going to be some shifts going on. Everybody is very bulled up as they should be on Nvidia. We actually like Intel and we’ve talked about that since they slashed their dividend and all the issues they had. Because big picture, the way I think about Intel is very simple. About six, seven years ago they made the decision not to go EUV, and in English that just means a new technology to produce chips. Which unfortunately, will cost about 250 million bucks per machine. Because they thought they were smart enough to get around it, use exotic materials and all this other stuff.
And then what happened was, they went from having technology leadership, to losing technology leadership, because TSMC adopted EUV early, and then they took the lead. And AMD riding on that coattails took a lot of share. Well, two years ago when the new CEO came in, he said that was a big screw up. Went all in on EUV and now they’re starting to see finally, some of the benefits from that. And so I think there’s going to be a lot of shift, whether you pick Intel where you say, “Well yes, Facebook may do well, but what’s going to happen to advertising spending overall?” Because ad spending is very economically sensitive. So if you do go into a recession, which is our base case for this year, later this year, because of the tightening that we talked about in financial markets, in terms of lending and rate hikes. Then advertising probably gets hit.
Well, Google probably feels some impact from that. Whereas Facebook, because of them already going through a lot of issues with Apple’s privacy and what’s going on with TikTok, they may be able to get through that better. And then what happens to Apple? Are people going to run out and buy a new smartphone? Are they going to buy a $3,000 mixed reality headset if you’re in a recession, especially if you upgraded your smartphone during the pandemic? And the stock trades at a high 20 P/E. And by the way, out of all the big tech companies that reported the March quarter, Apple was the only one to have June quarter estimates go down. Microsoft went up, Amazon went up, Google went up, Facebook went up, Apple’s went down. And smartphones for those who don’t realize this, smartphone unit sales were went down four years in a row before the pandemic spurred all of us to upgrade.
And Apple’s obviously the most valuable company in the world and there’s a lot of companies tied to that. I think estimates are too high for June, and we’ll see what happens, given where the multiple is relative to the market. As I said, valuations don’t matter until they do. But that gives you a way to judge the risk if something goes wrong. Much like with Facebook and what happened to that multiple. So I think that this is going to be a really fun year because you’re going to have to know really what you’re doing. Because the Fed stimulating and governments giving you stimulus checks isn’t going to be there. And the splits you see between the haves and the have-nots are going to be huge I think, as you go through the rest of this year. And also some of the quote/unquote, less exciting companies, like the consumer staples sector, we have a lot of investments that we’ve added in that space over the course of the last week or so, because those stocks are getting killed.
Anything with the dividend or value, et cetera. Utility stocks, healthcare stocks, they’ve been just getting absolutely thrown in the dust bin. While all the quote/unquote sexy tech names, because of the whole AI hype … and by the way, AI is real, it’s going to transform multiple industries everywhere. So when I say hype, I mean more in that every company is now viewed as, “Oh, they’re a play on AI and tech.” If you can brush it somehow with that brush. And so all these quote/unquote big cashflow generating companies are thrown in the dustbin. That’s where we’ve gone to look now, where we’re saying, “Okay, those are going to be much more defensive if we do go into a recession.” People hate these names. Energy’s another one you can throw in there. Financials as well, though that’s obviously a lot more stock picking there, because of some of the dangers in that space.
And so I think the market’s going to have a much different view, and potentially a 180 degree view, on which sectors they like and which ones they hate, by the time we get to the end of this year. Especially if a recession does occur, which is our base case.
Meb:
Man, there’s a lot in there. I feel seeing, this is very relatable to how it feels this spring/summer. As you think about the shorts, how do you dig these up for the most part? You know mentioned the timing is important, and how you think about valuation. But when you’re ready to put one on, is this sort of a timeframe when you’re thinking, is this weeks and months? Are some of these sort of you’re betting on them being terminal zeros over the course of years? How do they make their way in your book? And to the extent you’re willing to talk about any general themes, certainly feel free to use them as use cases. Or historical ones that you’ve maybe put on in the past that have worked out or not.
Dan:
Well, I’ll pick one today, it’s advertising. And so Google’s one where we’re looking at that. And so you’ve got to remember with my shorts, so by the time you air this, I may have shorted it, got long it, shorted it, got long it, as I’m looking for the optimal time to put it on. But people don’t realize the downside risk. Because if you go back to the last real recession we had, before Covid, advertising spending went down about 20% over that ’07, ’08 period of time. Now Google was just a fledgling company and so it grew through that. Now, and by the way, internet ad spending as a percentage of total ad spending was in the low double digits, today it’s over half. So if you do go into a recession and people do cut back on advertising, Google’s going to feel it. But investors sort of have this view of, “Oh, it’s AI.” Which it is.
I think I don’t see them losing much share at all to Microsoft, in that by the way. But I think people are viewing it as, “Oh, this is really safe, because look how well they did during the last recession.” And I think it’s going to look a lot different. So my views typically start with what’s going on big picture? And by the way, if you think about what we’ve seen, Disney reported. Their advertising revenues were absolutely horrible. They’re a pretty good company. Paramount, pretty good company, advertising revenues were horrible. You’re starting to see that show up in the media space in a big way, at some very good companies. Which makes me then go, “Okay, I’m starting to see some of the beginnings of this starting to show up.” And you got to remember, if you’re a tiny company, you might be able to get around this.
If you are a mega cap name, it’s much harder to avoid something, where if you are the dominant player in the space. And so the way I do it is, it’s sort of this mix of what are the big picture macro thoughts, what are the companies that fit within that? And then is there some discrepancy between what people think, versus what I believe will happen? Especially if things are way different today, versus the last time it happened. Being, internet’s gone from low double digits market share, to now two-thirds market share. And therefore, the fundamentals of the companies are going to be way different than what people think. And then I look at the valuation of Google’s … Google by the way, doesn’t have a demand in valuation. It’s a market multiple, that’s not a big issue. But when you have a market that’s this crowded where everybody piling into the same group of tech names, Google being one of them, then the potential for dislocation is really high.
Apple to me is an even better one, because everybody’s convinced themselves that this is like toothpaste, it’s a consumer staples company. Because they have one in their pocket so it kind of makes sense. But the only way you get that multiple is, you have to imagine that what we’ve seen since Covid is the way it’s going to be, versus what we saw in the four or five years before Covid, where smartphone units went down every year. And then you look at services, which is on top of that, services was disappointing when they reported, it was five and a half percent revenue growth. That missed, by the way. They guided to about the same in the next quarter. And with services, I don’t know about you Meb, but I know during Covid we subscribed to a whole bunch of different stuff to keep ourselves amused. And looking at it going, “Well, I really don’t use this service, and I really don’t use that service, and so some of this stuff we should cancel.” Because now we’re going out to restaurants, and going to movies, and planning on going on vacation, et cetera, et cetera.
And if the economy’s slowing down for people who aren’t as fortunate as we are, they’re going to tighten their belts a little bit on some of the stuff that they probably spent on, that now they don’t necessarily need. And with an Apple at a high twenties P/E, versus the market at a high teens P/E, there’s a real valuation discrepancy there. And so that’s kind of some of the thought processes I go through. Now, if it turns out that hey, people are buying Apple smartphones, and they’re not buying any Samsung or anything like that, obviously we’ll change our mind, because Apple doesn’t have the kind of dominant share that Google has inside advertising. Apple’s still … of course as big as the company is, they still have less than a quarter of the market share, we’ll change our mind, and we do.
As I said earlier in this podcast, we’re long in it right now, we’ll probably sell, turnaround and short it after the mixed reality headset launch that’s coming up. Because the stock has tendencies to run into these events, and then sell off on the other side. And if there’s a fundamental issue, it’s going to be even worse, and we think there is. So that’s kind of two case studies, in terms of how we think about the macro and the micro working together.
Meb:
How far down, we spent most of the time hanging out in the large-cap tech world today. How much time do you spend going down the market cap size? Where are you willing to fish? Does it bottom out at a certain level for you guys? And do you see opportunity in any of these sort of mid-cap or small-cap world?
Dan:
Yeah, absolutely. So for us, our smallest investment has been down about the hundred million market cap. So there is a trade-off between the market cap and the risk you’re taking on. Because if I’m long or short on a Google or an Apple, I can change my mind in seconds and flip the position. And the thing I think you have to remember when you’re a tech investor, or in any sector, is have you gotten yourself trapped? And if you’re running any kind of money and you’re in a small cap name and something goes wrong … and I’ve lost money in so many different ways, and that’s the good news. When you’ve been doing it this long, you have all these lessons of how fallible you are. And whether it’s my earliest with Worlds of Wonder, or up to most recently being long Facebook over a year ago when they ran into that problem with TikTok, you’re constantly reminded how fast things can change, and how quickly you need to adapt.
So if you move down the market cap curve, it gets tricky. There’s one name we’re involved with right now, which I don’t think I want to mention what it is. But when they reported earnings the stock went down 40%. It’s a very exciting company in terms of inventory management and tracking. It’s a semiconductor company and it’s one I’m looking at saying, “Well this could be …” And it’s on the smaller cap side. Or I shouldn’t say small-cap, it’s small to mid. Where I go, “Wow, this thing could be double, triple. But am I getting compensated for the risk I’m taking on?” Because the multiple is still about two x what the market multiple is. And so those are things you’re trying to work your way through as you’re looking at that. Because I think as you move down the market cap scale … Now for a retail investor it doesn’t matter as much, because you can get in and out of these names very quickly.
But for an institutional investor, at least for me, where I take big positions that’s the other thing. Most mutual funds have a hundred to 200 positions. You can’t have a hundred to 200 good ideas, it’s not possible. We typically have closer to 20 to 40 positions. And out of those, I would say I’ve got three or four that I’m like, “This thing I think could kill it. It could be a double.” And so if I put 10 to 15% of my portfolio in a small-cap and I get it wrong, you’re dead. Especially if you can’t get out of it except over a week or two. Because on these moves sometimes, as I said earlier, this name we’re looking at, it went down about 40% in a day.
Meb:
Let’s bounce around on a couple other things. You’re a classic style, a little more old school. I love it because it really, at the end of the day, it comes down to security analysis. I mean obviously there’s some macro elements to the long and short book and how they’re balanced, but it’s really security selection is the big driver. Let’s talk about a few things we’ve been talking about more recently on the podcast. One, we like to query people is kind of thinking out of the box and a little non-consensus. Any views that you hold that the majority of your peers do not hold? And this doesn’t mean specifically to a security, but just thinking about the investing landscape, or framework, or how you think about the world. And so I’d say at least three quarters of your peers would say, “Dan, no way do I agree with that.” Is there anything particularly non-consensus that comes to mind?
Dan:
Yeah, I think there’s probably a few. One is that inflation’s going to be a much bigger problem, even with slower growth, than most people think.
Meb:
You think it is going to be a bigger problem?
Dan:
Yeah. And then one way to think about that is the US as a services led economy. We’ve got 50% more job openings than people unemployed and that’s just going to keep pressure up. And we talked about some of the structural things. Population world slowing in emerging markets, ESG policies affecting inflation or commodities. And then on-shoring, or friend-shoring, or whatever you want to call it, increasing cost of production. And so I think that’s going to just keep inflation higher than what people are thinking, looking in the future. I also put 90 plus percent probability on China reunifying Taiwan in the next few years.
Meb:
90% that it’s going to happen?
Dan:
Yes, that it’s going to happen. And by the way, if you go back and look what we wrote entering 2022, we said one of the risks was Russia invading the Ukraine, and China invading or reunifying with Taiwan, and obviously the Russia scenario happened. Elon Musk said it very well in an interview he had recently where he goes, “You don’t need to read between the lines, Xi Jinping has told you what he wants to do.” So I think US investors are sort of taking this cavalier attitude on it’s never going to happen. And what I would tell you is, Xi Jinping has told you what he wants to do. And I also think the market has a lot more downsides. As I said earlier, I think 3000 is the low end of where it could go to. And the way I would put it to your viewers is, you should go back and look at 2000, what happened to the NASDAQ, because I lived through that. And what people were thinking in March of 2000, when the NASDAQ was, I want to say around 5,100 or so.
And then what they were thinking in October, I think of 2002, when the NASDAQ had gone from about 5,100, to about 1,100. So down about 78% from peak to trough. And Amazon stock had gone from 106 to six. Because if you think about it, the big thing back then was the internet. Internet’s going to change everything. We’re going to need all this more capacity, and optical equipment, and networking equipment, and processing power, et cetera. And all of that was obviously true two years later, or two and a half years later, when the NASDAQ had gone down 78%. So now valuations back then were a lot more egregious, I would argue than now. But in some ways valuations are more egregious today given the growth rates, than where they were then.
And so it depends on how you want to look at it, and you know what people are thinking. And so we’ll see how this plays out. So I’d say that’s another sort of non-consensus view, that the market has that much potential downside if things go really south. And I don’t think we’re done with the financial sector issues, because I think commercial real estate’s going to be an absolute disaster by the time we get to the end of this year. And the easy way to think about it is during Covid, you essentially doubled the commercial real estate available. Why? Because your home turned into your office. And so now we’ll see how work from home policies evolve, but all of a sudden, all these companies don’t need all this office space, because now you’re doing partial hybrid work from home environments. Some companies have obviously said, “Hey, everybody’s got to come back into work.” Which I understand for certain businesses that’s important. But you’ve now got rates much higher than they were three, four years ago.
And as a lot of these loans come up for refinancing, the value of the property is way less. The occupancy is weigh down, and the rates you’re going to have to pay to refinancing are way up. I don’t think we’re through this yet. And so I think there’s going to be a lot more damage coming out of the commercial real estate side. And I think some of these mega-cap tech names, and I’ve mentioned two of them that I’m thinking about, like Google and Apple. If you run into any kinds of issues with some of these names that are sort of, people have taken this view of, “Oh, just own them. Don’t worry about trading them, they’ll be fine forever, I would bring up the Amazon example. You brought up obviously Intel earlier. Whole laundry list, Motorola, Blackberry, Nokia, Yahoo. You can run through it.
But I think people have sort of convinced themselves because they made money during global pandemic, “Hey, what could possibly go wrong?” And I think this is just going to take a lot longer to play out than people think. And it may be years for us to find the right level and mix between valuation and fundamentals, because of 13 years of easy money policies, ever since the global financial crisis. And as I’ve said many times, there’s no free lunch. It may be a decade or two later that you’ve got to pay for that free lunch, but I think the payment is now starting to come due. And we’ll see because of high inflation tying the hands of governments and central banks.
Meb:
So let’s say somebody’s listening to this and they’re like, “Okay, Dan’s got me nervous here.” How should an investor think about a sell discipline? Whether it’s on a name, or kind of the portfolio dynamics in general. You mentioned you’re pretty tactical, and fast, and willing to change your mind. A, how do you think about it? And B, how in general should one think about it, if they’re trying to take some lessons away from how you think about the world?
Dan:
Goldman Sachs has this great phrase, “Be greedy long term.” And that’s how I think about it. And there’s one real easy way right now, where you go, “You have a great alternative. Three month treasury bills are around 5.2%. That’s a good return and there’s no risk.” And this is not like there used to be a phrase called TINA, there is no alternative. Now they call it TARA, there are reasonable alternatives. So you can get a reasonable return in something that’s completely risk free over time. And that, by the way, three month T-bills was one of our top five picks entering this year. And so there’s some periods of time, the 1980s is a good example, where there was a lot of chop and the markets would oscillate back, up and down, up and down. And on a price basis for a decade, you basically didn’t go anywhere because of this.
And so I think unfortunately, I mean investors need to think about this in a continuum. You made 16% in the S&P during a global pandemic. Which by the way, the long-term average return on a price basis is about 7.5%. So you made more than double the normal return during a global pandemic. And so you just may need, there may not be a lot of good alternatives over the course of a few years, as you have to work through that. Much like, go back to the tech bubble. You had a decade long expansion that then took two and a half years to work your way through, until you found the ultimate bottom and I think we’re still in that process of working our way through it. So fortunately, I think the good news is you do actually have a great alternative, and that’s treasury bills.
Meb:
Yeah, that’s weird to say. It’s been a long time.
Dan:
It’s been a long time.
Meb:
Before saying that. What’s been your most memorable investment? Man, we go way back to your times with your girlfriend.
Dan:
My wife.
Meb:
Anything really stick out as good, bad, in between? Feel free to talk about a couple of them, but anything really burned into your brain?
Dan:
Yeah. I mean a great one, and you brought up valuation before, was a loss a mistake of mine? Because it’s the mistakes I think, if you can learn from them. Some people just don’t take away the lessons they should. But I remember in, I want to say ’98 or so, I downgraded Dell. Because the multiple had gone from sort of a 20’s P/E to 40’s P/E. And for those of you don’t remember what valuations were back then, those PC stocks generally traded a low to mid-teens multiple. And so I looked at 40 and the reason it got up there was, there was this new thing called the internet and Dell was selling some PCs over the internet. And my view was, well wait a minute, everybody can sell a PC over the internet, this is not something new. And the valuation, I was like, this doesn’t make any sense.
The valuation then went from 40 times to 80 times. So I took it from a buy to a neutral, and that was a really good lesson. In a big cap, liquid name where you go, valuation just doesn’t matter. And then I remember I was doing some work around Valentine’s Day in 1999. And the good news is, IDC and Dataquest, they have these quarterly units that they would put out for the industry. Now Dell’s off quarter, so their quarter ends in April, but they sort of roll up numbers. And so I remember looking at sort of how it looked like things were tracking, going, “Wait a minute, I think they may have actually missed the quarter, and numbers have to come down.” Now you got to remember, Dell during the 1990s, the stock was up something like 89,000%. Which means 5,000 invested at the beginning of the decade would’ve netted you about four and a half million dollars at the end of the decade.
So this was a massive career risk on my part, where the stock was trading at a hundred, I put an $80 price target on it, the best performing stock in the S&P 500 for the decade. Because at this point, I looked at it and I said, at an 80 multiple, or that’s roughly where it peaked out, if they have an issue and it turns out others can sell PCs over the internet too, and the growth is slowing because oil prices have spiked, et cetera, then this stock’s going to get absolutely hammered. And they reported numbers weren’t great. Stock went from a hundred to 80, and then the multiple went from 80 times into the single digits over the course of the next several years. The lesson I took away from that though, is don’t look at valuations because they just don’t matter, unless something happens with the fundamentals that makes people look at the valuation.
And that was a fantastic thing for me to pick up. Facebook also was a great one, because if you remember when it went public, there was a lot of hype around it. And then when the stock got cut in half, everybody hated it. And then it’s like, well yes, because they not making any money off of mobile devices. And then when they did, it was great. And so that was another great one. And then most recently I remember being on TV saying, “Hey, I like Facebook here in the low nineties, because they just guided to what they’re going to spend. They can change that tomorrow if they want. And their fundamentals are really good.” There was nothing wrong with the fundamentals. They’re doing well against TikTok. Their TikTok related product called Reels, revenues have tripled, or I think doubled at that point, quarter to quarter. And user engagement’s good, which was surprising because everybody was on social media during the pandemic.
So I thought there’d be less engagement, there wasn’t. And I’m like, “This thing’s at a really low valuation.” And I remember telling that to people, “Zuckerberg’s not stupid. He will cut the spending if this is causing him to lose engineers because the stock’s collapsing.” And two weeks after that he did. But it just sort of reminds you again, don’t let the way the stock’s acting confuse you with what’s going on fundamentally. So those are some recent ones. And then as we talked about earlier, I mean I lived through getting the Startac was my first phone. Then had a Blackberry, then had an iPhone. Watching that whole transition was interesting. Watching Apple almost go bankrupt. Some of your viewers may not realize that almost happened to them, until Microsoft took a 25% stake in the company to save them from bankruptcy. That was interesting obviously, because I remember when the first Macs came out. And that really was the first personal computer arguably, and how they basically created an industry to some degree. And then, it’s on the verge of bankruptcy.
I worked at Digital Equipment Corporation and I remember Ken Olson, the CEO at the time saying, “I don’t think anybody’s ever going to want a computer on their desk.” And I remember working at DEC in the late eighties. And by the way, DEC at the time was the Google of its day. It was the hottest company on the planet, everybody wanted to work there. And I remember when he said that, thinking, “I don’t know? It’d be great to have a computer on my desk. I think that’d be wonderful.” And then obviously this no-name company called Dell showed up. And Compac back then, and Gateway, and a bunch of others that thought it was actually a pretty good idea. And then ultimately DEC collapsed and got bought out by Compac. And so those have been some of the ones that I remember most vividly, ’cause I worked at DEC obviously, and so I saw that whole transition.
Meb:
Dan, where do people go when they want to check out what you’re writing? You do a fair amount of video and press as well. Give us the best spots to follow you.
Dan:
Yeah, I mean I will put out things when I feel like I have something that’s useful, on my Twitter account or on LinkedIn. So Twitter account is @danieltniles. And my website where I’ll post, because I mean, how much can you really get across in 280 characters? On my website danniles.com, I’ll post interesting articles. Thought pieces on how do I see earning season, what are some of the big picture things I’m looking at? So there’s some really great charts on there. ‘Cause I’m a massive believer in a picture is worth a thousand words, and so I try to put more of the thoughtful, bigger picture stuff where you go, “Oh, well that changed, so I need to change my thinking.” So people can go there to get educated. Because that’s what I’m trying to do, is I’m trying to give people a way to think about things.
And not, you should buy this stock or that stock. That’s just a byproduct of this is how you should think about the ad market. This is how you should think about the smartphone market, or rates, or whatever. And so that’s where we try to put a lot of that research.
Meb:
It’s been a blast, Dan. Thanks so much for joining us.
Dan:
Well, thank you so much for having me on, Meb. I really appreciate it.
Meb:
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