Motley Fool Hidden Gems Investing - 1 Business, SO MANY Opinions!

Episode Date: February 10, 2022

(:20) Disneyland may be "The Happiest Place On Earth" but The Walt Disney Company is the subject of the widest range of differing opinions in some time. Despite strong 1st-quarter results, Wall Street analysts have very different views on varying parts of the business. Today Bill Mann analyzes: - The strength in the Parks division - How Disney+ was the company's life raft - The brand-extending powers of streaming video - Bob Chapek's track record in his 2 years as CEO (13:00) Asit Sharma and Emily Flippen discuss an underrated financial metric to know about before investing in any consumer goods or subscription business. Stocks discussed: DIS, CHWY, PTON, APRN, BIRD Our free Investing Starter Kit includes 15 stocks and 5 ETFs. For a copy just go to http://fool.com/StarterKit Host: Chris Hill Guests: Bill Mann, Asit Sharma, Emily Flippen Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Chris Hill. Today on Motley Fool Money, the house that Mickey built is under the microscope. We're going to take a look and see what we see. I'm Chris Hill, joined by Motley Fool Senior Analyst, Bill Mann. Thanks for being here. Bill Mann. Hey, Chris. How are you? I'm doing well. One of the things that I like about stock investing is the different views that happen every single day. This is something you've talked about before,

that when you buy a stock, someone is selling you that stock. Empirically, you're bullish on it and they're bearish on it. I like that there are different views, I like that. Yet, as I was saying to you earlier today, when it comes to the Walt Disney Company, I really can't recall a time when there were so many different views about the different parts of this business. Before we get into their latest results, let me start with this. What is the most interesting thing to you right now about Disney? I think the most interesting thing is the fact that their theme park revenue was up over 2019 on a per-person basis by 40%. Now, Disney is obviously a huge number of components, but I think probably the thing

that is most concrete for the company is when people are willing to spend a huge amount of money at one time to come and have the Disney experience. And that 40% per person, I don't want to emphasize that because it's an incredible number to me because the numbers that it cost to go to Disney in 2019 were not low. But in 2022, in this most recent quarter, 2021, I should say, it was 40% higher per person. And that says to me that the Disney brand has withstood every bit of potential pressure that it was under during COVID. Let's stick with the parks then, because as impressive as the numbers are, it's still taking place in an environment when they're not at capacity. There are still restrictions on the park. If you think about

international, I don't know what the percentage is of international travelers going to Disneyland in California or Walt Disney World in Florida, but it's significant enough that if you're a Disney shareholder, it's understandable you would be excited looking at these numbers and thinking, wow, they're not even at the point where they're getting a significant amount of the international travelers that they normally get. Yeah, I think that's exactly right. There are some analysts who have come out and said that they think that it's going to be years before Disney's domestic park segment is back up to full capacity. I don't know whether that is the best way to think about it or whether it will be that long. You tell me what the next

step for the pandemic is, and I'll tell you whether that's accurate or not. But it's really incredible. For everything else that Disney does, their parks are their crown jewels. The parks, their results were, to me, even given the fact that they are under wraps to some degree, absolutely staggering. Chris Hill And yet, the streaming service is getting, I don't want to say all the headlines, but a lot of the headlines in terms of the surprise that they added the number of subscriptions that they did. They're now at 130 million total subs for Disney+. I don't know. That's such good analysis. When I say I don't know,

what I'm really saying is I'm torn in a couple of different directions, because on the one hand, and this is an enormous number, and the growth for what is still a relatively young business in terms of how long has this business been up and running, it's an incredible number. When I referred to so many differing views, one of them is a not insignificant number of analysts coming out and saying some combination of this still isn't all that impressive and oh, by the way, they're not making any money off of it. The second part is true if you segment it in the way that, I mean, obviously, accounting suggests that they're segmenting it accurately. If you think about going back to

early 2020, when the theme park shut down, suddenly ESPN had literally nothing to broadcast, and they rolled out Disney+. Disney was their life raft. But what Disney has done in the meantime is that it has reinforced every single one of the Disney properties, to the extent that Marvel is still big, that the Disney characters are still big, that they've been able to roll out multiple characters based upon Star Wars. When the parks were able to start to come back to capacity, that's what people wanted to consume. I know it was a big movie in its but Avatar was kind of watch it and forget it. Suddenly, the Avatar component in the Disney Animal Kingdom theme park, it's massive. It is a massive, massive draw. I think it's

important just to keep in mind for Disney that, yes, there is something to be said for the fact that streaming is probably driven by their capacity to roll out new content. The Book of Boba Fett and then the Beatles retrospective, Get Back, were huge. Yes, it is not a perfect comparison to Netflix, but $130 million in two years, I don't care who you are, that's amazing. Is it just a function of the short-term thinking on Wall Street that companies like Disney are always going to get dinged for investments? The things that you're talking about, particularly on the theme park side of things. They're constantly looking to upgrade and put in new features and that sort of thing. That takes money, that takes time.

It seems like not every quarter, but at least once a year, someone's coming out and just dinging Disney for the amount of money that they're investing in their properties, even though history, as a guide, says, that's a hell of a great investment. Yes. I think part of it, Chris, if you were to open up, okay, this is going to be the super boring part of this segment, but if you were to open up the financial statements of Disney, you could not point to me on the balance sheet where they keep the value of the characters, where they keep the value of the properties. Those characters, and I think, to Wall Street's defense, when you have an intangible asset like these that requires some semblance of

reinvestment, it's really, really hard to pull that thread through and say, making sure that we rolled out with this new content for Boba Fett, for example, reinforce the overall value of Star Wars. Because I know a lot of people think that Star Wars is a real thing, it is an intangible. It does not really exist except through that reinforcement. But if they don't reinvest in this, then it calls to question the entire Disney experience. And so they're going to continue to do it, and it will continue to be a struggle for Wall Street to put their finger on what the return is. But the returns are much, much bigger than I think the Disney bears are giving them credit for. Later this month, Bob Chapek is going to hit his two-year

anniversary as CEO. How do you think he's doing? Bob Chapek and Bob Iger, the Bobs, came out and announced their changeover in early, early 2020. Then immediately afterwards, COVID hit and Bob Iger came back in and said, I'm going to take a little more of an active role for a while, which could have been a sign of a weak incoming CEO. That could have been something that seemed like it was undermining Bob Chapek, and they managed it perfectly. They managed every bit of it perfectly. Bob Chapek is someone who does understand completely the value of these intangible assets. I don't think he's done a perfect job, but I do think that he's done a really great job in circumstances that probably were unimaginable at the point in time in which

they were planning his succession and his stepping up into that role. Well, in one way, I agree with you. And I think that one of the ways Chapek is improving as the CEO is saying out loud how much he appreciates the intangible. One of the knocks on JPEG early on, and it was a completely fair knock. This is a guy who doesn't seem to express, not reverence for the creative side of the business, but just a healthy respect for the creative side of the business. I think he's doing a much better job of that now. I think partially. He's not a particularly emotive CEO. This is not Steve Balmer jumping around on the stage for better or for worse. Nobody wants that. Nobody really wants

that. I want that desperately from the CEO of Disney. He is much less emotive, but I think given his background, it doesn't really make sense to me at all that he does not understand deeply that the value of those properties, the value of that character library is the value of Disney. So I think that that was a little bit unfair because he just doesn't jump up and down about them. But he has shown through his actions that he values them very, very highly. Last thing, and then I'll let you go. In terms of the stock, shares of Disney are only slightly higher than they were when Chapek took over as CEO. Obviously, it's been a very eventful two years. Sounds like a miracle to me.

Very eventful two years. What do you think when you look at this stock? Early in the pandemic, this thing got knocked down in a big way. It's bounced back up from there. What do you see when you look at it now? When you look at Disney+, it's about to come into 42 additional countries this summer. Obviously, the parks in Japan and particularly in China have been impacted greatly, so I think that there is plenty of room for a rebound. They're not saying that's going to happen in 2022, because China is on an entirely different trajectory with COVID, as is Japan. But there is plenty of value to be extracted. I do expect to see more series coming out on the Marvel platform, more series coming out on the Star Wars platform.

I think we are underestimating the power of Disney at our own peril. Always great talking to you, Bill. Thanks for being here. Thank you so much, Chris. Obviously, so many different metrics go into evaluating a business like Disney. And let's face it, some metrics get more attention than others. Up next, Asit Sharma and Emily Flippen are going to discuss an underrated financial metric you want to keep your eyes on before investing in any consumer goods or subscription company. Just a heads up, we had some technical difficulties with this segment,

so the audio is a little wonky. I'm Asit Sharma, an analyst at The Motley Fool. I'm joined by my colleague, Emily Flippen. Emily, we're back in the saddle again. Today, I wanted to pose a question to you. There's something that I know you really start jonesing over when you look at a prospectus or an S-1, the registration documents for a company that's coming public. But I know you look at this, too, for companies that have been around for a while. That is the relationship between two metrics, customer acquisition cost and lifetime value. I think we got to explain them first. Maybe if you could explain these two metrics. Tell us why you're so obsessed with them and why they're useful to investors.

Well, to start, it's great when you have a metric that encompasses business activity in a really intuitive way. I think that's what the customer acquisition cost to lifetime value metric does, especially for those consumer-facing subscription-style businesses. It really is very self-explanatory. It's a ratio of the customer acquisition cost to the value of that customer over time. It's effectively how much earnings you get for each dollar of marketing spent to acquire a customer. In a basic sense, you can think about that top number, the customer acquisition costs, the marketing that you need to bring a customer into your ecosystem, and the lifetime value, just how much money that customer will spend

on a product minus the cost to produce that product, which really gets at the gross margins of a business. That ratio, in my opinion, removes a lot of the noise around business performance and hammers down on just the fundamentals. Would you say that it's fair that you can derive a lot about a business's long-term success by understanding the relationship between these two metrics? Certainly. I will say, it's a hard thing to create yourself. You do rely a lot on management of the business to produce these numbers for you and then sanity check them against your own expectations. But you can really think about it like a fundamental return on investment for a business on the consumer-facing side. If they're spending more money to acquire

a customer, then that customer has value over time. They're essentially losing money with each customer they bring in. Obviously, that sounds and is not a great thing for return on investment. Emily, you make it sound so simple, and I know it is, but here's what trips me up sometimes. In order to gain market share, in order to get ahead of competitors, some companies spend a lot upfront on their marketing in promotional costs. What they're saying is, I'm going to go in overdrive with acquiring the customers, and I'm going to run this relationship at a loss, even for several years. Over time, especially if this is a subscription business, I think with loyal customers, that's

going to have a payoff. Maybe I stretch out that payback period, but once I've crossed the Rubicon and I've got this critical mass of customers, they love my product, I'm going to be off to the races. Would it be fair to say that you give a pass to companies whose brand you love, whose product you think is superior, but are really pumping up those upfront marketing costs in order to obtain customers? Certainly. I think anybody who listens to me frequently will not be surprised to hear me say that I think Chewy is a great example of this. It really is an opportunity for investors who understand metrics like lifetime value of customers and acquisition

costs to get an advantage over those investors who don't. Because a business can look unprofitable on their income statement, as was the case with Chewy when they went public, but still have extremely attractive value associated with that customer. The reason why they're unprofitable is because they're spending so much money on marketing to bring those customers in. But once those customers are in the ecosystem, they spend a lot more money over time, so the profitability and the free cash flow comes in future quarters and future years. Chewy a great example of that. Part of the reason why I was really sold on them when they initially went public was because in their S-1, in their initial filing statements, they actually broke down the

customer acquisition costs to the lifetime value of that customer over time. You could see in year one, that ratio was less than one, which says, in year one, we are spending more money than that person is earning on our platform. But for the people who stay on to year two, and year three, and year four, all the way up to year six, when they went public, they spent a ridiculous amount of money on the platform that comes straight to the bottom line. So, it's worth it for them to spend that money upfront to acquire the customer. Emily, you remind me of something that I really look for when I'm looking in prospectuses and trying to judge whether a new company has a persuasive economic model, and that is cohorts. Companies that are really good at expressing

the relationship of their acquisition cost to lifetime value often will provide you with some really easy to understand visual charts. If you're listening to us today thinking, man, that sounds like something that I'm not going to have time for or quite understand, I don't know how to calculate these metrics, you can look at an annual report or an S-1, a registration statement, before a company goes public. You often get a really nice graph, which shows you how different cohorts perform over time. Let's say a group of customers starts in year one. The next year, we add on the second group of customers. The third year, we do the same. We can see on a graph how those images start to increase, they widen out.

That means each cohort is becoming more valuable over time, proving out this proposition. I wanted to say, if anyone's listening today and has some time, look through the annual report of a customer-facing company that you love. You might see these graphs. It makes it's simple to understand how the economics are panning out. It's actually a red flag if you look at a business that you think should have some of these metrics, and they're not breaking them out. Before the show, we were talking about Blue Apron as a good example of this. Now, this is an old company, old news here, but when they went public, they didn't explicitly break out their lifetime value of the customer

or their customer acquisition costs, so investors are left to wonder. When you see those ratios missing from especially something like an initial filing statement or an annual report, and you feel like they should be there, it can be your immediate assumption that, hey, maybe those aren't great, and that's the reason why management isn't being really upfront about it. It's really important to question yourself, should these metrics be in the report? If so, and they're not there, why aren't they there? But also, how are they calculating it? Because while they're industry standards, they're not regulated terms. There's no single way to define the acquisition costs or the lifetime value of a customer. Good businesses will walk you

through that definition, how they came to that calculation. You can think to yourself, does this make sense given my understanding of the business? I agree. Sometimes I penalize a company for not giving the specific breakdown of how they calculate their metrics or not providing really good visibility in both that customer acquisition cost and the lifetime value, so I can see what the relationship looks like. Once in a while, I'll give a company a pass. A recent example was Allbirds, symbol B-I-R-D. This company just came public. It's basically a high-tech shoe company. What I really liked in their S-1 is, they defined clearly what their customer acquisition cost is. It's simply

their total marketing cost divided by the new customers that came in on that marketing spend. But they talked also about their contribution profit. Think of gross profit, That is, what you have after you get in your revenue, you subtract your cost of sales, contribution profit, you burden that gross profit with a few other costs like shipping and fulfillment. What I really loved was that in their S-1, Allbirds said, look, our contribution profit, our gross profit, minus the cost to ship our product to customers, a few other costs, that consistently exceeds our customer acquisition costs. If you compare those two costs, we're making money right up front with our customers, which is rare. It's the opposite

of what many companies do when they're front-loading that marketing expense. Even though, Emily, they didn't provide a detailed breakdown of these metrics, they gave me enough that I could reverse-engineer. The company has the potential to be pretty profitable down the line. This is a really competitive industry, so there's a lot more to consider. But I'll give a company a pass when they talk about contribution, profit, and show me the relationship between these variables. I'm a gross profit type of guy. I always say, gross profit pays the bills if your fixed costs aren't rising. I pay a lot of attention to that. Just to say that companies have different ways of providing these insights on what their customer costs are.

At the end of the day, though, at some point in the race, you have to have that lifetime value start to exceed the cost of acquiring each customer. And it's okay if it's not starting out that way, but have a plan for how it's going to reach profitability. A good last example is Peloton, which did break out their lifetime value of their customers, nearly $3,600 when they were going public. However, they were losing around $5 per customer acquired because their acquisition costs were so high.

They plan to get it down. Clearly, we're not able to do so. But if you have a plan and you're willing to give passes, understand when you're doing that in your investments, because the difference between Chewy and Peloton is clear enough as day today. Yeah. At the end of the day, I think it is all about those economics, especially as you scale out. Chewy is a great example of a company that's doing it well. They're scaling their product. those relationships have remained consistent, so there's a path for them to exceed their fixed cost base, which is pretty large, which is why I think you have a lot of faith in Chewy. Also, Emily, I think you're a very happy customer of theirs, but that's all part of it, right? Keep

the customer happy. Keep Emily ordering. That's how you build that lifetime value. Well, Asit, thank you so much for this conversation. I hope everybody takes it upon themselves to go calculate the CAC to LTV on their own time now. Always fun. See you soon. That's all for today, but coming up tomorrow, we'll have the latest from the cybersecurity industry. On Saturday, we'll dig into the business of the Super Bowl. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what

you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow. Thank you.