{"id":14427,"date":"2023-11-10T13:42:25","date_gmt":"2023-11-10T12:42:25","guid":{"rendered":"https:\/\/www.gpbullhound.com\/?post_type=article&p=14427"},"modified":"2023-11-10T14:38:06","modified_gmt":"2023-11-10T13:38:06","slug":"tech-thoughts-newsletter-10-november-2023","status":"publish","type":"article","link":"https:\/\/www.gpbullhound.com\/articles\/tech-thoughts-newsletter-10-november-2023\/","title":{"rendered":"Tech Thoughts Newsletter \u2013 10 November 2023."},"content":{"rendered":"\n
Market:<\/strong> A volatile end to the week as Fed chair Jerome Powell opened the door to more interest rate rises, compounded by a weak 30-year treasury auction. There’s no getting away from tech broadly correlating to rates. As a reminder, though, on rising interest rates and “cash burn” as it relates to our portfolio, the companies exposed to interest rate rises are those with leveraged balance sheets. The tech sector \u2013 and indeed the companies we own \u2013 don’t have leverage \u2013 they’re cash-rich and cash-generative.<\/strong> Most of our portfolio are either paying a dividend or have buyback programs. Any volatility we’re seeing is around share prices<\/em> and not the fundamental earnings and returns of the businesses we own \u2013 that can certainly create opportunities for us as long-term investors. <\/p>\n\n\n\n Our investment philosophy as a team is to focus on companies’ financial productivity and ability to sustain that over a long time given competitive advantages. <\/strong>This, in turn, leads to a focus on cash flows and return on invested capital of the businesses we own and their ability to compound those (through reinvestment) over time. That focus typically leads us away from the more interest-rate-sensitive parts of the sector. <\/strong><\/p>\n\n\n\n Portfolio:<\/strong> We made no major changes to the portfolio this week. <\/p>\n\n\n\n OpenAI Dev Day <\/strong>was a reminder why keynotes should be back in person \u2013 10 times more entertaining and exciting than the latest iPhone launch, and nothing beats a live demo.<\/p>\n\n\n\n The highlights: <\/strong><\/p>\n\n\n\n The comparisons with Apple don’t stop with the keynote excitement being a bit like the early iPhone launches \u2013 what Altman was effectively describing was an App store for Chatbots: <\/strong><\/p>\n\n\n\n We’ve spoken a lot about LLMs and some of the unknowns \u2013 how many there will be (with Grok from Twitter\/X also launched this week), will there be a winner, will they all be free, and if so, what’s the business model? <\/p>\n\n\n\n In our weekly letter on 29th September, we argued that there’s a significant chance that LLMs end up being commoditised, and that an LLM’s ultimate success is much more likely to come down to distribution and whether they are underlying source codes for other apps. As a result of that argument, we said that for OpenAI to be able to justify its $90bn valuation, it needed to be a consumer app and not just an LLM.<\/strong> This is exactly what Sam Altman presented. While the event was called OpenAI’s “Dev Day”, in reality, it was a product launch at Apple. <\/strong>OpenAI hasn’t quite made the full pivot to being a consumer tech company (which is surely where the upside is), but we watch this space. Still missing is the control of the end device \u2013 OpenAI presented an app store for GPTs, which it will control, but the app store will be on phones and PCs which it doesn’t control. <\/p>\n\n\n\n That takes us back to the September rumour that OpenAI <\/strong>is raising money from Softbank’s Masa Son to build the “iPhone of AI” with Jony Ive. How long before we have an OpenAI hardware keynote to watch? <\/p>\n\n\n\n For us in the portfolio, <\/strong>Microsoft’s CEO Satya Nadella was on stage, happy with the partnership. “We love you guys. It’s been fantastic,” he said. It has indeed \u2013 remember that OpenAI benefits Microsoft Azure growth in two ways: <\/strong>1) OpenAI’s API runs on Azure, which means that startups that might previously have defaulted to AWS, are now running on Azure; 2) ChatGPT (OpenAI’s consumer business) has a revenue share agreement (though we don’t know the exact details) with Azure. <\/p>\n\n\n\n It’s helped Microsoft gain share \u2013 of the $3bn incremental cloud revenue this quarter, we believe $2bn went to Microsoft. <\/p>\n\n\n\n But it’s also worth noting that OpenAI reducing prices is likely a result of Microsoft’s optimisation of GPUs in its stack and taking those to higher utilisation \u2013 it can do that because it can leverage its infrastructure across all of its businesses (ie. Copilot) and OpenAI. It’s a partnership that’s working both ways. Microsoft remains a top 3 position in the portfolio for us. <\/p>\n\n\n\n GPT-4 Turbo getting cheaper is good news overall as it opens up more innovation and experimentation, and, ultimately, means we’ll likely get to those new feasible revenue and business models faster<\/strong>. That will drive more cloud compute and more sustainable investment in AI chips. We own Microsoft, Amazon and Google, which should see more demand within their highly profitable cloud services businesses. We also own Nvidia and AMD, both most obviously downstream of their capex (and TSMC and Semicap, which also benefit). <\/strong><\/p>\n\n\n\n There is an upside for the enterprise software companies that can effectively connect their own vast proprietary data sets to pre-trained LLMs, and offer AI tools and features to drive ARPU growth. <\/p>\n\n\n\n Finally, on Jony Ive’s “iPhone of AI”, it goes without saying that any mass-adopted AI consumer product, <\/strong>which we assume would be built with some hefty smartphone GPUs<\/strong>, would be very positive for TSMC and Semicap equipment. <\/p>\n\n\n\n Onto newsflow\/results: <\/p>\n\n\n\n Another twist in the China\/US restrictions \u2013 Nvidia “here’s one I made earlier”. <\/strong><\/p>\n\n\n\n Portfolio view: <\/strong>Good news for Nvidia as forecasts were starting to take down sales into China significantly (it doesn’t impact 2024 given Nvidia is effectively supply constrained, but it supports a counter-argument to those who had assumed there will be an air pocket in 2025 revenue). The H20 chip is a comparable die size and still consumes CoWoS supply, so supply likely remains as constrained as ever.<\/strong><\/p>\n\n\n\n October semis data \u2013 the smartphone is back?<\/strong><\/p>\n\n\n\n Portfolio view:<\/strong> In semiconductors, we see PC\/smartphone bottoming and inventory being cleared, and auto and AI are still seeing strong demand. The only areas of real weakness in the market now are industrial (especially China) and an ongoing server\/enterprise inventory correction<\/strong> (which we should be through in Q4\/Q1). But with the most significant market (smartphone) turning, we’re set up for good market growth in 2024. <\/strong> <\/p>\n\n\n\n Auto semis still showing strong demand and Chinese auto export volumes <\/strong><\/p>\n\n\n\n Portfolio view: <\/strong>Auto, along with AI, is a bright spot in semis end demand, with the structural increase in power semis in the move to EV. We continue to think the competitive environment for the global auto manufacturers is challenging \u2013 Tesla price reductions speak to that, and we don’t own any auto OEMs (manufacturers). But, there are only a handful of auto semiconductor suppliers, which are designed over long cycles and can maintain pricing power, making it an attractive place to be in the value chain. <\/p>\n\n\n\n Semicap \u2013 AI as a revenue driver, China still strong, subsidies continue <\/strong><\/p>\n\n\n\n Portfolio view<\/strong>: Semicap remains a key exposure for us (we own ASML, LAM Research, KLA and Applied Materials). The resilience of the space amid the recent downturn in memory and weakness in logic is something we view as attractive<\/strong>, and we expect multiple structural drivers (geopolitics \u2013 including national subsidies, tech leadership and China trailing edge demand) to support growth into 2024\/2025. The recent results indicate a shallower trough than prior cycles, which we may now be through. <\/p>\n\n\n\n The chip leadership race continues\u2026 5nm strength at TSMC<\/strong><\/p>\n\n\n\n Portfolio view<\/strong>: It speaks more broadly to the nature of technology companies, which need to continue to invest and innovate to survive. From a chip perspective, this is characterised by a continued race to get to the leading node or to build chips on the leading node \u2013<\/strong> that, in turn, drives investment at TSMC and benefits the semicap equipment names (which we own). <\/strong>Specifically at 5nm, which we think is fully utilised (Nvidia’s H100 and AMD’s MI300 are both built on it), we believe that TSMC will need to add capacity or repurpose 7nm capacity. <\/p>\n\n\n\n ARM \u2013 still question marks on whether its business model can capture it’s actual value <\/strong><\/p>\n\n\n\n Broadly speaking, the way I would think about it is, whenever you’re running one of these AI clients or assistance or agents, it’s going to require a significant uptick in terms of compute capability, both in terms of if there is an in situ accelerator and\/or through the CPU complex, keeping in mind that in the client device, when you run these AI agents or whenever you’re running something that’s going to be a co-pilot of some sort, nobody wants to see their battery life suddenly go down 40% in terms of everything that was involved in running the algorithms.<\/strong> So what that means for us in the broad sense is I expect it’s going to be a higher need for more compute capacity. We’ll see more advanced cores, we’ll see larger cores, more v9, <\/strong>which in the end \u2013 endgame should mean higher royalty rates for us. That would be our belief going forward in terms of just the megatrend.”<\/em><\/p>\n<\/blockquote>\n\n\n\n Portfolio view:<\/strong> For now, we continue to watch ARM from the sidelines, with too many uncertainties (the ones outlined above), little visibility and lots of risk in China, RISC-V competition, and a valuation that’s very hard to frame the downside on. <\/p>\n\n\n\n More signs that cloud optimisation headwinds are ending<\/strong><\/p>\n\n\n\n Portfolio view:<\/strong> We commented on the 27th October after all the big tech\/hyperscaler reporting that there were promising signs of stabilisation in cloud spend \u2013 that has a broader lead into enterprise software and large deals returning, which we’re exposed to both through the cloud service providers and enterprise software names. We still don’t own consumption-driven names, like Snowflake or Datadog, as we’re still trying to get a better handle on how they fare in a cycle and their competitive positioning in the market (can the cloud service providers move downstream?) \u2013 but certainly, Datadog is a positive datapoint this week. <\/p>\n\n\n\n Streaming \u2013 will it all lead back to the cable bundle and advertising<\/strong>?<\/p>\n\n\n\n Portfolio view:<\/strong> We don’t own Disney. Broadly, we question the long-term returns within the streaming sector \u2013 and Disney still wonders what Iger can do in terms of a strategy pivot and more cost-cutting. Streaming still feels like a really tough business, and churn has undoubtedly been structurally higher at maturity than was originally premised \u2013 it’s why we ask if there will be a more definitive move to ad-supported (could Netflix\/Disney at some point be free?). <\/strong>It’s also hard not to view the presence of Amazon, Apple, YouTube as the big behemoths (who don’t necessarily need to make profits in that category) as a very big negative to the path to profitability and the sustainable level of profitability. <\/p>\n\n\n\n Gaming demand robust but title-driven<\/strong><\/p>\n\n\n\n Portfolio view:\u00a0<\/strong>We own Sony, Nintendo and Microsoft (which has now completed its acquisition of Activision). We’re through the gaming Covid market hangover but still focus our exposure on the big franchise title gaming businesses, which have the highest returns on capital given their ability to continue to iterate strong IP.<\/p>\n\n\n\n For enquiries, please contact: About GP Bullhound\n
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Inge Heydorn, Partner, at inge.heydorn@gpbullhound.com<\/a>
Jenny Hardy, Portfolio Manager, at jenny.hardy@gpbullhound.com<\/a>
Nejla-Selma Salkovic, Analyst, at nejla-selma.salkovic@gpbullhound.com<\/a><\/p>\n\n\n\n
<\/strong>GP Bullhound is a leading technology advisory and investment firm, providing transaction advice and capital to the world\u2019s best entrepreneurs and founders. Founded in 1999 in London and Menlo Park, the firm today has 14 offices spanning Europe, the US and Asia.<\/p>\n","protected":false},"featured_media":11577,"template":"","categories":[49,64],"sector":[37],"region":[43],"class_list":["post-14427","article","type-article","status-publish","has-post-thumbnail","hentry","category-insights","category-tech-thoughts","sector-software","region-global"],"acf":[],"_links":{"self":[{"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/article\/14427"}],"collection":[{"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/article"}],"about":[{"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/types\/article"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/media\/11577"}],"wp:attachment":[{"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/media?parent=14427"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/categories?post=14427"},{"taxonomy":"sector","embeddable":true,"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/sector?post=14427"},{"taxonomy":"region","embeddable":true,"href":"https:\/\/www.gpbullhound.com\/wp-json\/wp\/v2\/region?post=14427"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}