Motley Fool Hidden Gems Investing - All About the Ads

Episode Date: August 10, 2023

Viewers may hate them, but ads are the future everywhere we go online. For investors that might be a good thing. Tim Beyers and Deidre Woollard discuss: - If Disney’s price increases will push subscribers to the ad tier. - Just how popular sports betting might be. - The Trade Desk’s role in the world outside of advertising’s walled gardens. Companies discussed: TTD, DIS, NFLX, PENN Host: Deidre Woollard Guests: Tim Beyers     Producer: Ricky Mulvey     Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Deidre Willard As viewers, we may hate ads, but as investors, we might have to love them. You're listening to Motley Fool Money. Welcome to Motley Fool Money. I'm Deidre Willard, here with Motley Fool analyst, Tim Beyers. How are you today, Tim? Tim Beyers Really caffeinated. Ready to go, Deidre. Glad to hear it. This is going to be an advertising-heavy episode. Feels to me like advertising is moving everything lately, even though it's been sort of an iffy market for it. But we have to kick things off with the House of Mouse, Disney. We had earnings last night. To me, this felt like a transition-y kind

a quarter. Losses were heavy, not a surprise, maybe better than expected. CEO Bob Iger dealing with multiple issues. One of them, which we also saw with Paramount, is that good old linear television, our old friend, it does not pay like it used to. Operating income at Disney's traditional channels down about 23%. Is traditional television, is it over? Is it a losing game? what is the future of traditional television, Tim? Oh, what a question. I will say it's definitely losing steam. And because there are so many alternative platforms and short form media is incredibly popular. And I'm not talking about streamed media. I am talking about things like YouTube and TikTok. You cannot discount the impact of YouTube and TikTok as programming

vehicles, particularly for Gen Z and younger. I mean, a lot of entertainment comes through those two channels, and that makes it harder to get engagement if you're an operator of linear TV networks. So is there must-see television on things like ABC? I think the only appointment television really left are live sporting events, for example. And I haven't looked the ratings to see what Fox Sports is getting on, say, the Women's World Cup, although I think that has been amazing. And then there are other shows that get buzz. And increasingly, the shows that do get buzz are not on linear networks, Deidre. They're on streamed cable channels. That tends to be how it goes lately. When we look at the linear networks numbers, as you were alluding to here,

on a revenue basis, revenue was down overall 7% year over year. Domestic channels down 4%. International channels down 20%. On an operating income basis, domestic channels down 14%. international channels, listed as not material, but from a $166 million operating profit in the year prior to an $87 million loss in the current year. Overall, you had a 23% decline in operating income for linear networks. That's really not a good sign here. It's hard to say exactly how well this is going to go. Now, to be fair, in the quarter, linear television still accounted for close to $1.9 billion in operating income, Deidre. It's not going away overnight. Is there an avenue to rescue this through things like connected TV. I don't know, but there is something a bit more

for these digitally native channels. So like the streamers that are, I mean, they just feel like they're built for connected TV from the ground up. And not surprisingly, Disney's kind of leaning into that with Disney plus and the Hulu bundle. Let's talk about that bundle. Cause man, Tim, I remember those good old days when streaming was like this cheaper alternative, and that is not the case anymore. So, Disney's going to raise the cost of Disney Plus without ads to $13.99 a month. The Disney Plus and Hulu bundle, that's going to be $19.99. Ad-supported products are staying the same, and Disney is expanding their ad-supported

content in Europe and Canada. So, two things happening here. It's getting a lot more expensive to have different products, and I think consumers are feeling that. And then you've got the ad-supported thing, similar thing happening with Netflix. I feel like these streamers kind of maybe want you to take the ad option. Well, I think they do. I mean, certainly in the case of what Netflix did, you know, you remember they eliminated the $9.99 tier and they said, you've got the ad tier and then you've got, I believe the minimum after that is either $13.99 or $15.99. They eliminated the middle

because they said, hey, look, the message there was we make a lot with ads. If you want to be ad-free, you're going to have to pay up because we're making a lot of money with ads. That's the message I got from Netflix. They have been saying that they can make more. They think they can optimize even further. So, Disney is leaning into something similar. It's very interesting, Deidre, to see Disney, I won't say copycatting, but sort of looking at what's happening over at Netflix and saying, you know what? They really have kind of figured this out, particularly down at the per-subscriber level. Netflix has really done a very good job of figuring out how to generate profits and cash flow per subscriber. That's not something

that Disney has really unlocked yet. If you wanted any more proof that this was true, just look at the password sharing crackdown that now Disney is deciding to do. It's fascinating to me. Let's just hit a couple of numbers very quickly here. Disney Core, that is domestic US and Canada, and international, that's excluding Hotstar, which is generally in India. Overall, year-over-year, it was close to immaterial, 105.7 million paid subscribers versus 104.9 million in the quarter prior, so that's up 1% overall. But Disney, Hotstar, on the Indian subcontinent, that subscriber base has run for the hills, down 24%, just quarter over quarter to $40.4 million from $52.9 million the quarter prior. ESPN Plus is roughly the same and Hulu

overall is also largely the same here. The growth in the direct consumer business inside Disney has gone missing. That leaves you, if you're Disney, in the position of having to raise prices, having to show value. It's going to be fascinating, Deidre, when we get to the next series of ad sales. I'm not sure we're going to get much information on this until maybe next spring and say like the upfronts. But boy, is that going to be something when you have all of the streamers who are the big ad inventory suppliers saying, all right, come on in. And Disney's saying, who wants Star Wars? Who wants Marvel? And we're going to see. We're going to see how much ad buyers really value those franchises. But right now, Disney is desperate to increase

average profit per member because it doesn't look like they're generating much of anything, right? Yeah. And we still don't have numbers really from Netflix on the ads yet. They've been keeping that really close to the vest. So we don't know how that's playing out for them either. No, we really don't. To be fair, if we're just looking at the average monthly revenue per paid subscriber, all of this points to Hulu. It points directly to Hulu. It was down 1% in terms of the overall live TV plus video on demand bundle, but that's where all of the money is. In terms of average monthly revenue per paid subscriber, the Hulu bundle gets Disney $91.80 per. If you're just talking about Disney Plus Core, both blended international and

domestic, it's $6.58. That's up 2% quarter-over-quarter. The numbers just aren't moving. ESPN Plus was down to $5.45 from $5.64. So they really do have to monkey around with pricing in order to get this right. But if I could make, in the spirit of This Week in Tech, if I could make a reckless prediction here, my reckless prediction is you are going to see a boatload of advertisements about upgrades to the Hulu bundle. I think Disney will be marketing the Hulu bundle like you have never seen before. Remember, Hulu was born with ads native to the platform. Hulu has always had ads. That's been part of the story from the very beginning. There's a lot they can do with it. They can make it a premium bundle and still wrap ads

into it. I think it's where they have the greatest likelihood of generating sustainable profits in direct-to-consumer. Expect them to market the absolute heck out of this, Deidre, especially heading into the holiday season. I will join you on the reckless prediction and also say that I feel like in some ways it's easier to make Netflix-style content with Hulu. With Disney+, it seems like you almost have to make the more expensive content. I think think you've got more flexibility with Hulu to make the kind of things that are bingeable, but sort of disposable. Yeah. Yeah. And sort of quirky content, maybe quirky content, maybe a shorter form, you know, and experimenting with licensing content

that maybe doesn't get a lot of views, but is getting more. I read something and I forget, I remember what it was. Suits came up. Where did it go to? Netflix. It is like number one on Netflix, oddly enough. Yeah. And this is the sort of thing, like old content that you can license for a relatively reasonable fee, but it has a following and it's stuck around. It's never quite gone away. You could see more of that, like what is the next Suits that folds into Hulu that becomes a bit of a draw. I would expect to see some of that as well. Yeah, yeah, absolutely. Good point. Well, let's turn to one other part of Disney, which is this ESPN deal. This came out before the earnings,

their ESPN bet. It's their deal with Penn Gaming. Looks like it's going to sort of be, now we've got sports books with Disney. You know, sports purists, I don't know, I think you might be a sports purist. They tend to not like it. Some people say this is a prelude spinning off Disney and turning it into something more than content. Iger says, we're not doing that. We might sell a stake, but not the whole thing. What do you think? Are you a purist? Well, I mean, I don't know if I'm a purist. I mean, look, I love my sports. I don't gamble with the sports only because I don't feel like I've got the money to do it and I don't want to waste the money on it. I guess if I had a lot of

disposable income. I was like, yeah, I don't care about this. Then I'll maybe throw it in there for fun. But it doesn't really appeal to me. But I will tell you where I get maybe a little bit of old man shouts at cloud on this particular issue is that I don't think we've seen this really work before Deidre. Has it? I mean, just because it's a thing and people do it, has it actually provided real tailwinds for a business that you or I could think of? I mean, I think we could both cite FuboTV, and I'm not so sure that this has been a rousing success for FuboTV, which is a stock that we sold out of Rule Breakers. Now, you could argue that my timing on selling that has been absolutely abysmal, and you would be right, because it has absolutely soared since

we sold it from a very low base. But as a matter of business, Deidre, I don't remember sports betting actually really generating the kind of cushioning competitive mode that Fubo thought it was going to be so what do we expect this to be for espn would it be an incremental take rate and we would expect that uh heavy engagement in sports watched i'd say like espn plus and you're gonna have betting as you're on the couch watching the game i'll tell you for me i don't think i may not be emblematic of other fans but when i am when i will be watching and i will be when I will be watching the Premier League this weekend and getting very excited and hoping that my team pushes through, I am not looking at my smartphone. I am fixated to the screen to like

pass the damn ball, you know, find a through ball. Like that's the sort of thing that I'm engaged in the match, not engaged in my phone. And so that's where I think things get a little weird. If you're expecting high volume on gambling in live sports, you're almost conceding that somebody is going to pick up their smartphone and make some bets and take their attention away from the game. Will they? I mean, I guess, but I don't know. I think there are different types of watchers.

I think there are people who have their teams and root for their teams. And, you know, I think it's, it's an older audience, myself included, that tends to be the, like, I'm just watching the one game, but I also know a lot of people who are watching multiple games and are playing fantasy or something like that. So then they're sort of piecing together different theories. It almost becomes like stocks because it's almost like a portfolio where you start, you know, putting together different, different bets on different things. So I see the appeal.

It's, it's not for me, but I think there's potential there. Well, like I said, could be me doing old man shouts at clout. So, there you go. Let's keep the advertising train going and talk a little bit about the Trade Desk. So, good quarter for them. Revenue growth rates slowed down a bit, still pretty strong at 23%. We know the advertising market has been up and down, but on the earnings call, CEO Jeff Green, he was really clear on this. He said, 2024, tidal wave of opportunity. And he said it was both exciting and daunting. He's kind of a hype guy. Is he overselling this? Well, he may be or he may not be, but if he's right, then the actions that the trade desk is

taking in terms of capital allocation are confusing to me. Let's start there and I'll hit some numbers and explain what I mean. For 2023, in the current quarter, revenue up 23%, percent. Adjusted EBITDA margin of 39%. That was up from 37% the year prior. So, good numbers here. They seem to be doing good business. They're forecasting for the third quarter, fiscal third quarter, $485 million in revenue. That would be also up 23%. So, maintaining the current growth rate. So things look good overall. And I would say these numbers suggest to me that the Trade Desk is the big dog. I expect them to continue to be the big dog. And so I like what I'm seeing here. Overall, operating income was $41.7 million. That's up from just $1.7 million in the year

prior, so they got some real benefits from just their overall increase in revenue and operating leverage from managing expenses properly. A really good one, they were able to cut their general and administrative expenses. I think they're doing quite well here. They have a really strong balance sheet. Here's what I mean by where the rubber may not meet the road in terms of what Jeff Green said here, Deidre. In the first six months of the fiscal year, the Trade Desk has generated roughly $316 million in cash from operations. Now, a fair amount of that from things like stock-based compensation and deferral of expenses that are non-cash, so they get some benefits from that. But setting that aside, that's a lot of money that is cash

that's available to the business. What they've done with that, though, is they've used $337 million roughly to buy back shares. If 2024 is a massive tidal wave of opportunity for the trade desk, why is the trade desk buying back shares? Why aren't you reinvesting back into that opportunity, sucking up the oxygen in the room now, so when that opportunity is unleashed, you'll be even more profitable. You'll grow even faster. I can't say that I know exactly how that money should be put to work, Deidre. It may be that they're still doing exactly what they need to to seize the opportunity in 2024, and this is all excess cash. But I have to say it doesn't make much sense to me. Well, it's interesting, too, because on the call, the CFO talked a little

bit about hiring and how they're hiring responsibly, that they're still increasing their headcount, but they want to be careful with it. So, you're right that there's a little bit of a disconnect there of like, hey, we have this extra money, we're going to buy back these shares, but we also have to be cutting costs elsewhere. Is there some other expense that we're not thinking about in terms of some of the new things that they're developing, like Kokai or the OpenPath or some of the other technology? I don't know. What we do know is that in terms of results from a peer in Pubmatic, that's on the other side. The Trade Desk is on the demand side of the digital advertising platforms,

and Pubmatic is on the supplier side. In the results that we saw from Pubmatic, now granted, I've only given them a cursory look here, but one of the big questions is, do they have pricing power. They just weren't generating as much pricing power as we might have thought. If that's true, then there is good reason. If pricing is under pressure generally in the advertising market, then the CFO's comments make a ton of sense. You could decide, if you think that on the other side of 2023 and into 2024, that there's a massive opportunity there. You could just take that cash, Deidre, put it on your balance sheet and say, hey, folks, we got a ton of dry powder. And when things get weird, we can either make a small strategic acquisition or we can accelerate

our investment in OpenPath, in UID 2.0, all of these different things to get ready for the green fields of 2024, but instead they took that capital and bought back shares. By the way, they didn't reduce their share count in the process. The share count was still up, which means what they were really doing is trying to soak up the effects of stock-based compensation issued to employees. It just feels at the moment, Deidre, like wasted money and doesn't really fit the narrative. I don't have strong objections to what the Trade Desk is doing here. I just find it a little bit like, I don't know, maybe raised eyebrows is the way to think about it. Something to keep an eye on for the future then.

Yeah. I would like to see. Let's say as we get to the fourth quarter, let's take a look for what that guidance looks like for 2024. How big is this greenfield opportunity. Jeff Green is a smart guy. He's no dummy. He wouldn't be saying this if he didn't really believe it. He is a salesman, but he's not a dummy. He's not going to try and set up his company to underwhelm on expectations. He's forecasting something that he actually sees, but it's weird that the way the capital is allocated doesn't match that the way I would have expected well you used the phrase big dog when talking about the trade desk earlier and i thought i thought that was interesting because that is sort of the exact opposite of the way

jeff green has been positioning their trade deaths because he's positioning them a lot is like we're the little guy we're taking on big tech we're taking on the walled gardens he talks a lot about the walled gardens he feels very you know he feels he feels sort of like coyote-esque about like taking on the walled gardens. They're doing some things about this. They've got the Kokai, which is their platform. It's Japanese word for open water. It's their AI-driven way to bring together the metrics from multiple platforms. Is this really the little guy taking on big tech in those walled gardens? Well, in a way, sure. Because inside of the Google machine and the Meta machine, those are advertising markets that are controlled by

those two. They are absolute in terms of how those markets are controlled. This is more of the open wild where if you are talking about advertising, connected TV advertising that is outside of of those walled gardens. In that market, I would say the Trade Desk is the big dog. Everything is relative here, so everything in context, but they would say, and I think rightly so, that they're trying to get more advertising dollars out of the walled gardens and position something, what they do is highly effective. You can be on the trade desk doing advertising buying in a very effective, very useful, and very high ROI way. Why would you want to be spending all of your money inside those walled gardens when we can give you a verifiably

great experience with your different advertising, particularly as it relates to newer mediums like connected TV. I do think they are up against it. However, when you're talking about advertising that is outside of the walled gardens, I think by far the No. 1 demand-side platform here, Deidre, is the trade desk. They have mastered, in my opinion, the platform for buying ad space. I really think they've done that in a way that no other platform has really matched up to this point. And so you do have supply-siders like Pubmatic who are not going up against them, but instead are partnering. For sure, I think you would say for brand advertising, Meta is clearly a big dog, that's a closed market. In search advertising, Google is the big dog,

that's a closed market. When you go outside of that, outside of those walled gardens and you are doing any kind of demand side advertising, I think the Trade Desk is leading the way. and I'm not sure it's particularly close. Interesting. Well, you just talked about partnerships a little bit. I know the connected TV opportunity is massive, huge, but the other opportunity I'm paying a lot more attention to lately is retail advertising. We've seen it become a bigger part of Amazon. We know it's going to be a bigger part of Walmart when they announce earnings. On the call, Trade Desk talked about Walmart adopting UID2, which is sort of a way to replace third-party cookies, which we've already seen Safari doing away with

and Google is slowly, slowly stepping away from. So a little bit, what is UID2 and how should we think about this for Trade Desk and these retail partners that are now sort of a bigger part of the advertising conversation? So you're going to have to pardon my full lack of understanding of UI2, but here's how I think about it. When you get away from using directly, personally identifying information, you don't really get to ... We've kind of moved away from that idea of you are essentially selling your personal information without consent. This is a way to think about identifying and finding audiences using a lot of data and a lot of context and doing it in a very smart and AI-driven way, algorithmic way. You have ways to intelligently

target audiences and maybe break it down even more. I think the perfect use case for it is connected TV because you have a login and you have a history, and it's not the same as the Nielsen box where you are clicking and doing ratings. It really is much more like the internet-based experience because it is connected, it is logged in, and by virtue of being logged in, the datasets are bigger and way more interesting. Really, what this boils down to, Deidre, is what can the Trade Desk do uniquely well for targeting advertising buys with data? Ultimately, this is a data-driven business and the Trade Desk wants to get really, really good. They've historically been really, really good at making better advertising

decisions with data. This is just the next step in doing that, but in a way that for the most part strips personally identifying information out of the equation or more so than we have seen in the past because there was a lot of hullabaloo about using PII for years. We're moving beyond that into a much more of a first-party data platform where people who give you insight via their logins, via how they do business with particular channels and so forth in particular media, they give you insight into what it is that they prefer and then you can build entire profiles off of that. The more data there is, the smarter the Trade Desk can be in how it offers targeting to its customers. I think it's really important and the more that

the industry adopts this UID 2.0 platform, the deeper the Trade Desk moat gets. They have a vested interest in really pushing this standard, so I'm not surprised to see them doing it. Yeah. It's really interesting to me, the retail advertising side, because I think that there's just so much opportunity there. You've got this audience that is already there and already shopping, and so you have an opportunity to just build upon that. Right. The more data you get, yet, the better the context, the sharper the message, the better you can do. Some of it is still going to be annoying. Advertising is never going to be perfect. Advertising is never going to be perfect. But you can do different things when you are talking about

different digital environments, particularly like connected TV. One of my favorites that I think can be really useful. One of the reasons I believe that connected TV has more of a future is when you watch movies on one of the digital platforms, let's say like a Peacock or a Paramount Plus, they'll give you two minutes of ads and say, hey, once we show you these ads and then you get an uninterrupted movie." They have to really nail it with those ads at the front end. I like that model because I'm way more willing to not just check out from the ads when I know that on the other side of the ads, I got two hours of entertainment coming. and I find that fascinating. I think we're going to see more experimentation in that mold.

There's lots of things that we could see. As a data-driven platform and as a digital platform, the Trade Desk gives advertisers a lot of opportunity to experiment with not only their platforms, but also formats. We're stuck with the ads, but maybe they'll be a little bit more relevant. We hope. I think so far when I've been on, I will say this, I think the ads on the streaming platforms that I frequent have been better than the ads that I see on YouTube, and yet both are getting better. For one, this is the ad I always get on YouTube. I can't tell you whether or not the trade desk is involved in this or not, but I get endless, endless Deidre ads for Notion, which is the note-taking tool that I use.

I'm looking at it right now. I use it every single day and it is getting sharper and better. It's clearly more relevant. It doesn't mean I'm going to pay for more Notion, but at least they're hitting me with the right message. That works. Well, thanks for your time today, Tim. Thanks, Deidre. As always, people on the program may have interests 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 Deidre Willard. Thanks for listening. We'll see you tomorrow.

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