Sunday Finds + 3 Things I Thought About Last Week
Snap and Nelnet
(To improve our weekly newsletter, I’m going to start writing about three topics on my mind each week - Brett)
3 Things I Thought About Last Week:
One of the biggest stories in the investing world last week was Zillow deciding to quit its iBuying business. Management really ripped the bandaid off too, laying off 25% of its workforce, taking a massive writedown, and admitting that its business model was unsustainable. Zillow stock got absolutely hammered after the news, down 36% in the last five trading days. This is no surprise as iBuying was supposed to be one of its key growth drivers in the next few years (if you don’t know what iBuying is, here is a good overview). Curiously, at least from my seat, Opendoor stock didn’t react negatively to this announcement. The pure-play iBuyer competing with Zillow saw some volatility, but it seems like shareholders were generally not concerned with Zillow’s statements on the difficulties associated with this business model. We even saw people claim this was good news for Opendoor, including everyone’s favorite VC on Twitter (who is also a large backer of the company). The argument seems to go like this: Zillow had no idea what it was doing, and with them gone, Opendoor has a clear path to dominating this trillion-dollar industry. This might be true, but what if…the business model of iBuying is flawed in general? I don’t have any hard views either way, but I tend to lean towards being negative on iBuying because the financials don’t make much sense to me. In Q2, Opendoor did $159 million in gross profit (the spread it makes on buys/sells), sold 3,481 homes, and bought 8,494 homes (moving its inventory up to $2.7 billion). Without the balance sheet flexibility of a large bank, this seems like a terribly fragile business. Maybe I’ll be eating my words after Opendoor reports Q3 earnings this week, but either way, it will be interesting to see whether the company can succeed with this strategy over the next few years.
When you buy a high-growth stock at a premium valuation, life can come at you fast if the business underwhelms the market’s expectations. Peloton last week was a great example. The company posted (in my mind, and I think everyone else’s) a terrible quarterly report. Three of the company’s most important metrics (churn, subscriber growth, and future hardware sales) are all moving in the wrong direction. As a result, Peloton’s stock was down 40% last week. I think it highlights the two questions I try to ask before taking the risk of investing in a stock with a premium valuation:
Is industry/consumer demand durable and predictable?
Does the company have any competitive advantages?
Peloton does not operate in a durable industry (fitness in general feels durable, but Peloton’s niche? I’m not so sure) and it is unclear whether it has any sort of competitive advantage that can insulate it from the competition. This doesn’t mean Peloton won’t be a good investment over time, but I just don’t see why anyone would want to pay a premium valuation for a stake in a business with so much uncertainty.
I don’t know much about the new spending and tax bill, but there is one provision in it that makes no sense whatsoever. It is the new nicotine tax, which will tax all products with nicotine at a flat rate of $50.33 per 1,810 milligrams of nicotine. The rationality behind the proposal is that it will not discriminate against certain products across the industry, giving everyone an equal footing in the market. However, whether intentional or not, this bill favors cigarette makers and hurts harm-reduction products like vaping and nicotine pouches (more details on the proposal here). Why? Because different types of nicotine products have different absorption rates, meaning that some products need more nicotine per serving in order to get the same buzz a consumer is looking for. According to the article linked to above, under this new bill, a can of 20 nicotine pouches with 8mg of nicotine per pouch will have a tax of $4.45. This is higher than the price of an entire can right now! If passed, this new tax could kill the nicotine pouch industry, leading consumers back to using deadly cigarettes. The direct effect will be to hurt nicotine pouch makers like Swedish Match (we own shares of this company, which is why I’ve heard about the tax proposal), but the knock-on effects will be much more important to the country. If such a regressive tax is passed, hundreds of thousands of consumers will likely move away from harmless nicotine pouches back to cigarettes, eventually leading to hundreds if not thousands of unnecessary deaths in the coming decades. This benefits no one except the cigarette manufacturers, and will only raise an estimated $10 billion in tax revenue over the next 10 years. I guess that’s why they call it regulatory capture. I also wouldn’t discount how upsetting this would be for many citizens, especially for young adults and college students where nicotine pouches are extremely popular (side note: pouches have been a great development for public health the last few years, as they have replaced cigarette habits for many college students). If/when nicotine pouches more than double in price, hundreds of thousands of people around the country will be upset, and the only people to blame are the politicians who signed the bill into law. I doubt that this will become a huge political news story, but it would be pretty easy to see how the minority party right now could use this nicotine tax as a way to convince people to switch their voting allegiances. It will be very dissapointing for the country if this nicotine tax gets signed into law. And again, nobody will benefit except the cigarette manufacturers.
Catch-up on Our Shows From This Week:
3 Good Reads:
1 Good Listen:
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