I'm excited I'm excited because a lot of folks have made a lot of money maybe in a market that's been pervasively down for quite some time through the course of this year but to really generate alpha or outperformance in this kind of Market you really have to have a strong view about the places that are going to be the worst off or the valuations or the most stretched to the upside right now and for that we've got two of the best in the business that doing their homework on this kind of thing so we'll get right into it because I know that we've got a limited amount of time and maybe Jim will start with you from a from a structural standpoint right now there's been a case to be made that valuations across the board have been stretched to the tilt because interest rates are rising right now I wonder though in this kind of environment if there are places that are due for the bigger fall and Are there specific industries that you think are going to be the worst off because of that kind of right environment so Dominic first thanks for having us and I'm excited too because it's great with Stanley druckenmill here that we're not the most bearish people at delivering Alpha today um so yeah as I mentioned it today at lunchtime on halftime report one of the things that we're focused on kind of thematically um is business models that just simply don't work with higher interest rates an awful lot of a lot of businesses have flourished or survived in an era of low ultra low interest rates and if we're just I don't know where interest rates are going but if we're just going to normalize and get away from the the zero interest rate policy and and QE to something more akin to rates equaling nominal GDP then there's just a lot of businesses that that need to re-rate meaningfully lower because they're so leveraged so one area that that has been mentioned I I know you guys picked up on it and the Ft picked up on it is our data center short which is our sort of big short right now and that's a business that is really an ultra low return on Capital business that's highly leveraged with negative free cash flows and and that's before they compete with Google Microsoft and Amazon which is a much more longer term to the story and it's it's going to be difficult for those kinds of businesses and I know Carson has has is a couple that fit that too where these companies that just have negative free cash flow or even negative even da and massively leveraged balance sheets are just going to find it a lot more difficult to a keep their valuations and maybe more ominously raise capital in an environment where investors now have higher hurdle rates so if those higher hurdle rates are are in play right now and you talk about the idea that data data center type companies are poised for the fall we can think and when I think of data center I think of a spattering of different kinds of tech companies that are all part of that ecosystem right I mean it could be the it could be as simple as the alphabets or microsofts or or maybe even ship companies like Nvidia or or meta platforms but there have to be places that are positioned worse off and some of these guys have strong enough balance sheets right I mean the bigger players yeah the hyperscalers right right exactly so where are those negative profitable companies the Legacy data centers the guys that are building the warehouses out in New Jersey Northern Virginia and and suburban Chicago that's the problem area the hyperscalers are their enemy and I've also I've joked that the cloud is the enemy of the Legacy data centers not their business and and read investors seem to think it's their business but the cloud is actually taking market share from those companies so if you look at a company uh like uh digital Realty DLR which is one of the leader is the largest footprint of these Legacy data centers I mean they're they're really growing I think at four percent a year um their their noi which is a Reit metric is actually shrinking um and the capex is just enormous they're going to do 2. 2 billion of ebitda this year and they have 2. 5 billion of capex and and and so really the Returns on incremental invested capital in this business have been negative in dlr's case just to to underscore what a bad business this is since the business peaked which was basically 2016 which is when the cloud guys really began to kick in um DLR has needed 11 of capital incremental capital for every one dollar of Revenue incremental dollar of Revenue they've generated and they have uh they have 50 ebitda margins so that means that it's taken them eleven dollars of incremental capital to create 50 cents in incremental gross cash flow that's a four and a half percent incremental return cash on cash they just did a debt deal at five and a half percent uh last week and if you look at their income statement uh if their rates are at five percent they're playing they're paying an uh implied below two percent right now in their income statement if their rates were five percent they did a deal at five and a half last week they lose money and and so we've been short the office reads as well and the office reads began the year at six percent cap rates they're now between nine and ten percent cap rates and for those who know the office rates are down 50 this year that's how they've re-rated so the data centers began the year at roughly five percent cap rate they're at about a six percent now if they were to go to seven DLR would be down 25 from here if it were to go to eight percent cap rate which is not unheard of right now in the current environment stock can be down almost 50 percent so these kinds of things are out there but but okay so so that's very much a value I mean you mentioned the net operating income issues you mentioned the valuations that we have with regard to we're interested you also by the way said you don't know kind of where interest rates are going but this is very much an interest rate discussion on multiples and basically how much more return you need to get above risk-free returns backed by the full faith and credit of the US government right if it's digital Realty there you mentioned some of the office reads as well are there compelling places to still be short given the fact that we've already seen the massive revaluation of many of these so again it depends I you know we wouldn't be pressing office rates here we were short them at the beginning of the year in much greater amount but the data centers to us look like they're just starting the re-rate and and I think that that again if you're earning a four percent plus return on Capital in an environment where the governments issuing debt at four percent you've got a problem and and that's before capex by the way that's the scary thing and I know Carson's got kind of similar you know some similar thoughts so let's bring that it's a perfect segue because we mentioned the macro environment and how interest rates are framing a lot of these discussions right now and this that so-called re-rating right it's not necessarily that the businesses are terrible businesses they're just not good businesses when you can find alternative measures of returns elsewhere in the market for a lot less risk you have been very vocal and I heard your interview on Squawk Box this morning you've talked about some of the ESG industries that have been there in the past but where do you think it's going to be that re-rating that's kind of just in the beginning stages of happening right now maybe because of Interest maybe because of interest rates maybe not so yeah we're we're generally not thematic we look for companies where managements are actively deceiving investors but when I look back on the past 18 months a lot of what we've been doing is in Green Tech and the reason for that is that so much money has been thrown into that space indiscriminately and you have a lot of charlatans coming out to basically Hoover that money up and so one of the companies that were short and I did talk a little bit about this morning is Sunrun now Sunrun works for us when investors become more risk-averse so you can tie it directly to raids for one issue with Sunrun is that when they tell investors they have four and a half billion dollars of net earning assets there are several assumptions they use that are ridiculous such as 90 percent uh renewal rates after 25 years but they discount that back at five percent uh so you know obviously with a couple of rate hikes since we published on them in July this is even more absurd but really what we depend on is if investors are losing money in highly speculative names risk aversion returns and in that type of environment we think investors see through these fairy tales much more readily than they have previously they have to right they have to I mean if you're capable of learning a lesson if you're capable of having your hands bitten by a dog you might then not go and readily pet that same dog again so if you're capable of learning that lesson so that's you know if if investors aren't then I should really close up shop because you know that it's over you mentioned the capitalization rates and it's something that you mentioned as well I mean this idea that the hurdle rates are kind of in this certain sphere where they can go higher with your with your thesis specifically when it comes to and I'm gonna try to find a reason to see why some of the people in green energy Alternative Energy are are taking the other side of that trade because there is so much more money coming out with the inflation reduction act with everything thematically that's happening with so much more attention being put on green energy there's a fundamental reason why the sector could grow or the total addressable Market or the Tamp and get that the pie can get bigger and that all of these companies should have even if a smaller piece but a bigger pie that they should still do better okay so when you take a business that at 30 tax subsidies is value destructive and so where where the solar companies got their pop or the renewable companies the subsidy per the previous law the subsidy dropped to 26 percent do you just returned it to 30 but they destroyed tremendous value even at 30 percent in order for those businesses to be economic at least the ones that are publicly traded because I they they spend a lot on sales and marketing I suspect that there's a lot of what's really sales and marketing expense that they classify as other operating expenses but for those businesses to actually be economic the subsidy rate would have to be significantly higher so that's that's the issue this so to the extent that the subsidy is increased this just enables companies like Sunrun to destroy more capital or more value in a shorter period of time can I jump in here yes please I happen to know this company pretty well he's being kind to them this company is the aluminum siding of the 21st century for those either old enough to know what I'm talking about it's a roofing company it's basically a roofing company with us with a second mortgage subsidiary attached to it it's not a green company it's not it doesn't produce solar panels it doesn't produce converters it buys them from other people and puts them on your roof and leases them back to you basically and and it had trailing 12-month operating cash flow before they put up a single panel of negative 900 million dollars and and and they have eight billion in net debt and preferred eight billion in net debt and preferred operating cash flow of minus 900 million for the trailing 12 months before capex that is a science project and and and and so again my friend Carson is being very kind to Sunrun and then they have tax issues and a myriad of other things but because it's seen as ESG because it's perceived that's the variant perception and that's where you can make a lot of money on the short side when everybody believes this but the reality is this but what what happens I mean you also mentioned this idea that that a big part of that macro picture is the tax credits that are involved that there's an incentive being put into place for me I don't have let's say I don't have solar panels on my house yet but I'm thinking about it because everywhere if I go to my local Costco or I go to my local kind of Warehouse Club there's that guy set up at the table right there and he's telling me all of the economics behind how I can make my bill cheaper over the next 10 years and and the the payoff they sell the tax credits they sell the tax credits the Goldman Sachs and Google and other people well but here's but here's the other issue with with Rising rates the solar companies like Sunrun are dependent on the securitization markets because basically they're going to lease you they lease 70 of the systems they deploy and then they securitize those now they are not able they're going to have to pay higher rates on these securitizations and they're also going to get you know smaller Advance or lower Advance ratios against those securitizations or against those leases so they're not able to jack their pricing of that lease up as much as the rates have gone up because you're going to compare it to what your what the electricity you currently buy costs and so that's not going up in line with interest rates so that's also going to squeeze them as well what happens though if I'm one of those millions of Americans who keep reading stories in the media right now about just how expensive my utilities bills are going to be this coming winter we kind of know the macro economic backdrop we know the geopolitical backdrop for why Energy prices are soaring I've already been told by people in newspapers and media that I should expect much higher natural gas bills in the coming months that my electricity bills will be in incrementally higher if not much more higher because of things like natural gas prices and the electricity generation and everything else and I think to myself but I've got a solution it's in the sky and it's free and all I got to do is set this stuff up there there's a fundamental reason why I would want to go after solar because I think over the next several years I'm going to be better off for it as a consumer well over a 25-year span of lease basically I don't think that you can expect these prices for Nat gas and by the way if you have appliances in your home that are powered by not gas well you either have to pay to replace them turn them into electric or the panels are not going to solve your problem but I mean we obviously have these factors right now geopolitical factors that are driving up the prices of of energy but I mean is that really long term and PS in California one of those factors that's driven it up is shutting down a bunch of power plants and replacing them with solar Dominic it's like my grandma who bought aluminum siding literally from a from a door-to-door Salesman from Sears in the 70s being sold on the idea of higher home heating bills and all that heat leaving your house and if you put up aluminum siding it would keep it in it didn't work out for her and it didn't work out for Sears okay I mean so these companies are really literally selling this stuff it it it actually is reasonably high cost power um it's not not that competitive as you might think with the electric grid and and the returns to the sun run shareholders are negative that's the important part this isn't a viable business it took years for that thesis to play out with aluminum siding you know I mean they they were able to sell that stuff at a fairly decent clip for a long time I mean how what ending are we in right well there's also a financing chain here so we've talked about the equity side we've talked about securitization these solar companies also have Warehouse lenders so in the case of Sunrun it's Credit Suisse and so if they can't get securitization done I mean Credit Suisse might be left holding a bag here on what's already in the warehouse but there's there there are chain this financial this financing chain is vulnerable in multiple points so I mean if these companies cash flowed it would could be a different story is that the same thing for for the data center thesis as well it's it's got to be slightly different than the data centers the game being played with the data centers one one of the constructs that I would like you to think about again is is very in perception and the data centers are capital intensive businesses it's not just a landlord collecting a check right they're constantly replacing equipment and they have to run these things if they were actual operating companies and not in REITs so if digital Realty was an operating company it would trade at 90 times earnings declining earnings right now and so the the Reit investors say oh yes Jim but you have to add back the the depreciation and and it's a Reit and forget all that capex and the companies with a straight face say oh the the billions of capex that we have 90 of it is expansionary only 10 percent of it is maintenance capex which you should deduct from our results and if you do the numbers you realize that it works out like 150 year life for the for the racks the air conditioning units and all the rest of it inside the data centers which is of course absurd um so there's there's a lot of semantics going on here it does not get away from the fact that this is a tremendously Capital intensive business where stuff constantly has to be replaced or is becoming technologically obsolete and the little game that that the industry plays is is say you have an HVAC unit at a legacy Data Center and it goes out it fails um and you have to replace that unit if you can convince your internal Auditors that by replacing that HVAC unit you will have one new customer or you can raise rents on customers you can put the entire ticket price as expansionary capex and that's the little accounting game that they play of course it's maintenance right it went out it has to be replaced so you you see these really uneconomic businesses that digital Realty is earning four percent on its capital pre-tax and that's before before capex um it it really is uh it's kind of stunning of how poor these businesses are but yet if you're financing yourself at 1.
6 or 1. 7 percent which they do or they did you can you can lever up and and show investors some sort of minor return at five and a half percent it's a different game Jim have you looked at I mean have you looked at the I guess the next layer of that if if the data center business is that in your words poorly run is that overvalued at this point and and is playing kind of a little bit of a an accounting game if you will with regard to how they can treat certain items that ultimately then flows downhill to certain other parts of that data center business that are reliant on those centers being viable options yeah for technology yes and no so the hyperscalers Amazon Google Microsoft who are building in many cases not only building their own data centers but they're also tenants of the Legacy guys they equal about 20 25 of the the tenants of the existing businesses so there's a little bit of an interesting Dynamic there um but they are building more modern newer centers um and and that will continue There is growth in data there's that's not in question it's just not accruing to the old guys to the Legacy what about the people who make the server computers what about the people yeah so the we look at the hyperscalers to see what the real growth in data is and and it's down really it's kind of down from sort of 40 year over year to 30 percent it's still pretty robust and again compare that to the Legacy guys which are growing you know four to ten percent um if Microsoft or Amazon were to come out one night and say okay take your Cloud growth you know numbers down to 10 percent from 30. that would be akin to what MCI warned in the summer of 2000 about internet traffic that would have a big impact on a lot of companies the companies you're referring to okay now Carson on your side of things you mentioned Sunrun that that's the the E component of ESG right that's the clean energy the environmental kind of side of things if you've taken such a a perhaps more pessimistic view on ESG as a whole is there anything outside of clean tech is there the S component is there a g component that you were targeting or that you're thinking about have have the fundamentals screen that there's something else besides solar out there that could be the next Target of say a revaluation well I've never met an ESG investor who's told me they've made a single investment based on G so the G doesn't exist like that's fantasy the s I don't know I'm not really sure what qualifies as s but doesn't qualify as e so I think that now to be fair there are people who say hey this is a conflation of ESG with impact investing and what ESG is intended to be is you intended to rank companies in a given industry this one's most carbon intensive this one has the best gender pay Equity this one's the most diverse Etc but the way that people understand it and the reason why so many of these dollars flow to ESG is because people think it's investors think it's about saving the world and so they really think about this e component so no I think you have to you know if if you're going to play this thematically you look at the the Green Tech and and just to give you an idea of how bad G is I mean there's really an inverse correlation between a high e-score and the g score the gold standard for governance in based on what I've observed in this space in Green Tech is Tesla and yet Tesla is the only large company that I've ever come across that has to self-insure for DNL so that's you know like if that's the gold standard of this space in terms of governance governance is irrelevant in you know to ESG investors one of the other places I think that that a lot of folks have keyed in on with regard to the ESG Trend right now is in fact that it's a trend and that it's become marketed in that way and that it's become an impact point in that whenever I see folks who pitch Investments along these lines they say that you're doing the world of service that you're starting to kind of make the world a better place by doing it and you have people really believing that and for that reason there might be not infinite pools of money but certainly substantial ones that go in there we mentioned the interest rate environment and the overall macro economic environment right now do you do you feel as though that ESG fund flow so to speak from people who are pitching and reaching out to retail investors say hey save the world make it a better place by impact investing in this way do you think that that dries up and if so is it those clean tech companies that that get hit the hardest well obviously as liquidity conditions tighten I mean everything yeah all asset all financial asset prices will suffer or at least you know as a general matter now I I think there's an and this maybe will be controversial but I believe that the private sector is not capable of addressing the serious environmental societal problems that we have and the reason that the private sector is so you know so vociferously pushes this idea of ESG investing or impact investing I mean number one it's a higher fee product but this in the investment industry I mean almost everybody is remunerated based on valuations being high right so the higher my AUM the higher my management fee and if I'm paid on performance the more stuff goes up the more I make as a performance fee so the investment industry is structurally opposed basically to government regulation and legislation in order to rein in the private sector and address these problems I don't think you can really address these problems in a substantive way without government intervention and that's and so the longer that industry and the financial industry can sell the world on this idea that the private sector can heal these ills the longer they're able to Stave off the legislation and regulation that will impact everybody's in the in these businesses impact their wallets one of the places that uh risk assets have seen some of the deepest pullbacks even before the the interest rate driven revaluations that we've seen in the last several weeks here has been in the Chinese market has been many of the U.
S listed Chinese names and Technology specifically in media that have taken an absolute shelling over the course of the last 12 to 18 months a lot of that in the initial stages was because of what was perceived and what I'll just call because I'm in the west and I don't have to fear the sanctions from these guys is a government campaign to crack down on these companies right that really kind of hammered them a little bit I'd like to take the time that we have left here to address an issue that both of you have some familiarity with and that's the Chinese market it's been very geopolitically sensitive given the current environment between China and Taiwan semic inductors have been at the front of that story many of these Chinese Tech Giants have been at the center of that story I wonder Jim from your standpoint are there still places where China has companies that are doomed to revalue to the downside even further than they are right now and if so where I'm going to handle that question deflect that question a little bit and point out something perhaps even more ominous and that is if what is going on in the world whether it's Russia Ukraine whether it's central banks losing control whatever might be weren't happening right now I think what would be happening in the Chinese real estate market would be front and center for investors it is I've long said that that Chinese apartment prices are the most probably after treasury bonds most important asset class in the world and they are declining we are seeing a real real estate problem in China over the past 18 months that the government does not seem to have a handle on and the reason that's important as you know is that that investment is still almost 50 percent of the Chinese economy and that residential real estate is almost half of that so residential real estate is 20 to 25 percent of the Chinese economy which is a stunningly large number they're still building 15 to 20 million Flats a year and and the fact that that there is a major meltdown occurring amongst the developers both public and private over there is a major story that's really kind of on the back pages of our Financial press um are you saying that evergrant is just the beginning here evergrand was the start of it that was 18 months ago and and there was another default I think just this this overnight in a different developer um you have to understand that like Tokyo in the late 80s almost every large company in China has a real estate development arm so it's not just the developers this is endemic to the whole economy there and and I think that that we ignore it at our own Peril But realize just how how much of Asia is tied into China it's a big story and and I think we're kind of all because of other things it's off the thing and and a focus on tech stocks as you say because mostly it's tech stocks that trade in the U. S Chinese tech stocks as Josiah reminded me a number of years ago at delivering Alpha here that I didn't understand Chinese companies um and and you know it's uh it's Italian with the government that you cannot get away from it's the state economic model whether you're publicly traded or not and capital going into China just is not treated well and particularly Western capital is not treated well in China and and this has been going on now for a long time not just the past few years Carson where does it manifest itself the most in in your mind what does your gut tell you about whether or not there is any kind of a a real shoe that's left to drop here when it comes to Chinese companies and their economic viability in this kind of environment well what the past year and a half have really brought front and center is I mean like Jim was just talking about the state involvement in the economy and until about a year and a half ago just would always hear what Western economists laud the government in China oh the government's going to do this the government's going to do that and these are the same economists generally who freaked out when the U. S government got non-voting pref stakes in our banks you know so it's like there's always been this cognitive dissonance there but in the past 18 months we've investors have really been smacked in the face by the fact that this is not only in a totalitarian regime but it's also capricious and they've she has clearly judged that he no longer needs or even really highly desires Western Capital so you're rolling the dice if you take a look at a lot of Fortune 500 CEOs they appear pretty sanguine and you might say well you know what if these guys if they're if they're okay with investing more money in mainland China and they're not really panicked and this also ties into the China the past the scenario in which China attacks Taiwan if they're not panics maybe I should you know maybe I should be okay with it but I would point this out and this is a reality of the world I mean certainly you see this in asset allocation if you Zig when everybody else zigs and you all Zig off the cliff you know you're not you're not going to really suffer adverse professional consequences for that you Zig when everybody else zags and it doesn't go well then you're going to have a problem so just because all of all of these people get all these Fortune 500 CEOs are willing to increase their bets in China that they had already made you know don't take that as them being the smart money here and by the way the China invasion of type in the scenario in which China invades Taiwan I mean it is the biggest issue there is no issue in investing in China or Asia that surpasses that and you know like how how do you know like how do you know whether they I mean you really want to bet that China does not invade Taiwan like what's that based on you know because they need the US I wouldn't make that bet does that mean that Chinese based or I should say this taiwan-based manufacturers and semiconductor companies are in your mind to hold right now don't touch them well it's interesting because if you're a Taiwan in one hand you could say hey the smart thing to do might be to build Fab capacity elsewhere in an area that can't be attacked by China but on the other hand if you want to make sure that the U.
