Associate portfolio manager breaks down her firm’s fundamental approach to a narrative-dominated market
Two weeks ago, sustainable footwear brand Allbirds sold all its existing intellectual property and assets for $39 million (USD), a massive fall from grace for a company once valued at $4 billion. On Wednesday it announced a pivot, from shoes to Artificial Intelligence. Saying they secured a $50 million funding deal, the company announced plans to operate in the AI compute infrastructure space and rebrand themselves as "NewBird AI." By mid-morning the company’s stock was up over 700 per cent.
“Narratives are so loud,” says Laura Baker, associate portfolio manager at PenderFund Capital Management. “It’s not dissimilar to what we saw in 2000 or ’99 where if you put dot com on any business you saw a valuation increase.”
Baker explained that amid the noise and narrative that surrounds the AI theme, investors can’t choose to simply ignore the potential in this space. She explained how her firm takes a bottom up approach, trying to see through the noise and look for AI-connected companies with the capacity to derive real value and profit from AI. She outlined how some advisors and investors can mirror that approach and deal with some of the dynamics shaping AI interest today.
“The way we’re looking at it is that the biggest risk isn’t necessarily AI itself but it’s how markets are pricing in its impact going forward. If you look back to 2000, every single story that had dot com in the name got funded and five years later there was a clear gap between winners and losers,” Baker says. “The winners were companies with real customers that had real cash flows and real business models. And I think it will be a similar dynamic today. It’s just a matter of what that turn eventually looks like.”
Baker acknowledges that this kind of discipline can be tough, given the degree of FOMO that exists around AI. She notes, though, that investors should find out what these businesses do, if they’re generating any cash, and if there is any longevity in the underlying business beyond what they do with AI. PenderFund’s approach, she says, is less about predicting the macro story about AI. Instead, they try to understand what differentiates a particular product or business, connect with their management team, and assess that company’s capacity to grow in spite of or because of a major macro trend like AI.
That approach is focused on small to mid-cap names and Baker says they’ve found success in the software space. The narrative of AI disruption in software, she says, has cause massive sell offs in the tech subsector. In some cases a devaluation has been warranted, but in others it hasn’t. Baker says that her team have been able to find mispriced growth opportunities in the space, where markets are implying a terminal value of zero. Eventually, she says, there will be a realization that these businesses are stronger than their current price implies.
On the winning side of the AI boom, some of the significant multiples seen at the height of the market have compressed somewhat. As those names recover, Baker suggests that advisors still need to maintain a critical view of these businesses, assessing whether they can embed AI successfully into real workflows that generate cash. She notes that this will be a key test for some of the largest mega-cap companies connected to the AI trend, such as the so-called “magnificent seven.” Many of those companies had previously been very capital light in their operations and while they have other business lines that make them highly profitable, they are embarking on an AI infrastructure buildout that could be more expensive than the building of North America’s transcontinental railroad system. Given the amount being invested into data centres and other infrastructure now, Baker believes that the eventual revenues from AI will need to be astronomical in order to generate any meaningful ROI.
She contrasts that expenditure with smaller vertically integrated software aggregators, which don’t need to make the same kind of investment in AI infrastructure to use AI to meaningfully improve their businesses. She believes that an approach focused less on narrative and more on these mispriced upside opportunities can offer the kind of AI exposure that investors can benefit from long-term.
“In times like these where uncertainty is so high and narratives are so loud, that’s typically where at least we like to find the most opportunity and we feel like active management and bottom up investing adds the most value,” Baker says, “I think it comes down to trying to understand what businesses are actually going to generate free cash flow and what are just benefiting from these really loud narratives and being driven more by future stories than their current results.”
