3 Tech Recs From Our Writers

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The tech industry is known for huge boom-or-bust stories -- small caps that go on to become multibillion-dollar companies, and promising companies that fizzle out into nothing.

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In this week's Tech episode of Industry Focus, three Motley Fool writers pitch one of their favorite stocks in the tech sector and explain why each of them is a solid investment for the long term. Find out what's so exciting about IBM (NYSE: IBM), Netflix (NASDAQ: NFLX), and Mindbody (NASDAQ: MB), how these companies are making their money and growing their earnings quarter after quarter, the most important risks investors should know about before buying, and more.

A full transcript follows the video.

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This video was recorded on Oct. 20, 2017.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, Oct. 20, and we're wrapping up our "Pitch a Stock" week across all of the Industry Focus episodes. Today, we're going to be throwing three tech stocks at you. I'm your host, Dylan Lewis, and I'm joined in the studio by Thursday host Sarah Priestley.

Sarah Priestley: Nice to be here. Thank you very much for having me!

Lewis: It's a pleasure. Do you have any fun weekend plans, Sarah?

Priestley: No. [laughs] Netflix marathon and knitting, probably.

Lewis: I don't think you meant to do this, but that's a nice entree into what we're going to be talking about later today.

Priestley: I didn't mean to do that. But yes, we will be talking about Netflix.

Lewis: That's the benefit of me doing the Friday show, I always have that question to ask people, like, what are you doing this weekend?

Priestley: Do people have boring answers like me?

Lewis: Always. [laughs] And I'm always like, cool, give me something to jump off with here. I remember I did this show one time with Taylor Muckerman, and I was like, hey, Taylor, how's it going? And he was like, good. [laughs] 

Priestley: So you're not going to be knitting this weekend?

Lewis: I will not be knitting, no. I have a friend's birthday, I have some errands I need to do, some very fun errands. I'm going to go around town in my roommate's car, try and knock them out.

Priestley: Oh, wow, a car in D.C.! Crazy kid.

Lewis: To me, this is adventurous, because I just ride around on my bike. Everyone else is like, yeah, I have a car, duh. What are you talking about, Dylan?

Priestley: Millennials.

Lewis: [laughs] Anyway, to bring it back around, listeners, we're doing this theme week, this pitch week, and if you've been listening all week you know the spiel at this point. For folks that haven't caught the earlier episodes, we had all of our writers in town recently for our annual writers' conference, and we thought we would take advantage of that and have some folks come in and do some pitches in the studio. And so we have three pitches. We'll be hearing about IBM from Tim Green, Netflix from Danny Vena, and Mindbody from Rick Munarriz. After each pitch, Sarah and I are going to share our thoughts on the stock and add a little context, maybe some things the writers didn't include.

With that in mind, Austin, do you want to get us started and roll the tape from Tim's IBM pitch?

Tim Green: I'm Tim Green. I write mostly about tech stocks. I'll be talking about International Business Machines. On the surface, the IBM the story does not look very exciting. Revenue has been slumping for the past five years. Earnings are down. The cloud computing business, one of its major growth initiatives, is being overshadowed by the two market leaders, Amazon (NASDAQ: AMZN) Web Services and Microsoft Azure.

But IBM has one big advantage that I think is being overlooked. Entire industries rely on its products, and it has long-standing relationships with major organizations in nearly every country. A few examples that drive home this point: 90% of global credit card transactions are processed by an IBM mainframe, which IBM has been selling for more than 50 years. Essentially all the world's largest banks use IBM products to run their infrastructures, and four-fifths of all travel reservations go through IBM's system. Its broad base of customer has allowed IBM to generate more than $12 billion of free cash flow each year, even as it invests in new businesses that it hopes will return it to growth. 

Its cloud strategy plays to this strength. IBM is focused on enterprise customers, high-value services, not simply growing revenue as fast as possible by renting commodity commuting resources. Earlier this year, IBM signed a 10-year cloud services deal worth about $1.7 billion with Lloyds Banking Group, a major U.K. bank. This will be a minor part of IBM's total revenue, but it represents exactly the kind of deal that will drive growth in IBM's cloud business. The bank is big, with over a trillion dollars of assets. It's a long-standing IBM customer, and the deal represents a brand-new revenue stream with IBM not only hosting applications in its cloud, but also managing migration of those applications.

IBM has also struck deals to build platforms based on blockchain, a distributed database technology that underlies cryptocurrencies like bitcoin. It's working with a consortium of major banks to build a blockchain-based platform for tracking international trades transactions, and it's working with foods companies like Wal-Mart and Nestle to use the technology to add transparency to the global food supply chain. Just like in its cloud computing business, IBM's existing relationships with many of these companies is a valuable asset, especially when dealing with such a new and unproven technology. 

None of this has helped IBM avoid a long slide in revenue, and it's hard to predict exactly when it will turn a corner. But with the stock trading for barely more than 10 times earnings guidance, I think the market is being far too pessimistic.

Lewis: I think one of the important things to note with that pitch is, we had our writers' conference last week. Tim recorded his pitch, and, actually, Danny recorded his pitch on Netflix, before both companies reported earnings. Tim's IBM pick here looks even better when you consider the market's reaction to its most recent earnings report.

Priestley: Yeah, Tim looks stellar after this. The earnings report came in, and they had a beat on earnings per share of $3.30, versus the $3.28 which was expected. Their revenue was better than expected, but still a decline for the past 22 quarters. Tim touched on that in his pitch; it continued.

Lewis: That's the thing we're constantly watching with this company: Where will the bottom be for the revenue growth? And when will they stabilize and return to growth? I think people were pretty optimistic this most recent quarter, because the decline wasn't as much as maybe they had thought, which is tough to curb into a bull case.

Priestley: Yeah, absolutely.

Lewis: But really, I think what Tim's getting at here is, this company has been struggling for quite some time, but the floor is so high for this business because they're this entrenched player, they're already installed in so many businesses, that basically, you're getting this big business turnaround play at a fairly cheap price. And he mentioned valuation a little bit there. The stock has a trailing P/E of 13.5, which is practically half of what the market is trading at right now. And that's even after they were up 10% following earnings.

Priestley: Yeah, absolutely. I think you described it before we came in: People were wondering whether they've hit the bottom of the earnings plateau, and I think that's exactly what people are expecting. And there were some highlights in their earnings. Strategic imperatives, which is their analytics, cloud, mobile, security, all of their new endeavors, grew 11% year over year, and that's 46% of their revenue, from this segment. A particular bright spot within that was cloud revenue, which grew 20%, which is actually incredible growth.

Lewis: If you read through the earnings call for this company, you see them highlighting all these different growth factors. You just mentioned a couple right there. For them to consistently struggle with growing the top line, that obviously means that part of their business is not working.

Priestley: Oh, yeah.

Lewis: What's going on there, Sarah?

Priestley: Core Technologies declined 80%. Within that, you have their technology services, which was down 3%. Global business services down 2%. A lot of this is exactly as it sounds, their legacy core infrastructure that they have established, and a lot of their long-term contracts. And part of the reason for this is, it's harder to make money than it used to be. It's harder to get those margins. Another reason is, it's just so much more competitive, and those two played together. But the other thing to note, and I'm sure you were going to touch on this, the big reason their earnings came in so well was their effective tax rate, which we were talking about yesterday.

Lewis: It was, like, sub-15%. It's crazy.

Priestley: It's 11%. It's the second-lowest tax rate in the Dow Jones. The only other company that has a lower tax rate on the Dow is GE. And the way that companies do this, as I'm sure a lot of people know, is through -- I don't want to use the word loopholes, [laughs] but it kind of is loopholes.

Lewis: Creative accounting.

Priestley: Creative accounting, yes. Kind of, transferring assets between business units, writedowns. In this case, it was transferring IP between business units.

Lewis: One of the things that Tim didn't mention with his pitch that I think is pretty important with IBM is the dividend. You look at this company -- it has raised its dividend for 22 straight years. They're just short of that 25 that you need to be a Dividend Aristocrat, which is this vaunted dividend status. If you want more on that, we have a piece, as I'm sure Michael Douglass has told pretty much every Industry Focus listener at this point.

Really, even not being a Dividend Aristocrat, IBM is one of the bankable tech dividends. And they're not going anywhere anytime soon. They're probably going to become a Dividend Aristocrat. I think they've been paying out dividend for over a hundred years; they just haven't consistently raised it long enough to be in that class.

I mention this because, to me, IBM is far more compelling as an income investment, not necessarily a growth investment. You're getting a 3.75% yield on IBM shares currently. That's not too shabby. But we talked about how they have these growths drivers that are available to them, and yet, the struggle of the core business is so much that they haven't found that floor yet. And I worry, even when we get to the point where revenue is stabilized, what is actual revenue growth going to look like? Is it going to be in the low single digits? Because, if you're looking for growth investments, I don't know that IBM is the place to do it.

Priestley: I would agree with you. I do think we shouldn't underestimate the base that IBM already has. It's a huge company. The scale is massive. Like you said, reading through the earnings report, trying to keep track of all the divisions that they have is difficult. They have this large, sticky core base of software and hardware legacy products, across 170 different companies. Just in the services business, they own 5.7% market share of this ginormous business globally, which is double the next person behind them.

I think, while we shouldn't underestimate that, I 100% agree with you. I think there are so many companies now -- Microsoft, Oracle, Amazon -- jumping on these strategic initiatives around big data and machine learning, it's going to be really hard for them to deliver the margins that they have had before.

Lewis: And it's a company where, if you're really interested in them, you have to go into it knowing what you're getting. You're going to be getting consistent dividend growth, maybe some share price appreciation now that the company has started to turn around. But with a $150 billion market cap company, it's much harder for them to double or triple the way that a smaller medium-size or small-cap company might be able to.

Priestley: Yeah, and that's one of the issues for their clients, in the sense that it's such a big, huge behemoth company that, to try and understand how each of the divisions relates to one another, what services they need, it's very complex. And I think they're probably not leveraging a lot of the opportunity that they have between inter-divisional learning that they could be.

Lewis: This is all to say, we haven't talked about IBM all that much on the show. And given what an incredible pitch that was from Tim and how articulate and clean-cut and concise it was, I need to get him on the show and make that happen.

Priestley: Oh, yeah. Definitely. I would love to hear that.

Lewis: Especially as we see some big jumps from them, and the market may be turning its favor on them a little bit and getting a little bit more interested in the stock. Why don't we look over at Netflix now? Austin, do you mind playing that pitch from Danny?

Danny Vena: Hi, my name's Danny Vena. I cover tech and consumer-goods stocks, and I'm here to talk about Netflix. Unless you've been living in a cave, you've probably heard of Netflix. Netflix is a pioneer in streaming video. Netflix has evolved from delivering DVDs via little red mailers. Over the last few years, Netflix has grown to be a worldwide content-distribution service.

In the last few weeks, Netflix has announced a price increase, which was a subject of great interest to investors. The folks that have a $7.99 plan will still pay the same. Those that have a $9.99 plan will have a $1 increase to $10.99, and those with the $11.99 plan with additional concurrent streams and Ultra HD will bump up $2 to $13.99. So the most popular plan is going up by $1. Now, investors believe this is probably going to raise an additional $650 million in domestic revenue, which will provide another $274 million in contribution profit.

For the coming quarter, Netflix believes they're going to increase their revenue by about 30%, and subs are going to go up about 4%, with about a 750,000 increase in domestic subscribers and about 3.65 million in international subscribers.

Now, there are those that believe that Netflix is going to have trouble duplicating the success that they've had in their U.S. market internationally. But if you go back and look at some of their earliest international markets, you'll see that really shouldn't be a worry. In Brazil, which they've been in since 2011, they currently have a 77% penetration rate, and a 90% customer satisfaction rate of customers that say they are extremely or very satisfied with the service. There are similar results in the U.K., with 49% penetration, and 59% of the customers say that they are very or extremely unlikely to cancel the service.

Netflix has had a lot of success in their original content. They recently won 91 Emmy nominations for their original content. I think Netflix has a big runway going forward. There are a lot of reasons to like it. There are some investors who are afraid that the cash burn is going to catch up with the company. I don't think that's going to be an issue right now. They are spending a lot of money. They have negative cash flow, but they're doing that to build out a content library. I think once that content library is built out, Netflix is going to be able to ramp down that content spending. 

So I'm here to pitch Netflix. I think it's a great opportunity for investors.

Lewis: Like Tim with his IBM pitch, Danny recorded his Netflix pitch before they reported earnings. Like Tim's IBM pitch, Danny's Netflix pitch looks even smarter after the company reported earnings.

Priestley: It does. They must have future time abilities. [laughs] 

Lewis: I don't know. Whatever they're doing, it's working. [laughs]

Really, though, Danny mentioned some of the numbers to expect with the earnings report. And you look at what actually happened, what the company delivered, they really blew the doors off of a lot of expectations on the subscriber side. On the top line, they beat as well. A lot of really positive news around this company right now.

One thing in particular that I would really like to home in on, he briefly mentioned this, the price hikes. He mentioned that the company raised prices for two of its service tiers. None of that baked into the results that we saw in the most recent quarter. Really, we're going to start seeing that playing to the financials in coming quarters. It's something that new folks that sign up for the service will be paying, and I believe the old folks will be grandfathered in over the next couple of months. To me, that's a lever that, while the company has just pulled it, they have the opportunity to continue to pull that going forward. I think there's room for them to increase the prices of their services, and that's a really easy way to boost the top line.

Priestley: Yeah, absolutely. And this is the third price hike in three years. I think the rate of price increases is probably going to slow. And as you said, I do think they have plenty of room to keep increasing up to a certain point. But we were talking before the show, they're going to add, is it $600 million?

Lewis: Somewhere in that neighborhood.

Priestley: Yeah, add that to earnings with this one move. Which is incredible when you think about it.

Lewis: Six hundred to the top line. And I think Danny mentioned, it was somewhere in the neighborhood of $250 million in contribution profit.

Priestley: For just one switch. It's an incredible move for this company.

Lewis: And when you think about how strong their customer satisfaction is, and how loyal their customers are, that's really not going to cause a lot of people to cancel their subscription.

Priestley: No. The average Netflix user spends 90 minutes a day watching Netflix. I'm probably contributing to that. [laughs] 

Lewis: I was going to say, I think we're both guilty of fueling that number. Something to watch with this company: Danny mentioned the international expansion stuff. In this most recent quarter, international paid subscribers were higher than domestic paid subscribers for the first time. So if you're an investor, you'll love to see that, because really, while they are experiencing growth in the U.S., the international markets are where they're going to be able to live up to their current valuation.

Priestley: Absolutely, that's their growth runway. I think it's important to note that they're expanding into all these different countries. Obviously, they're having a ton of success doing it. They are having to spend a lot making localized content. And I think it remains to be seen how that plays out for them. But it's something to factor in. You can't just take, necessarily, U.S. content and make it work in every other country.

Lewis: I have to tap you as our resident foreign correspondent here. It is ubiquitous here in the United States. Everyone at least has access to Netflix, whether they pay for it or not. Maybe they're lumped in with their parents or their roommates' subscriptions, or whatever. Is that the case in England?

Priestley: To some degree. I think Danny mentioned, I think it's, like, 50% penetration back home. TV is structured -- we don't necessarily have as much cable, and our basic, you know, if you didn't have anything package is pretty good. So people are probably slower to adopt streaming. But, yeah, 50% is still huge. And it's becoming increasingly popular. I use my mother's account. That shows you there's one person back home doing it.

Lewis: Do you have access to content that you shouldn't have access to because it's a British account? I guess they know that you're accessing it from the United States, right?

Priestley: Yeah, they know. My parents actually used to live in Belgium. The content that they got there, it was completely different to what you get in the U.K., completely different to what I get here. I can kind of see the difference, the spectrum of what they're offering in different places.

Lewis: And some of that is licensing deals, some of that is localized content, right?

Priestley: Yeah.

Lewis: Looking at this company, Danny mentioned as well and I think it's worth touching on, one of my concerns is the cash spend, and the idea that, the content party has to slow down for them at some point. They have been throwing billions and billions of dollars into original programming. And it's what makes their platform strong. But it's also what's killing their cash flow.

Priestley: Yeah, they had a $1.5 billion free cash flow loss for the first three quarters of this year. Last year it was $1 billion. So that's a huge acceleration, huge growth in that figure. I agree with you. I think a lot of people's bull thesis is based upon the fact that they're spending all this money to create this content. It's going to create this huge backlog, and eventually they can rely on the backlog and feed a slower pace. To some extent, I think that's true. But my concern is the same as yours. I wonder, how much with competition from Amazon and Hulu, HBO, Showtime, everybody trying to bid for the best content and the newest, big blockbuster TV series, how much they're going to be able to do that.

Lewis: Yeah, because at a certain point, theoretically, they're not going to be spending $6 [billion]-$7 billion a year on original programming. It will scale down, maybe, to a couple of billion dollars. Only a couple. [laughs] 

Priestley: Yeah, we would hope. But you do have to factor in that they have a legacy in the U.S. that they don't have in other places. So content spending might not slow as much as people are expecting, because other markets could blow up the way the U.S. has, and they have to spend a lot on content there.

And I think, we're talking about this content spend, it is important. It's attracting a huge amount of talent to the organization. You have Orange Is the New Black, House of Cards, Stranger Things, all of these shows that have been so successful -- they're not just attracting us as consumers; they're attracting great talent in the industry. So I can see the trade-off there.

Lewis: At the end of the day, this is a stock that has been absolutely on fire the last couple of years. It's been a great stock to own.

And while we have these concerns about content spend, while we have some concerns about the international expansion, things like that, you look at the core product, and the customer satisfaction is incredibly high. I'm part of the paying subscriber base, and totally see the value that they're providing to people. It's a company that's been really disruptive and managed to basically create this space for themselves and then innovate within the space, basically deciding to make streaming available and then within the streaming market saying, "No, we're not going to just take reruns of The Office; we're going to spend a lot of money on original programming, because that's what makes our platform sticky." 

I think you look at management there and say, they really understand what's going on in this space, probably more so than anybody else. And if you're a Netflix bull, that's a big part of your thesis.

Priestley: Yeah. We were talking about IBM with the move to big data, and that's where everybody's going. It's machine learning and AI. Netflix is a prime example of this. They have thousands, millions, probably at this point, of hours of viewing time of data of what people's preferences are. Do they pause at this point, do they fast-forward, do they lose them at some point in the series? And all of this is going to play into the content that they're going to create in the future.

There is a lot of competition, as we talked about. Amazon, Hulu creating their own original content. Their backlog isn't as large, so their data pool probably isn't as large at this point. So yeah, that's something that's a really unique point.

Lewis: Yeah. They went from this point of basically using data as a recommendation engine, to then using data to inform programming decisions, and what kind of series should we be offering, and that kind of stuff. So the opportunities there are super interesting.

We have a pitch from Rick Munarriz on Mindbody. Rick is a longtime Fool, someone who has been writing for the site and working on some of our premium services for a long time. If you haven't read his writing, one, you should. He covers a lot of fun, interesting things, and I think in a lot of ways, it's the standard of Foolish writing, striking that right tone of accessibility and being very playful. And I think that comes through in his pitch. Austin, do you mind rolling that?

Rick Munarriz: Hi, I'm Rick Munarriz, TMFBreakerRick, and I want to talk about Mindbody, ticker symbol MB. This is one of the smaller tech companies in the tech universe. It's about a $1.3 billion company. Mindbody has a pretty unique product in that they run this app, this software, a cloud-based platform, for a lot of the wellness industry. I'm talking about not just medical, but yoga studios, beauty salons, Pilates classes. All these small independent players out there sign up with Mindbody, and then Mindbody delivers leads.

And it does so by making the reservation process transparent. A lot of times, when my wife needs to get her hair done, she'll call up a hair care salon and say, "I want Monica to cut my hair," and it becomes this whole hassle. Mindbody has gotten rid of all that. It's a place where, through the app or online, you actually have access to any area, any participating person that's around there, and you can just pick. And it's transparent, the availability, what they can do, their services.

What's cool about Mindbody, they have nearly 60,000 companies that have signed up for Mindbody. This is a company that, even though they're small, and they're still not profitable, they should be profitable by next year, they grew the revenue at 31% in the second quarter. In the third quarter that ended back in September, their guidance was for revenue to grow 29% to 31%. So this is a company that's actually growing at a very healthy rate compared to a lot of these other specialty companies.

With Mindbody, what's cool is, they collect money two ways. First of all, there's a subscription revenue to be a part of it, and services for the leads they deliver, sort of like an OpenTable in the restaurant world before it got acquired by Priceline. You have a case with Mindbody where they also make a little money on the payments side, which is actually a faster-growing part of the business, but still about a third of the revenue.

Mindbody is actually collecting money when they're helping process payments. These small companies, they turn to a company they trust. And they trust Mindbody to deliver leads. And we're seeing revenue per subscriber, revenue per customer go up high. It's up about some 20% over the past year. You have a case where companies trust these platforms. And there's a whole networking effect. If you go somewhere, and you say, "I trust Mindbody; I'm going to fire up the Mindbody app because they really did a good job on getting this massage I needed" -- and you're saying, "I think I would like to check out this yoga studio, and it's right there, it's on the Mindbody thing." So being part of the Mindbody family opens you up to other possibilities.

The company, again, it's not profitable yet. Some analysts think it will turn profitable by next year. The others think by 2019, but it's definitely coming. But right now, the growth is spectacular. And even though this is a $1.3 billion company, I don't expect this to be the next huge $100 billion market cap company. All it has to do is double or triple in the next five years or so for you to make out pretty well. And companies like this that are category leaders in this very thin fragment really do pretty well on their own, or, if not, they get bought out by a bigger company.

Either way, I think Mindbody's future is bright, and the stock has done really well over the last few years, and I think it'll continue to do so. So that's Mindbody, ticker symbol MB. Namaste!

Lewis: Is that not the most Rick way to cap something off? 

Priestley: Yeah, it was great.

Lewis: [laughs] I'm glad that Rick pitched Mindbody, because we got two megacap companies with Netflix and IBM, so it's kind of nice to give our listeners something that's maybe a little bit less covered. This was actually a space where Rick spends a lot of his time covering for some of our premium services. So, nice for him to bring some of that into our discussion here today.

Rick mentioned it in his pitch, but it bears repeating: Mindbody is a small-cap company, so the growth runway is significantly longer for them. But it's also a little bit riskier. As someone starts to grow and really get a meaningful chunk of the business, and starts making some money off of a very pretty particular segment, other people tend to perk up and notice that there's a big opportunity there, and competition might swoop in.

But they're kind of a niche player, which he talked about. They're this software-as-a-service company. And because of that, you look at their financials, and while they don't pull in a ton on the top line right now, about $160 million over the past 12 months, they command pretty high margins. They grossed $112 million on that $160 million over the past 12 months. So, typical software business here, where it's very scalable, and the margins are great.

What do you think about this fitness and wellness market in general, Sarah?

Priestley: We were joking yesterday about millennials as part of our Halloween costume for our team, and I think it really plays into this whole generational move. Millennials like boutique fitness classes, apparently, more than we like gyms, and we're willing to spend a bit more on that. So it's this secular transition that the company is tapping into. I think boutique studios now make up 42% of the health-club market, and that's a $24 billion market, so there's a huge opportunity here. Whether it stays around remains to be seen.

But right now, I do agree, there's definitely an opportunity. I think people who go to boutique classes spend about 1.9% of their income on those, whereas people before who were just attending a standard gym, it was under 1%.

Lewis: It's kind of this lifestyle brand thing. In some ways, a lot of these classes are a place to be seen, or a place to go with your friends. I'm not a part of this. I work out alone in the basement of Fool HQ's gyms. So I don't know, but I get the sense, at least, you're talking about barre classes or yoga classes, it's as much a social thing as it is why you're there for wellness.

Priestley: Vince and I on the Consumer Goods show on Tuesday, we've talked about this before. There's a whole shift, as you said, toward lifestyle fitness. A lot of that is showing in the athleisure industry, and everything else is having ripple effects. And a lot of analyst concerns across this broad spectrum is just, how long it's here to stay. I do think, honestly, it's a change that will remain for a while, at least.

And obviously, Mindbody is really making the most of it right now. Subscription and services grew 29%, payments revenue up 37%, they're clocking incredible growth, they're growing their number of subscribers. Importantly, they're growing the high-value subscribers, which is a key metric to look at if you're considering this company.

Lewis: We talked about the trend here, generally. Something that I I look at this space, and I don't think people are going to get less healthy. It's possible. Unless we invent the pill that makes it where we don't need to work out at all. That'd be great. That would be a beautiful thing. But, I do think wellness has become so much a part of the modern consciousness in a lot of ways that I don't really think it's going anywhere.

Something that I do like about what they do, as opposed to investing in a pure-play fitness company like a SoulCycle or something like that, it doesn't really matter what the hot workout style type thing is, whether it's barre or spin classes, whatever. They can provide for that market. Mixed martial arts, they can do that, too. So it's a little bit less tied to the specific flavor of the week within wellness, and more people are going more to boutique fitness classes, and this is a company that helps those types of businesses organize everything and get it done. They support a whole bunch of different things. Like I said, yoga, they do personal training, wellness, boxing. Basically, if you can book it. They also do hair cutting, apparently.

Priestley: Oh, really?

Lewis: So it's a little bit all over the place. There are some growth opportunities for them into other segments. In terms of the suite of stuff that they offer, online scheduling, marketing, point of sale, client management software, staff resources. They're kind of building out their functionality and what they offer to these businesses. And I've talked about this Monday's show with Michael that I did, the more and more you can build out your offering if you're a business provider to the point that you become a one-stop shop, the more compelling you become to customers. And it seems like they're doing that.

Priestley: Yeah, absolutely. And you said it, these software companies, if you look at Square, Shopify, they create a platform that's very easy for small to medium-sized businesses, which is a huge market, and probably a hugely underserved market, and they really capitalize on that. As you said, they offer a ton of things. You can create your own design in their app interface, so you continue that brand all the way through in the customer experience. As you said, they're brand agnostic, gender agnostic, too, because a lot of these fitness places tend to skew to women. But as you said, fitness, martial arts, all those kinds of things that men are picking up a bit more.

Lewis: Something I was surprised with Mindbody was, hearing the pitch, I was like, how big is this market really? They currently serve about 60,000 businesses. Management estimates that the total market size is about 4 million businesses. So their penetration is super low in the addressable market that they see. Obviously, they won't realize all of that. But, that is to say, there's a big, big opportunity out there.

I know, recently, there's been some focus on their number of business subscribers, basically. Look at their users. The company has focused on basically their higher-value businesses, working away from their low value and spending a little more time with folks who are making use of more of their functionality and bringing in more money for them. I think, obviously, short-term hit to numbers like the businesses that you support. But longer term, it might be a really good move for the business, because they're not spending a ton of time on low-performing businesses that really aren't doing that much for them.

Priestley: And average revenue per customer is $244 a month, which is pretty high, when you think about it. And I think, as they transition to these more, 13% growth in high value subscribers is what they achieved last quarter, compared to 6% subscriber growth overall. So they're obviously tapped into this market much more.

Lewis: The thing you worry about with this, and I've seen some other software providers run into this trap sometimes, is you provide this service to a business and you grow with this business, and then the businesses grow to the point where they decide to build out their own infrastructure for those things. This very famously happened with Twilio, the app-developing business that provided a lot of the communication software for Uber. Uber was one of their big clients, and at a certain point, Uber said, "I think we're going to handle this on our own. I don't think we need you guys to do this anymore." So they lost a very big book of business because of that.

So the pro is, these types of businesses scale with the companies that they support and they enjoy the same successes. It's a symbiotic relationship. The con is, if they get really big, if they go from being a local chain with a couple of locations to a national chain, they may decide, we're going to handle all the software stuff on our own.

Priestley: Yeah. The con to your con, if you like, is that if you look at Shopify, a lot of the companies they have that have grown into, not huge companies, but good, medium-sized companies with a lot of cash flow, have remained with them because their platform is so sticky. Square, again, is exactly the same. They're growing their medium-sized businesses with a lot of revenue growth. And I think of the 60,000 that they have, if you consider that maybe 5% become these huge national chains and leave the platform, that's still a huge groundswell that you can maximize.

Lewis: Yeah, it's not a huge, massive risk, but just one that I wanted to highlight.

Priestley: OK, sorry. [laughs] 

Lewis: But I think the con to your con was a good walk back on my fearmongering. I didn't mean to strike fear into Mindbody shareholders.

Priestley: [laughs] Wow, I will not be invited back on the show. That's what we learned from this.

Lewis: I think that's the perfect note to end on. You will not be invited back on the show. This was great! I loved having you on.

Priestley: It was great! Thank you very much. A lot of fun.

Lewis: Listeners, that does it for this episode of Industry Focus. If you have any feedback or questions for us, you can shoot us an email over at industryfocus@fool.com, or tweet us, @MFIndustryFocus. I will say, I personally manage the Industry Focus Twitter account, so if you have ideas, you can tweet them at the Twitter handle for the show. You can also tweet them @WilyLewis. I'm super responsive. Much like Michael Douglass, while I'm not as desperate in my pleas, I'm equally responsive. If you're looking for more of our stuff, you can subscribe on iTunes or check out the Fool's family of shows at fool.com/podcasts.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell stocks based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass today, and for getting to the studio early during the writers' conference to help make all these recordings possible. He's the MVP this week for sure. For Sarah Priestley, I'm Dylan Lewis. Thanks for listening, and Fool on!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Dylan Lewis owns shares of Amazon. Sarah Priestley owns shares of General Electric and Square. The Motley Fool owns shares of and recommends Amazon, Netflix, Priceline Group, and Shopify. The Motley Fool owns shares of Oracle and Square. The Motley Fool recommends Mindbody and Twilio. The Motley Fool has a disclosure policy.