Episode Transcript
The Finance Ghost: Welcome to episode 275 of Magic Markets. We hope that you've been enjoying our slightly punchier format over the past few weeks. We've gone back to our roots somewhat in doing these 15 to 17-minute shows. So far, so good,
Moe, we're going to do another one today, and we're going to be talking about platform businesses, but not generically. We are actually going to touch on specific names, things we have in our portfolio. And this has all been inspired by our decision to do Uber this week in Magic Markets Premium, which I'm pretty excited about, because it is a stock that I hold and it's a stock that I find super interesting.
Let's dig in, shall we?
Mohammed Nalla: Indeed, Ghost. Platform businesses are very interesting, I think topical as well, because yes, we've just had the Uber results come out, but we've also seen a lot of pressure on the whole SaaS complex, the software-as-a-service space.
Are platform businesses like Uber effectively in that space, yes or no? We can try and unpack some of that.
Ghost, where do you want to actually take the discussion? Because there's so much to unpack on a topic as chunky as this.
The Finance Ghost: We're going to stick to our knitting here of doing something shorter, so I'm going to jump straight into asking you about what platform economics actually are.
I think let's just spend a few minutes on that, because some of the businesses are doing really well, like YouTube inside Alphabet. That's absolutely killing it at the moment. And on the other end of the spectrum, things that are getting killed - some of the SaaS names - they're really getting hurt.
There's this umbrella term, “platform economics” - what does it really mean out there in the market, and why can these things make a lot of money when they go?
Mohammed Nalla: I think that's a great place to start, because as you mentioned, platform economics can be a very powerful thing. But it's only when the platform has something called real network effects - I'll unpack some of that - as well as a clear way to monetise the activity that's happening within their ecosystem.
The basic attraction is quite simple, because platform businesses don't just sell a product. It's about connecting the participants in that ecosystem. In the case of Uber, it could be riders and drivers. With YouTube, it's creators and viewers. In the eCommerce space, it's merchants and consumers. And then, obviously, in the social media space, it's the advertisers and the users in social media.
And so that's effectively what a platform business does, is it connects these various parts and hopefully makes money out of doing that. When this works, it's actually very powerful, because you get a flywheel: more users in the ecosystem attract more suppliers, and more suppliers then improve the overall customer experience, and then that becomes self-reinforcing, because a better customer experience in turn attracts more users.
Once the platform reaches scale or maturity, it becomes very hard for smaller competitors to replicate that ecosystem. And so that is what I would call the first point, really the first source of value for these types of businesses, which would be network effects.
A second point, which is very key when you're looking at platform businesses, is operating leverage. Because something that's kind of common across a lot of these platform businesses is that they tend to be asset-light. And once a platform is built, each additional transaction or user can be very profitable, because you don't need to rebuild the entire platform for every new ride or every new video that you're putting on there, every new restaurant order.
That is why investors love these businesses when they mature, is because the revenue can keep growing while the cost base thereafter - once you hit that inflection curve - grows more slowly, and then margins can actually expand quite meaningfully.
Now, I say this theoretically, because some businesses do this well: they make money, they generate cash once they hit that inflection. Others - it's questionable.
And then a third source of value in the space would be the data and personalisation that goes into that, because this is where platforms see behaviour in their relative ecosystems at scale. They understand the users, they know what they want, and so they use that to understand what prices will clear the market, where are the friction points. And that data then improves recommendations, matching, pricing - a whole bunch of stuff.
And with that particular point, YouTube, I mean, that's a great example, because it's a platform for creators, viewers, and advertisers, but it keeps improving that matching between content and attention. And you actually see that come through very strongly in Alphabet's latest results.
Uber, slightly different, but I would say the platform economics rhyme, because riders want availability; they want short times. On the back of that, you've got drivers on the other side that effectively want demand; they want earning opportunities. And that's where that matching comes in, and that's how the data and personalisation comes all the way back into the network effects that we mentioned.
One last point I want to just touch on, and it's very important: not every business that calls itself a platform - they don't deserve that platform multiple, because these businesses have historically traded at a bit of a premium. And you're starting to see that now. I mentioned the kind of “SaaSpocalypse” that we're seeing, and that's because the market is now asking harder questions.
Does your business actually have a genuine network effect? Do you have pricing power? Are your customers loyal, or are they just being subsidised? We saw that for the longest time in a lot of these platform businesses.
Does the platform business generate cash, or does it actually suck endless amounts of capital just to keep that flywheel spinning? Are they still growing? Where are they in that inflection curve?
Platform economics, in general, can be lucrative, but this is really when the scale creates defensibility, gives you a bit of a moat, where the data improves the product, where monetisation will improve with maturity as you go through that inflection on your maturity curve. If the platform doesn't have the real network effect or real cash flow, the market is becoming a lot more circumspect around the valuations there.
Now, Ghost, I want to link this to some of the stuff that we've discussed recently, because recently we looked at Tencent just last week in Premium, and the valuation there was under a lot of pressure, dragging Prosus down with it.
But Prosus is a business that actually has a number of ecosystems that aren't your traditional software-as-a-service play. Instead, they're focused on B2C. They've got various lifestyle plays, like in Latin America, India, even in Europe.
And so my question here is, is this a baby that's being thrown out with the bathwater? What is your view at the moment with that whole story at Prosus? Is something else wrong? And what are you doing with your position? Because I know that you're an investor in that company.
The Finance Ghost: Yeah, so you're not wrong. I am an investor in the company, and I'll get to the position just now. Let me talk a little bit about Prosus first.
But before we can really talk about Prosus, we have to understand the thing that is underpinning its value, and that is Tencent, which we covered recently in Magic Markets Premium. And that share price is down 29% year to date, roughly.
And as we discussed in our Premium research, what is essentially happening here is you've got this Chinese ecosystem that is already very large and struggling to achieve even double-digit growth in revenue, which is a low percentage versus what the market is used to seeing in the West.
Over the years, gross margin has been increasing, but it hasn't created a particularly smooth profile in free cash flow. This makes it difficult for the market to really take a risk on Tencent.
Plus, then you've got this big hangover in the market from what happened with Alibaba and the Ant IPO and the associated regulatory disaster. You may recall the magical disappearance of Jack Ma. It literally smashed Chinese tech valuations, and they've never really recovered since. So you just don't have the situation you have in the US, where valuation multiples tend to expand well ahead of the numbers. In China, if anything, the multiples contract and the numbers have to catch up.
You've got erratic cash flows, you've got relatively light growth there, structurally lower multiples, and now on top of that, you've got the risk of high levels of AI spend and what that could mean for margins. And that is the backstory as to why Tencent has been struggling.
Now, unfortunately, this has dragged Prosus down with it, roughly 27% year to date. The gap between Prosus and Tencent does tend to chop and change between negative and positive, but the charts track each other pretty closely. Sometimes Prosus is ahead, sometimes Tencent is ahead.
This is despite Prosus working really hard to create a “Tencent-plus” environment instead of a “Tencent-minus” investment case.
So where will you find the Tencent-plus investment case? A good place to look would be the shareholder letters written by CEO Fabricio Bloisi. He uses the word “execution” a whole lot. In fact, if you look at the two most recent letters, to have the word “execution” in the title tells you that they are trying hard to tell the market this is going to be a period where they bed down what they have, rather than chasing new deals. Not a bad thing.
And it is all about embedding AI in the lifestyle platforms run by the group. So in Latin America, for example, they are building around iFood. No surprise there - it’s the business Bloisi understands best. But there’s major competition there. Bloisi’s latest letter refers to something called “irrational spend” by a competitor - essentially someone just trying to break into the market, spending like mad. And that drags everyone down for a period of time. Only consumers win in that environment, and they have no choice but to respond to it at iFood. So they expect pressure on the next year’s adjusted EBITDA.
On the plus side though, Despegar, which was a platform that they bought as well, 17% of Despegar’s net revenue is now from iFood referrals. So what they're trying to do there is tell a story around how these lifestyle assets actually can belong together and how a platform business like that can become more valuable as these things are added on because of the referrals, because of the synergies.
If you look in Europe, it’s more about OLX on the classifieds side and Just Eat Takeaway.com on the food delivery side, or JET. That is a turnaround story. Four years of declining key metrics - that is really the deal where Bloisi needs to win. That's been his landmark push since he took over at Prosus, and he has to execute on that because they've made big promises to the market about how they will use AI and other techniques to turn that around.
Europe is not a growth market. They are up against some big competitors. We're going to be covering Uber this week. Uber is one of their competitors with Uber Eats in Europe. And Uber specifically mentions Prosus in the earnings transcript, which is pretty interesting.
They hope to get to revenue growth by the end of the year - we'll see if they can do it.
And a quick mention of India: they have PayU there that's just turned profitable. Still small, but they are using it as a connector for other businesses in India.
Long story short, what am I doing about it? Well, Prosus is an important part of my portfolio. It gives me “tech platforms ex-US” - that's basically the bucket that it is. I'd love to have MercadoLibre as part of that bucket, but it’s just so expensive - it always is. Now back at 2021 levels, so I’ve actually not really missed out on MercadoLibre unless I had been trading it along the way. Prosus, not much better if you look over several years, but I bought it at a good time. My position is still up 13% despite all the pressure on the share price.
So what am I doing? Well, I'm not a seller, but I'm also not a buyer right now. Unless Tencent starts to turn the corner, that's the chart to watch. I've learned this from traders, I've learned this from you as well, Moe.
I don't need to perfectly pick the bottom here - I really don't. I plan to wait until there are decent indications that the pain has stopped and that it's actually achieved some positive momentum.
Mohammed Nalla: Yeah, I think those are some very important points, because a player like Prosus - that’s massive. It’s these large businesses that incubate some of these ecosystems within their overall investment portfolio. That tie up with Uber, for example. Uber, I think, just recently bought Delivery Hero from the Naspers/Prosus grouping there, again showing you some of the competitive pressures.
But that AI point that you raise is also very important, because yes, you don’t have to pick the bottom. That AI spend is so massive across this entire space, we actually have to see if that money is capital well spent. Does it actually flow into some of those positive flywheels that I mentioned? Are these businesses cash generative? Can they actually reach that inflection point? I think that’s really key when you’re looking at companies in these kinds of spaces, whether that’s SaaS, whether that’s a platform business.
The Finance Ghost: Yeah, absolutely, Moe. So let’s bring it home now with the last question. We’ve talked about Uber, we’ve talked about Tencent, we’ve talked about Prosus here. We haven’t really talked about the SaaS names. We don’t have time to go through that whole area in detail. But we did see layoffs at Intuit in the last week. We also saw layoffs at Meta contributing to the bear case around these SaaS names, unfortunately.
So where are you at the moment with some of these names? Are you buying any of them, or are you still just watching what’s going on there?
Mohammed Nalla: The SaaS market is going through this really important reset at the moment, because for the longest time software had this almost perfect investment narrative, right? They had high recurring revenue, strong margins, low churn, big TAMs, and also the promise of operating leverage coming later. And that kind of gets pushed out depending on how heavily they invest and where they are on that very important inflection curve that I mentioned.
And this all works fine in a low-interest-rate world. But right now we’ve actually seen yields going up, and so the market back then was willing to pay these enormous multiples, and now they’re actually being a lot more circumspect.
I think that ties into a point we discussed last week on the show, which is the valuation pressure, because with discount rates higher, those distant cash flows are worth less. And if a SaaS company is still promising their profitability out into the future, the market’s going to be a lot more circumspect and apply a much tougher discount rate to that.
The second pressure in the SaaS space - you’ve mentioned it - is AI. And I see this as the bigger immediate change, because AI is forcing investors to ask whether some of the software products are actually as defensible as people thought.
Let me unpack that, because if AI can automate workflows, generate code, handle customer service, produce reports, analyse data - all of these fantastic things - then some of the SaaS businesses and their tools out there may actually just become features rather than standalone products. And so it’s the question mark around the moat.
Now, this doesn’t kill all of the SaaS names, but it does mean that the market is no longer willing to give every single company the same benefit of the doubt. And that’s why it’s important, looking at these layoffs at Meta and at Intuit, because these are not your traditional recession layoffs. They’re actually strategic reallocations of capital, if you really think about that.
Meta’s restructuring involved layoffs (I think 7,000 people) and it’s really around transfers of staff into AI initiatives and cutting management layers. They’ve just got to get a lot more efficient.
Intuit, 3,000 employees. They’re also trying to streamline their operations, sharpen their focus on AI. And so I think the message is very clear from Big Tech, that AI is not just a product feature. It’s changing the business model, it’s changing the cost structures, the staffing model, the whole competitive landscape.
When I look at SaaS names, I put them into three buckets.
The first one I would say is your mission-critical software, the ones that are deeply integrated into their clients. And those tools become so embedded into how companies operate that it becomes a moat in and of itself. Switching becomes very painful. Good examples would be things like Microsoft, ServiceNow - that’s another interesting one out there. You can even look at companies like Salesforce, which again get quite embedded into certain workflows. So that’s a segment that I think has a decent moat around it.
The second bucket, this I would say is slightly weaker, and it’s where you’ve got these horizontal software layers with weaker differentiation. Companies like Monday.com - that’s very prevalent in project management.
Other services like Dropbox or Zoom - the reason here is that they can get disrupted by companies in the first segment that I mentioned. I mean, Zoom competes with Microsoft Teams, and so there’s that potential for disruption. But there’s also the aspect of: can AI replace some of these functionalities? Whether that’s a Dropbox or whether that’s a Monday.com - and I think the answer is yes, it can. And so I would be very circumspect around the second bucket.
The third bucket would come into the core discussion of today, which would be platform businesses with distribution. Now, these are not pure SaaS names, but they own the users, they own data, payments layers, for example.
And so in this space, I would see AI almost as an opportunity, because it becomes an accelerant rather than a direct replacement threat. And good examples here would be YouTube - a great ecosystem. You connect your creators, viewers, advertisers, and again AI could actually catalyse the content generation on YouTube, so it becomes additive to the overall ecosystem to a degree - yes, cognisant of AI slop.
The same thing could apply to companies like Uber, like Shopify, where there’s a different ecosystem, there’s a use case behind that. And so I think that’s the difference between just a SaaS tool and then some of these platform businesses that are actually inherent ecosystems with a moat of their own, and especially where platforms own the distribution.
My conclusion is I’m cautious on generic SaaS names, especially where AI can commoditise or disrupt the product. I’m still interested in platform businesses where AI can actually improve the overall ecosystem. And I just don’t want to get involved in software because it’s software, or not be involved in software because it’s software. I’m looking at strong moats, strong ecosystems, data ownership, cash flow, network effects - all of those flywheels I discussed upfront. I think that’s what makes or breaks an investment thesis in this space.
The Finance Ghost: Thanks, Moe - super insightful. As we bring this to a close, the one thing I’m watching is Salesforce versus Adobe, mainly because I just want those charts to do something different to each other. For as long as those two charts are doing exactly the same thing, we know it’s a SaaS story and not an underlying business model story, because they have nothing in common other than being SaaS names, and yet they are moving almost perfectly correlated. It’s very interesting.
If you are curious about Magic Markets Premium and some of the work that we do there, then please do check it out. I think you will enjoy it and get a lot of insight into how we think about global stocks and how we analyse these things.
Mohammed Nalla: Hit us up on social media. It’s @MagicMarketsPod, one word, @FinanceGhost, and @MohammedNalla, all on X, or go find us on LinkedIn. Pop us a note on there.
We hope you’ve enjoyed this. Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
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