Khush: 0:09

Welcome to the QRC crisis, we challenge ourselves to explore the world of business, tech investing and science. Get curious and be part of the journey as we discuss challenge and Lukie episode 10. Mate, how are you?

Luke: 0:23

Very well, very well. How are you,

Khush: 0:25

mate? I am very well as well. And I'm so excited for this episode. So it's a bit of a special and it's one of Lucky's and my favorite things. So we're going to do a 10 minute thesis. So 10 minutes of pitching each other. One of our highest conviction investments, whether it's a stock or a crypto, we actually have no idea what each other we're going to pitch. And at the end, we will have time for probably, you know, two or three questions it stems from, we used to run this thing with a couple of mates Dylan and Riley, a one hour thesis where we'd present on an industry topic or or an investment or a peak and deep dive, but we thought we'd condense it termina thesis for episode 10. Lucky mate Europe, what do you got for me? Perfect.

Luke: 1:10

So we'll get we'll get straight into it. We'll try and be quite time sensitive for this one. So mine is chip design, manufacturing and the silicon goldmine. So I mentioned previously that I was looking at chip manufacturing, I was looking at, you know, design and architecture, and I was learning about this stuff. And I know that it's it's something that's growing, and I decided to do a bit of a deep dive. So I guess this is this is my my 10 Minute Thesis, like, I'm so keen. Yeah, so I'll get straight into it. You know, we use chips and everything. And the growth of the industry has only continued, it has not slowed at all. And some people might be familiar with Moore's law about computation. And computation is moving into everything. But the chip manufacturing industry has been basically undergoing significant transformation. And that's been driven by a few factors. The obvious one that everyone's aware of is AI. So, you know, LLM is large language models, self driving, cars, graphics, processing, anything related to AI, image and video generation, all of these things. That's all linked together. But the other thing is, I guess I've touted this modification of things. So cars, having more chips and doing more computation or, you know, watches and like, everything's now smart, like, that's the next big thing. And then the big thing in my eyes is actually the smaller nanometer architecture that's been really growing. So moving down from seven nanometer to five to four, and now to three very recently. So as of this month, probably when this comes out, Apple just unveiled their M three chips, which are part of their Mac lineup, and they're using a three nanometer manufacturing node by TSMC, the toe Taiwan Semiconductor company. And yeah, basically, that's the first three nanometer chip that has been released, as far as I'm aware. But the industry as a whole has really been growing. So the US job industry is projected to grow by 33% by 2030. But that has significantly increased already. Yeah. And I guess one of the big things is that not only are they everywhere, but the the revenue from this is insane. And so something that's really interesting that I came across was the hotspots for semiconductor design, because the world leader at the moment is TSMC, which is coming from Taiwan. But there's a lot of growth and a big push from the US government to try and get more of that happening in house. Yeah. And so what I was looking at was, okay, well, we already know that TSMC are leading, and they're probably, you know, second place post Samsung manufacturing. Where else can we get some, you know, significant upside. And to me, it looks like it's the US. And so this thesis is essentially on the one that I'm not 100% pitching this stock. By itself, it's more of a the industry play. But if I was to choose one, it would be Global Foundries, which we'll get into in a bit. So something really interesting is the foundry revenue, shares by vendor. So TSMC make 54% of the revenue, even though they don't necessarily sell 54% of the market, they probably it's probably much less. And then Samsung, the next closest competitor is only 15%, which is crazy. And a lot of that stems from the small processing nodes that they're able to do. So as of 2022, and quarter, one 12% of all nodes were five and four nanometer and they were really, really new. And then just before that was seven nanometer and six nanometer and they were 18%. And so the growth towards smaller nanometer processing nodes has been growing significantly because everyone wants the fastest stuff. And so there's a move towards the US. There's a move towards smaller processing nodes, but who's capable of that. And as far as I've been able to see, the the leader in that is Global Foundries. So if we look at the suppliers, TSMC is the largest, then Samsung then UMC, and then Global Foundries, which is the only US manufacturer that's in the top five. Right? Yeah.

Khush: 5:21

So sorry. So they are in the top five of total chip sellers by market share.

Luke: 5:27

Yes, in terms of in terms of supply, not necessarily by revenue, but by supply. Yeah. Okay. And so there's a few players that you could do here as well, like, you don't have to go for the manufacturer, like we're talking about TSMC and stuff. But you could also make a play where you purchase in video, for example, which is using these after the processing, or you choose Apple, for example, who's using these three nanometer, but you know, they say, you know, gold rush, you can, you might as well sell shovels, right. And, you know, that's, that's the ideal scenario. And in this case, that's what this is, who's making the wafers and where can you get that profit from. So one of the big surges has come from investment from the White House. So they put out a paper, basically saying, we want to invest in the US economy, we want to invest in chip manufacturing, and it's called the chips act. And it's been a huge boom, where they've invested $52 billion into the American semiconductor industry. And a lot of that is going to go to Global Foundries. So they not only are going to capitalize on the chips act, but they're also going to capitalize on a growing economy, in terms of the chip manufacturing within the US is growing. And they're also have less competitors there. And they're still one of the top players in terms of supply and in terms of revenue. So that's, that's one of the big things. And what's crazy is, even though the supply of these chips is coming from Taiwan, as the market leader, that doesn't mean all the equipment is because what you have is you have these really complicated machines that basically bounce light around, and like ingrain into the wafer to make the chip, right. And there's constraints there in terms of like wavelength and the speed of light. And there's all these like physics constraints. And all of that technology comes from the US. So even though they're not manufacturing, they're selling the shovels to the people selling the shovels, if that makes

Khush: 7:23

sense. Yeah. To tears up, yeah, yeah, they're selling

Luke: 7:27

the metal to make the shovels to sell to the goldmine. That's kind of like the situation here. And so I think that if they can get their head around the the manufacturing, you know, challenge, which is what Taiwan seemingly perfected, they are going to be able to supply internally, all of them the things that they need. And they do have, you know, they have leaders already in the space, and they have so much research as well going in from universities, that I think that it has a really, really high chance of, of really poppy. Yeah, and what's great is Global Foundries doesn't have, so I was looking at their P E ratio, and it's only 19, which is actually quite healthy. And if you compare that to like, people consuming the chips, like an Nvidia or an AMD, that's like 100, or 50, respectively, which is crazy. So yeah, I mean, the other, the other big thing is there's the small business opportunity as well. So like Global Foundries don't just sell to big players, you know, they sell a lot of small to smaller players. But the thing is, they sell quantity to the small players. And I think that they're really going to be able to eat up a bit of that market share as well, because you have, like TSMC, who's focusing on let's get smaller nanometers and sell to, you know, Apple to Nvidia, some of the bigger contracts, but they're not going to be able to they have all these supply constraints. And Global Foundries has a huge opportunity with investment from the government endorsement from the government, all the things that they require in terms of manufacturing these things internally, they have a fantastic opportunity to take some of that huge market share, and so and grow their business. Exactly and grow their business from that. Yeah. And so they have so much of the support that they require. And yeah, I mean, they're definitely something that I'm going to be looking at in the next few weeks and continue learning about them. There's a lot there. But I think one of the biggest things is, yeah, just the, you know, it's easier to predict what's not changing in the future, rather than what is and chips aren't going anywhere. They're only growing. And yeah, you know, there needs to be more manufacturing because there's already some five constraints and TSMC can't manufacture all of the world's supply. It's just, it's not feasible. And so yeah, with a huge capital injection and a growing industry, I think it's a recipe for success.

Khush: 9:48

Mate, that was phenomenal. I absolutely love that. I'm gonna allow myself one comment and up to three comments and questions, unless you've still got more Yeah,

Luke: 9:57

no far away,

Khush: 9:58

mate. Love that. So first Comment, I absolutely love the thesis point on sort of the onshoring. Like, it's a massive trend, pretty much the opposite of globalization nowadays, especially with critical, whatever it is critical infrastructure, critical materials. In this case, you know, critical, like semiconductors are critical to, you know, the US is probably security and as technology and its economy essentially going forward. Huge, huge point there. Love that. And I've seen it in a lot of the other industries that are looking at investing in terms of their energy transition materials and stuff like that. Specifically, just

Luke: 10:32

just to clarify, I'm talking about the lithography process. It's those machines are manufactured in the US, those are the machines that the market leaders are using. That's what TSMC and Samsung use is us made lithography machines. So yeah,

Khush: 10:46

and that's, and that's what Global Foundries uses well, and

Luke: 10:49

well, that's what I'm not sure that that's what they use, but that's what they can use to get to the really sought after small nanometer process that everyone wants. So

Khush: 10:58

then the question is, like, do you think there will be able to grow and sort of gain those capabilities to be able to service the growing need and the growing market, and the very high value market that it seems, comes from these particularly small chips?

Luke: 11:13

I think so. If I was to summarize this, I would say that in the short term, no. So in the short term, TSMC, is so far in front of everyone else, they even have plans are getting their nanometer process all the way down to one nanometer, which I have no idea how they're going to do. But apparently, they know they have a plan. But I think that they are market leaders and no one's gonna get close to them. But that means that there's a lot of market that can be taken up because of supply constraints, because they only have, you know, these fabricators can only make so much, there's going to be all these other opportunities where, you know, you're not making three nanometer process chips, but everyone still wants five or seven or whatever, or 10 nanometer versus chips that they need to use in cars, you know, whatever, all types of appliances. And I think that that's what they're going to be able to eat up. And that capital injection from the government is going to be allowing them to build another factory where they can fabricate more of these wafers. And I think that's where they're going to make a lot of money and gain a lot of the market share of, I guess the cheaper but it's the lower quality, but the higher quantity, yeah, but then they have the potential for the high quality later. Okay.

Khush: 12:17

Okay. So essentially, then what you're saying is, it's sort of calming down a question is, it's not a zero sum game. So essentially, the winning is the industry of semiconductors. But there's winning in terms of producing those really high value small chips, but then also, there's winning in terms of the market expanding, these guys being backed by the government. And they're going to make significantly more money because it's selling significantly more chips. And they're growing. They're their production. Yep. Mate. Outstanding. I love that. I am going to put that on my to read into research list. And I'm just going to pick your brain a lot more on so get ready for it. Yeah,

Luke: 12:55

well, it's still early days for me as well in this. So it's just kind of getting my head around the market. And I guess my thesis is, I want to get into the market and I want to get in there soon. Yeah, so yeah, hit me with your 10 Minute Thesis,

Khush: 13:08

mate. Love it. Also, yours is pretty big on 10 minutes, so great stuff. Okay, so I'm gonna pitch you zero ASX exaro. And I absolutely love this one. Because essentially, I picked this investment because my mom told me about it. So shout out mom love, you know, not actually like she's not really into investing. But the story goes, you know, back in the day when I was living at home and why Mom and I shared an office space, like a home office space. And she's incredibly cute. Like, she just gets super passionate about things, random things like libraries that offer free audiobooks that you can download and listen to she really likes that. But the other thing, this is where the investment idea came from, is so she's an accountant by trade. And she would like we'd be working there you know, any time of the day and she'd be just burst into like a cush. Zero is just so good. Xero is a fantastic product. It's so easy to use. It's so user friendly, it's so you know, clean, they understand business processes, they understand the taxation system. The accountant uses it, like her account uses it. And it was just so helpful. So she would just rant on about that. And this is young me like at this point, I was trying to live the WA dream of investing in mining spec ease and one of them going to the moon and retiring when I was you know, 19 years old. But what stuck with me was just her her absolute love for the product. And on the actual professional side of things. He's like very credible, like she's a chartered accountant, and until recently was the CFO of my brother's business aligned agency. So they used zero day in day out and why I love the company and why I'm pitching it is because it very much aligns with the my principles for investing and what I've talked about in some of the other episodes in investing in something that you know, you like you believe in and you You just understand really, really well. So like, how do they make money? And if it's like prevalent in your day to day life, which, as it turns out for me, it definitely is. So, for a quick overview for those that don't know, firstly, I have actually no idea what the share price is today because I don't believe in checking it too often. And, honestly, I'm pitching your business No, no, no a stock ticker. But Xero essentially offers a range of accounting and financial management solutions, mainly for small to medium businesses. And it's accessible through the cloud. So it's cloud accounting, and it's beautiful business to quote their tagline. But you know, when I asked those that actually use it. So accountants and small business owners, it really is. It's basically software to design to streamline a heap of business processes, including invoicing and expense tracking, payroll, bank reconciliation, financial reporting and tax. And the platform aims to simplify these tasks for businesses and improve the overall financial visibility and therefore the health. So it's essentially to me it's a textbook software as a service business, which we absolutely love for revenue certainty. But we'll get into that in a bit. But more importantly, on the user side of things on the consumer side, it's just a beautiful, usable, extremely needed sticky product that solves a huge problem for so many small and medium sized businesses around Australia, the UK, increasing and increasingly the US and beyond. And the thing is it look it's not rocket science, it's buddy, it's accounting. It's simple, and it's kind of boring. But at the end of the day, every single business needs to manage finances to so they can get paid, like what's the purpose of business to earn a living. And so often small, medium, businesses don't want to waste the effort, time and money doing, you know, all the accounting, the invoicing, the taxation, and that boring stuff, and developing those capabilities in house or doing it manually. And so rather, they can get paid for what they're really passionate about. And good at, you know, if you're a small company, you don't have all those service functions. Like for example, you know, what landscaper wants to finish a long hard day's work out in the yard creating Alfresco masterpieces to head home to slog over spreadsheets, so he can pay his guys invoices, clients and try to track his expenses. Essentially, that's where zero comes in. It sort of positions itself as an all in one solution for small and medium sized businesses. And it has a very fantastic in like sort of marketing in through a few channels. So it makes life easy for the consumer, but it's also very easy to be sold. So I'll sort of explain what I mean, there. Zero, has a selling engine from the people that use it. So I think, obviously, it does marketing and stuff like that, but the selling engine Zero has is from accountants. So just like my mom, and just like, you know, the accountants for the for the business, the huge advantage that Xero has within the industry is that it makes not only the accountants life easier, but also the customers at the end of it at the end of the line. Because if the accountants clients are using XERO, it produces documents super clean, the record keeping is is seamless, and it's all super integrated. So, you know, it makes life easier and cheaper for both the can and the business. So therefore, it's it's recommended, you know, already without zero doing anything, you can think of it as free marketing in the form of word of mouth. So, you know, imagine if your sales engine comes from the customers that are already paying you to use the software. Yeah, so zeros pricing model includes different tiers of plans, allowing businesses to choose a package that aligns with their needs. So initially, usually the client, so the end clients are brought on, on the cheaper, more basic subscriptions that are just for, you know, cash flow management, taxation, and doing the books at the end of the day. But because it's so wonderful and easy to use, it really ends up being integral to these businesses. And therefore it goes that point that it's super, super sticky. Like, it just becomes day to day practice for these businesses to be logging on and, and through the Xero ecosystem. So this is one of the absolute keys. It gives zero huge opportunity. And this is a classic buzzword in software as a service business. It gives zero a huge opportunity to grow its annual revenue per user, because these customers, you know, their small businesses, again, they don't have all the support functions. They don't want multiple interfaces with technology. If you know it's a very focused business on, you know, for example, a builder or something like that they don't want to have six or seven different little apps to manage their business. And because zero is super integral for them to get paid. It's very easy for them to add features, for example, workday management software, advanced reporting features and optimization features or cashflow for an engaged business owner. And essentially, it can end up growing that base of revenue that they get from their existing customers. And they don't need to spend so much on developing all these apps and extra services in house. So instead, what they do, which is very, very clever, I think, is they have all these third party apps that do all the other stuff that they don't want to spend development dollars building, they have an integrated within the zero suite. So it still keeps the customers within the Xero ecosystem that they just pay a little bit more, maybe they give a cut to the power developers, but it just keeps them in there. So essentially, it's just one thing I love about Xero is it grows it the way I look at it, it goes vertically and horizontally, so it grows tall and fat. It grows tall by adding users. Because it's just such a good software, it's such a good solution. People love it. And it's sold by its customers out to other customers. And it grows fat by you know, when they have a customer they've got It's so sticky, people love it, there's a very low churn rate, it's very, very uncommon for a customer get on zero and then get off zero, just because it becomes such a close part of their business. So that's why I absolutely love it. Like I think it's a textbook software as a service business end to end, all I'm gonna go through is some of the numbers, and then I'll summarize and then we'll be done. Okay, so I've told you the qualitative, the quantitative is unreal, so in the last two years, and it's pretty representative of their growth over the last sort of period. But this is what I looked at, particularly for this pitch, their last few years of revenue growth of 28 to 29%. year on year, almost all of that translated to annual monthly recurring revenue. So again, software as service, they get paid this consistently, they're very, very sticky. So these customers don't go anywhere. So that's another floor on the earnings going forward. They've had subscriber growth of between 14 and 19%. So high teens, pretty good. And then annual revenue per user has also increased seven to 10%. So that's that vertical growth and horizontal, so they're growing taller and fatter. And that's, yeah, that's absolutely what I love and why I think they're able to in the last last year, they had $102 million worth of free cash flow. So they find all their own growth. They're not, you know, consuming all shareholder money or debt to pay for this growth. And finally, as in why I'm pretty comfortable holding it, I think their market cap was around. Like, it's not much more than I suppose, I think 15 billion or something. And one thing they they report on is total subscriber lifetime value, which is essentially, how much you're going to make of these customers over their lifetime as a customer. And while that can sound a bit risky, because of all the things I've talked about, like on the qualitative lights, it's a beautiful business, why not many people leave it, why they only start, they're paying zero more for the additional services, it gives me confidence that these future cash flows are actually going to eventuate. So you know, I think they they reported a total lifetime value, which had a three year compound annual growth rate of 30%, which is insane. And last reporting, they had a lifetime value of $13.5 billion. So worth of future cash flows from all these customers have on boarded. And, you know, the market cap of the company is not much more than that. So, you know, it gives me pretty good confidence. So, look, mate, I've got a couple of questions. I'm going to summarize and then your all your yeah, that's all it basically on on investing on my principle of investing in what you know, look, my brother and mom run the accounts with over line agency fully through zero. I got invoiced last week for for drug products, zero, my housemates an accountant and use it for his family businesses. And my Accounting has come tax time, you know, the writing's on the wall, it's in front of my face. And something I've learned is you don't have to, you know, hit rocket science to get a phenomenal business or investment. This thing's just growing, it's solving a huge problem for small to medium businesses. And it's got a massive addressable market in pretty much every small to medium business around the world. The growth is epic, the numbers speak for themselves. So looking at I'm sold, what do you it

Luke: 24:13

sounds very good. I've got a couple of questions. And so I think some of them were kind of answered in that quantitative side at the end there. Yeah. So you mentioned about how, you know, it's really sticky so so people stay with the product. And, and I'm interested around growth, because it seems as though because because of that aspect of them, they're looking for more users and less so about, you know, getting more value out of their users more and I know that it was both, you know, wide and high in terms of where they're getting their their money from. But you know, you can only scale some an individual have so much Right, exactly. So, how are their growth numbers been? I guess previously like, are they is it exponential like or is it linear growth rate like Have they They have they continued to grow, and really gotten value out of that sticky aspect of the product.

Khush: 25:06

Yeah. So I think what sticks out to me here is there, the last few years of revenue growth probably average around mid 20s. So mid 20%, revenue growth year on year, which is very, very healthy for any growth business. The fantastic thing, obviously, it's recurring revenue. But that revenue growth is built of both subscriber growth and getting new people on board. And I think in the earlier year, so probably more looking towards three to five years in the past, those were north of 20%. And at the moment, as they've transitioned to really pushing into the US market, and European markets, that subscriber growth has come down a little bit into the high teens, which you just spoke about. But because also they're getting they're extracting more value out of the US they already have that revenue growth is saying really, really high. But to answer your question, yes, there is probably a cap as to how much they can extract from each user, because there's only so many services that have small business needs. And then on the growth side, the new CEO that's come in, I think you'll see I did a fantastic job, but new CEO that's coming in is very, very driven on the motive of expanding into those new world markets, because they do a phenomenal product. It just has to be tailored to the specific markets. And I think specifically the US that it's breaking into to keep those growth numbers going. But yeah,

Luke: 26:25

yeah. So look, we're just about a time. I'll give you one more quick question. Sure. You know, how do they deal with so you said it's mostly small to medium businesses? And how do they deal with businesses outgrowing their service? Yeah.

Khush: 26:38

Okay. That's, that's a very good question. I think it would be a significant change. If a business outgrew zeros. Services, because there's so integrated and accountants of all different sizes, sort of use Xero to help invoice and work with their clients. I think the only case that happens in my understanding is if a company gets acquired by another company. So that's taken on to their books, or, yeah, it gets so big that you have a full in House Finance team that comes in sort of thing. But I don't think that's really the issue for for Xero. Because those companies have probably high maintenance and lower relative value to small businesses paying a small amount, but it's very, very easy for Xero to manage. So I don't think that's really a risk for the business. So

Luke: 27:26

proportionally, even though there might be a big spender, they're not losing enough of them, even if they are from acquisitions or whatever, that it's a significant impact on revenue.

Khush: 27:35

Yeah. So to answer the question, I suppose their churn is less than 1% year on year, which means there's not many businesses of any size leaving their service.

Luke: 27:43

Yeah, not cool. Awesome.

Khush: 27:46

Night. That was so much fun. Yeah,

Luke: 27:48

that was that was fantastic. Good 10 minute faces. We may have crept over a little bit, but yeah, look, thanks for listening. Find us at the curiosity crisis.com and QC classes on Instagram, or on all major streaming services so you can listen how you like. And Coach, I think you have a favorite to ask our listeners

Khush: 28:05

may if you got anything out of this episode. Obviously this isn't our financial advice is purely for entertainment. If you got anything out of these pitches, recommended your friend gives them the Joy of listening to us talk about semiconductors or boring counting software, and you might just find the next peak.

Luke: 28:21

Perfect. Unreal. Alright, catch you next time. Quick

Khush: 28:25

reminder, this is purely for your entertainment and education. This is not financial advice. This is just our opinions, but I hope you get something out of it and enjoy it.