On this episode ofMarket Foolery, Chris Hill andJason Moser discuss what they like about Coach's (NYSE: COH)deal to buy Kate Spade(NYSE: KATE)and why the markets were pleased with the quarterly reports of online furniture seller Wayfair(NYSE: W) and hotelier Marriott(NASDAQ: MAR). On the flip side, it appears investors were unhappy with what they heard from music streaming pioneerPandora(NYSE: P).
A full transcript follows the video.
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This video was recorded on May 9, 2017.
Chris Hill: It'sTuesday, May 9th. Welcome to Market Foolery. I'm Chris Hill. Joining mein studio today, from Million Dollar Portfolio,Jason Moser. Happy Tuesday!
Jason Moser: Hey, hey!
Hill: Thanks forsliding out of your usual Monday slot.
Moser: It wasmy pleasure. You know I took the opportunity to --
Hill: Take a nap?
Moser: Well,I did, actually. I took a little bit of a cat nap.I did some work from home yesterday, I wasable to finish up a report onEllie Mae,which was great. Hey, whileI was sitting there making dinner last night, I said, "Hey,Alexa, play Market Foolery." SoI listened to you and Michael Douglass talk about theBerkshire Hathawaytrip. It was a very good episode.
Hill: Yeah. Again,I said this on yesterday's episode, I think it's a sign of Michael's age --
Moser: Orlack thereof.
Hill: Yeah, orlack thereof, he looked great. If I had gone to Omaha for the weekend andgotten up before the sun,I would be totally dragging stuff. Earnings-palooza rolls on. We havea lot to talk about today.I actually want to start,before we get into the earnings, with, I would argue, the bigbusiness story from Monday, and that isCoach buyingKate Spade for $2.4 billion.I'm curious what you think of this deal. This is a week after Coachput up some pretty good numbersin terms of their latest earnings report. Shares of Kate Spade up on the buyout, and shares of Coach were upyesterday as well. I think it's because,among other things,enough investors looked at the deal that Coach was getting here and felt like they weregetting value.
Moser: Yeah,I think that's a good point there.I think, generally speaking, my wife and I were talking about this last night, I say this as the owner of a Coachbriefcase that I'm very fond of,I think this is the marrying of twofantastically mediocre businesses. AndI don't mean that necessarily to say that this is a bad deal.I think what we've seen here over the course of the last five years really, is generally,what happens in retail. Particularly, we've been talking about Coach, and how it'saffordable luxury and what not. At what point do you go from being luxury toaffordable luxury to justtotally mainstream? There was a point whereyou could see the writing on the wall withall the discounts they were listing,and the outlet stores and everything, andit became very clear that theystepped away from that affordable luxury, andthey were making the strategic move tobecome more of a lifestyle brand. AndI think that's fine.There's nothing wrong with doing that,because they really do need to figure out a way to increase volume. They'renot just handbags anymore, it'shandbags, they're getting into clothes and shoes andall sorts of other things. So, while I don't think either business on its own is atremendous opportunity forinvestors going forward, I do think thisprobably makes more sense, someconsolidation in this sector bringing together a healthy portfolio ofdifferent offerings.
And that's ultimately what Coach is doing. They'llstill talk to that lifestyle brand, andtry to bring more things out there foreverybody to peruse. It'snot just a handbag company. But, again, this is, to your point about value, I think this values Kate Spade atsomething like 16.5 times trailing earnings,which is really not that bad at all. Coach is the bigger company. Kate Spade, I think, hasplenty of opportunity of grow,particularly globally. So,I think Coach took an opportunity to get in there andmake a reasonable offer for a company thatI'm sure they'll be able to extract some value from.
Hill: I think you mentioned themediocre businesses, andI'm not going to dispute that.I will say, however, I think the brands are stronger than the businesses. I think that might be thepotential promise for investors --these are too pretty strong brands. Going back to the value point, Kate Spade, three years ago, that stock was around $40 a share. Now it's in the teens. So, the brands,I don't look at them as beingdamaged or even mediocre,I look at them as solid brands. Ifthey can get the operation part right, thenI think it can work out for them. Andyou mentioned the discount,that was a big part of the story last week with Coach. Theystarted ratcheting back the discounting, and lo and behold, theirmargins started to look better.
Moser: Yeah,go figure. At some point or another. We see it withrestaurants, we see it with retail,eventually you hit a year where yourcomparables become too easy to clear, and the businessstarts to look better just because the past really looked so bad. Coach, for a long time, was a brand that I thinkpossessed more pricing powerthan it does today.I don't know that it really does possess a whole lot of pricing power today. But,I do agree with you. I think the brands themselves are still very strong, and cantranscend lines. It doesn't have to be just a handbag company, itdoesn't have to be just a shoe company or whatever. I think they throw lifestylestrategy around, they want to become a lifestyle brand, and you think, "OK,what does that mean?"I mean, I get it, you're going to go out there and seeeverything from keychains to handbags to shoes to hats towhatever, and that's going to be the best way for thesebusinesses to monetize and growon a meaningful level. And I think, just as we see withcertain restaurants when they hit theceiling of their growth opportunity, andI think a good example here would besomething like maybeBuffalo Wild Wings. Theidea wasthey were going to start bringing moredifferent types of restaurants under their umbrella. That was thePizzaRev, that was Rusty Taco. I think Coach islooking at this very much the same way.
I think we'll see Coach continue tolook at some strategic acquisitions. It'snice to see that theydidn't feel like they needed to overpay.I think the folks over at Kate Spaderealized they were caughtin a really difficult situation, andthe writing was kind of on the wall. They saw what Coachwent through, and they knew, "This iswhere we're going to be goingif we don't figure this out." Andthat's the problem, it's not too easy to figure out. At some point or another,you have to figure out a way to get merchandiseinto the consumer's' hands. Usually,the best way to do that ismake it a price you can't pass up.
Hill: Let'sget to some of the earnings today. We'llstart withWayfair, the onlinefurniture retailer. Wayfair'sfirst-quarter loss wassmaller than expected, and Wall Street is apparentlythrowing them a parade,because the stock is up 22%. How good was this quarter?
Moser: Imagineif they were even more unprofitable! No, I kid.
Hill: [laughs] I mean, to cut Wayfaira little slack, their sales numbers looked good. Their revenue number, I think,is a big part of what's driving the stock today,because it wasn't just a smaller loss, it was like, "You guys areactually putting upbigger sales than we thought you were going to put up."
Moser: Yeah. Wayfair has been a fascinating company to cover.I've covered it since its IPO. We had iton the watch list in MDP for a time, removed it justbecause we felt like it was a bit smaller, a bit of a riskier play thanwhat we were looking for in ourportfolio. Someone asked me at some pointin the past week or so onTwitteraboutAmazonstarting to dip a toeinto this line, moving into more home furnishing and home goods and things like that, andwas that going to be the death blow for Wayfair? To me, that's that old, what'sgoing to be the Wayfair killer? What's going to be theNetflixkiller? Any timeyou start talking about that,I think you have to take a step back and realize,first and foremost, that ultimately validates theopportunity that Wayfair has been seeing and has built this business on, so there'ssomething to that. To your point, they do continue to grow sales at a nice clip, sothat means they're doing something right.I think part of that is the fact that it's acompany very much built on beingextremely customer-centric. I think when you have leaders who are building their businesses based on giving their customers what they want, whether it'd be value, quick delivery,whatever it is, those aregenerally very powerful businesses over time.
Now,I think that with Wayfair, the metric thatI always continue to pay the closest attention to is looking at thepercentage of ordersplaced by repeat customers. Ultimately, what Wayfair isgoing to have to do to become profitable is,they're going to have to really ratchet back thespending on ad spend, marketing, and whatnot, thosecustomer acquisition costs can bevery expensive up front. So, they want to acquire customers and thenkeep those customers. That was a metric that really came through this quarter. It was 60.4% of ordersplaced by repeat customers this quarter, versus 55.4% a year ago. That is a trend that'sgoing in the right direction. A trend thatmaybe isn't going in the right direction,operating expenses were higher this quarter than they were a year ago. So,the big question mark for Wayfair is,when they start pulling back on that spending, are they going to be able to maintain that growth? I think that's a fair question.I haven't necessarily come up with the answer yet. I think they'redoing a lot of things right.
Thereaction today is a bit surprising,because the business is still unprofitable. So, I thinkit would probably behoove them to focus on trying to get profitableas quickly as possible. I feel like we're at this point in the market where the market is paying up forall sorts of growth,whether it'sTeslaorZillowor Wayfair --it's not about profits, it's just about the promise. At some point, that wormis going to turn, soit's going to be in their best interest totry to at least get this business asprofitable as they can as soon as they can so that they canat least tell that side of the story. I think it's a good business. Having just moved ourselves, I've seen one or two Wayfair boxes on our doorstep as well. But all in all, most of themetrics are all trending in the right direction. They'rebringing in more active customers, they're hanging on to those customers, thosecustomers tend to buy more over time, theybecome very valuable over lifetime. Itremains to be seen exactly how important this move Amazon makes is. Time will only tell that one. But all in all, good quarter for Wayfair.
Hill: Let'smove on toMarriott. Their first quarter profitscame in higher than expected. The stock is up around 6%, hitting a new high. They really crushed it this quarter. The stock is up 22%, but it's hadsuch a great, steady run for so long here. Youlook at the fact that theiroccupancyrates are higher, and their room rates are higher. Ifyou run a hotel, it doesn't get a whole lot better than that.
Moser: Noit does not. Chris, I must say,I'm a little disappointed with this quarter.I was hoping maybe for a poorer performance and some tepid guidance,because we have this on our watch list in MDP and we have a very firmprice that we're looking to add this to the portfolio at,and today's pop is not helping that cause.
Hill: It's not helping?[laughs]
Moser: No,not at all. I really like this business. Theuncertainty with Marriottfor the past six months wasthe acquisition ofStarwood. There wasa little bit of a back-and-forth there with some competing bids and whatnot,but that deal went through, so nowMarriott owns Starwood, and they'vecreated the biggest hotel company in the world. And it's acting like it. RevPAR,which is revenue per available room, that's their version of comps, and that was up 3.1% for the quarter. Improvingtrends in Europe and Asia Pacific regions led them to vie fora bit more than optimistic revPAR for the remainder of the year. And when you get that,along with a management team that has made a commitment toreturn a lot of value to shareholders hereover the coming three years, they're going to spend somewhere in theneighborhood of $7 billion in buying back shares, and another $1.5 billion in dividendsover these next three years. That'sultimately how they juice that earnings growth, they bring that share count down and continue to pay out dividends.
It's a lovely business model. These guys don't own the buildings, they're not maintaining these buildings, they're justselling their services. They have this bigportfolio of like, 30 different hotel brands. The folks that own the real estate say, "We want to work with Marriottbecause it's a known and respected brand, andit'll bring in a lot of traffic." Thenthey go in and run these hotels, andthey do a darn good job of it. There's nothing to hate here.I was hoping for perhapsa little bit of a weaker outlook. We felt like it was fair, at least, to think it might happen,because of concerns as far as travelrestrictions, the stronger dollardoesn't necessarily play into their favor, either. Butit didn't work out that way. It'll remain on the watchlist. If you're an investor inMarriott today, I think you'll befeeling very good about owning these shares.
Hill: Togo to something we talked about with Coach and Kate Spade, the Marriott brand is as solid a brand --I'll just speak for myself, but I knowif I'm traveling somewhere, if that's an option, I think, "OK, good, I'm fine." IfI'm staying at a Marriott,I'm going to be taken care of. Andit's not going to break my wallet.
Moser:Andthat's a very good point you make, andthat's one of the bigger catalysts that they have going for them, is theloyalty program that Marriott has had has been very sound. Theyhave a customer loyalty second to none. Andreally, Starwood is kind of the same nature,so the acquisition is really bringing twovery powerful loyalty programs together. AndI think that over time, that'sgoing to be something that theyexploitin a good way. Now, it's interesting to think ---the other day, I was reading a takeon this sector in general,and how technology, and how review sites likeTripAdvisorhave changed thatsentiment that you just expressed there.I think for a long time, people would say, "I'mgoing to go to Marriottbecause it's a known quantity,I know what I'm getting and I know it's going to be good," whereas now you can go tosomething like TripAdvisor and readall of these different reviews onall of these different hotels in the area. Hotelscan be sort of a fragmented market,and suddenly now, it opens this world ofopportunities up.I don't just have to go to Marriott,because I could find out what these other hotels are like,and I can really shop for the best deal. So it is a little bit of a different dynamic today than it was before, but Marriott fights that byhaving so many different brandsunder that umbrella that hitall of those different value points. And theacquisition of Starwood reallyonly strengthened that.
Hill: You canemail us. Marketfoolery@fool.com is ouremail address. You can follow us on Twitter @MarketFoolery. We'rePeriscoping today's episode,if you're following us on Market Foolery,hopefully you're watching. Andyou can join our Facebook group, which is Motley Fool Podcasts. Thank you toKatie of Virginia whoposted something for me in our Facebook group. Sheposted a picture of the newestlimited edition Oreos flavor.
Moser: What is it?
Hill: Waffles and syrup. Again,if you're aMondelezshareholder --
Moser: Isnothing off limits?
Hill: Apparently not. As Katie wrote, "The hitsjust keep on coming."
Moser: Waffles and syrup,I don't know how to feel about that.
Hill: It has to be the easiest gigin the world if you work in the Oreos division for Mondelez, because it's just like, "Whatideas do you have for flavor? We'lltry anything. Ham and potatoes? Great, Jason, we're going to have some people work on that, we'llthrow that out there."
Moser: [laughs] Ham andpotatoes, an interesting combo.
Hill: Someone will buy it.Pandora's first quarter loss was smaller thanexpected, but unlike Wayfair, revenue fell short ofexpectations, and the stock down about 8% this morning. We weretalking before we started taping with ourproducer Dan Boyd. This is kind of like Coach andKate Spade, the brand is stronger than the business. I feel likethat's a little bit what's going on with Pandora.I like Pandora. Dan was talking about, "Ilisten to Pandora a lot." So do I. I use it a lot. The business part, they'restruggling with, and I'm wondering if they are starting to put themselves in aposition for sale.
Moser: As a listener ofPandora, do you pay for subscription?
Hill: No,I do the ad-supported model.
Moser: OK. Deezy,do you pay for a subscription? No, OK.
Hill: He'sshaking his head no.
Moser: OK. There'sthe problem right there.I think that is it in a nutshell for them. AndI'm sure there probably is a suitor out there who could makePandora bit more of an attractive business. I think this is a testament to, No. 1,I think they dragged their heels a little bit. I just don't think they really thought the competition in this space would ramp up so quickly. Also, the economics of thisbusiness, of this market, are really difficult. There aren't manymusicians out there today who aregoing to sit there and tell you howprofitable being a musician is, who are like, "Youhave to be amusician because when you put out a record or a song, it's anever ending spigot of money that keeps on flowing." Itdoesn't work that way anymore. Really,if you want to be a successful musician, youhave to figure out a way to tour for a living. And I thinkthat's one of the concerns, that you havemusicians wanting more, and you havebusinesses that can only pay so much, becausethey can only bring in so many subscribers, or that ad-based model is onlygoing to let them spend so much on the content. When youlook at Pandora --I agree with you that the brand is stillsomewhat strong.I think it's something that'srecognizable.
But when you look atthe financials of this business, ever since these guyswent public, they've never been profitable, they'venever been cash flow positive. Andthere's a reason for that.One time, it was a neatoffering because of the advent of streamingmusic. But then you had Amazon, you hadApple, you hadSpotify. And really,I'm looking at Apple and Amazon here astwo of the big competitors out there, and the reason why they're soformidable is that they are not justin the business of streaming music. Thestreaming music is essentially complementary toeverything else that they offer. And I thinkthat makes Pandora's business really difficult to sustain on any meaningful level. Now, to that end, sure,I bet you there's probably a bigger player out there that could buyPandora, figure out a way to make it a bit of a better offering as we see internet music continue totake the direction it's taking.I've heard before ofrumors out there that perhapsSirius XMwould be interested inacquiring Pandora for some reason. So who knows? ButI think when you look atthe economics of the business, andyou look at the history that Pandora has, it only gets tougher for them. And ifover the past five years, they'venot been able to make it work, I can't fathom a solution that helps them make it work going forward, other than an acquisition. I mean,I wouldn't buy shares based on that thesis. So,I think they're really stuck between a rock and a hard place.
Hill: I'm wondering who's making the case forSirius XM buying Pandora.
Moser: I don't know.
Hill: Sirius XM seems like they're covered,both in terms of music and business model. Unless the price is so amazing ...Sirius XM is, what, a $22 billioncompany, something like that? It'sroughly 10 times the size of Pandora.
Moser: Yeah,somewhere in the neighborhood of 30 to 32 million subscribers. Now,I think a lot of those subscribers came on forHoward Stern. I could certainlyrelate to that. But I do think that, Stern's contract,I think he has 3.5 more years on hiscurrent contract. Once that ends,I think the going wisdom ishe's going to hang it up and do something elsewith his life. But they'llcontinue to have access to his contentfor an additional seven years beyond that. Perhapsthey would see something in owning that Pandora brand.Again, as we've seen in retail, someconsolidation in the sector makes it a little easier. Perhapsconsolidation there. At this point,I'm sure they could buy Pandora for a song. No pun intended.
Hill: [laughs] We'regoing to wrap up now. I'vesaid this the other people,I expect that from Simon Erickson,I don't expect that from you.
Moser: Well,I said no pun intended. It'skind of like Ricky Bobby,"I said with all due respect!"
Hill: Jason Moser,thanks for being here!
Moser: Thank you.
Hill: Asalways, people on the program may haveinterests in the stocks they talk about,and The Motley Fool may have formal recommendationsfor or against, so don't buy or sell stocks basedsolely on what you hear. That'sgoing to do it for this edition ofMarket Foolery. The show is mixed by Dan Boyd.I'm Chris Hill. Thanks for listening, we'llsee you tomorrow!
Chris Hill owns shares of Amazon. Jason Moser owns shares of Apple, Berkshire Hathaway (B shares), Ellie Mae, TripAdvisor, and Twitter. The Motley Fool owns shares of and recommends Amazon, Apple, Berkshire Hathaway (B shares), Buffalo Wild Wings, Coach, Ellie Mae, Facebook, Marriott International, Netflix, Pandora Media, Tesla, TripAdvisor, Twitter, Wayfair, Zillow Group (A shares), and Zillow Group (C shares). The Motley Fool has a disclosure policy.