Motley Fool Hidden Gems Investing - All Eyes on the Attention Economy

Episode Date: August 12, 2024

Two quarters in, Reddit’s looking pretty good. And big box office numbers and streaming profits can’t distract investors from a slowdown in Disney’s parks segment.   (00:21) Asit Sharma and Dylan Lewis discuss: - Reddit’s strong growth numbers, some of its monetization opportunities beyond ads, and why it could buck the trend of struggling social companies like Pinterest, Snap, and Twitter/X. - Why strong box office and streaming results weren’t enough to get investors excited about Disney, but long term the company’s prospects still look good. (16:43) Jason Moser and Mary Long discuss Wayfair, the power of a good distribution network, and the company’s path to consistent profitability. Companies discussed: RDDT, DIS, W, AMZN, KO Host: Dylan Lewis Guests: Asit Sharma, Mary Long, Jason Moser Producer: Mary Long Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. Dylan Lewis I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst Asit Sharma. Asit, thanks for joining me.

Asit Sharma Dylan, thank you for inviting me. I think it is telling that last week was so full of news that we didn't get to hit earnings from some of the pretty big names out there, including Disney and 2024's largest or at least maybe most popular IPO, Reddit. Just kind of a sign of how tumultuous and maybe headline-driven the last week was, Asit. Yeah, we started off with the market itself being the headline, and then just a big firehose of earnings. But I like this, Dylan.

this is what investors should do. The dust settles, you go back and start looking at the things you wanted to get to. Don't just forget about them and wait until next quarter, you dig in. Yeah, that's right. Way to keep us honest there, Asit. We're going to start out looking at Reddit's results. Those came out last week, their second report as a publicly traded company. I look at the report here, and I'm pleasantly surprised, Asit. We had 54% year-over-year revenue growth. We saw very strong daily active user growth. It seemed like there was quite a bit to like here. Totally. Except for all the acronyms they use, like WALK, that is weekly active uniques.

But that increased as well, 50% year-over-year, to a pretty big number, 342 million unique users in this past quarter. I think the thing that's interesting about these results, just general, forget fine-grained analysis here because it's Monday, there was so much smack in the financial press being talked about Reddit's move to monetize its user base. I don't own shares. I'm following this as I do many IPOs quarter to quarter, let the data season some. But I was getting a bit skeptical after reading through the S-1 and listening to some conversations between investors on our team that were giving both sides a positive, skeptical side of the argument, just about this move where a community, which is heretofore not really had to worry about being

the object of the financial product, now shift their attention and think, have we lost our legitimacy as a platform? But it seems like the momentum is still there, Dylan. And because they're taking this ad-based approach to revenue, advertising is the driving revenue power here, really, the users don't seem to mind so far. It's a pleasant surprise, as you noted. Yeah, I shared some of those concerns as a longtime Reddit user when the company came public. I was looking at the prospectus and what their plan was here. Yeah, it's been surprising. They haven't gone too heavy on ad load yet, and I think it's probably worked to their benefit. You mentioned the ad-based model. It's about 90% of the top line. Ad revenue is up a little

over 40%. We also saw their other revenue segment, they have that data licensing business asset, much smaller. It's just under $30 million. That was up just under 700% year over year. It's a big growth number, probably not going to be a long-term huge driver for them, but it's a nice way for them to diversify that top line a little bit. A lot of that revenue winds up being because of some of the broader ambitions that other companies have when it comes to AI, and having datasets to train their AI on? Yeah, I think that's really accretive to margin. As time goes on, it will help them keep that gross margin really healthy. Licensing revenue is some of the best revenue you can

get in this world. I think that's good. In general, the composition of the P&L is pretty pleasing. If you're a shareholder, the company, I think, lost just a little bit of money this quarter, maybe $10 million all told. That was the net income loss. What's really driving loss is research and development. They are consciously cranking that up, Dylan. There's a lot of investment in their ad platform to make it more robust, to be able to integrate better with some demand-side platforms to bring in different ad yields for different advertisers who can monitor their activity via dashboards. A lot of this looks like some of the ad platforms we've traditionally seen as offering tools to their customers. They're targeting, in

addition, a lot of non-U.S. advertisers because so much of the user base is spread out across the globe. They're also cranking up that sales and marketing spend that increased this quarter to $72 million against $59 million in the year-ago quarter. But all in all, the company is approaching breakeven at these numbers. You mentioned before we taped that it looks like to you they're going to hit a run rate of around $1 billion this year in revenue. I think that's correct. When you have just a little bit of loss on a few hundred million dollars of revenue, that shows that you're probably in a position to scale profitably. I'll also note that without much debt on the balance sheet and about $1.7 billion between

cash and marketable securities, they're making some interest income as well. There's like $20.7 million just of interest income this quarter. The real operating loss, $31 million, but then you get the offset from interest income, and that's how we get to that $10 million loss number. One of the things that I thought was interesting that popped up when management talking through earnings and a lot of coverage of the earnings afterwards that I want to get your take on was, CEO Steve Huffman talked about how they are continuing to look for new ways to monetize on the platform and meet user community needs. One of the things that got

thrown out there was this idea of exclusive content or premium subreddits. It all sounds to me quite a bit like what's going on over on YouTube and Twitch, where you have these places where people build up a following and then creating creator tools so that individuals can monetize that following that they have. What do you think of that as an offering for them, as a strength of the platform for them? Yeah. It's the other side of the coin, right? If one side tells us, like, I can't believe you're monetizing this community, the head side could be, wow, I could make a little coin doing this. Give me the tools. I have something to say. I should get paid for it. It reminds me of sort of the movement to

Substack of a lot of individual bloggers a few years ago when they realized I don't have to give this stuff away for free. So I think that's positive. And it also lends itself to something else they're working on, which is all these sports partnerships that they have. I think in In the future, what we'll see is these exclusive AMAs, Ask Me Anythings with sports figures. There may exist a world in which even a sports figure can get some of that slice, but it's a model for other creators to see how that works, to visualize on the platform, and then to adjust those things. If you're sitting out there in obscurity, like myself or Dylan Lewis, and you see how

an athlete presents him or herself, or themselves, and gets a traction of viewers, then you've got the imprint to do it yourself. I think it could be meaningful. Time will tell. Happy to be here in obscurity with you, Asit. As it stands right now, shares up about 15% from where a lot of investors would have first been able to get their hands on them post-IPO. Because this is their second earnings report, We are also now lapping that six-month lockup for insiders being able to sell shares. We're starting to get a couple of quarters of results to see those earnings and user numbers season a little bit, as you mentioned.

Is this one interesting to you at all, based on what we're seeing? It is in a couple of ways, Dylan. One is, again, whenever there's a lot of skepticism in the market and the contrarians maybe don't turn out to be right, but at least their point is proven a bit in the early going, that's something to pay attention to. On the other hand, it is still early days for this business. You and I were chatting, and you were reminding me that there's been a lot of platforms that have come out that seemed to be very promising, but were based on user community. That stuff can be hard to

sustain and grow after a while. The early stages, now they've got all this money from public investment, they're turning up the marketing effect. The growth right now, we know it's not sustainable, it could be promising if they could eventually keep these numbers, which are above 50%, at a 20% to 30% level. But I do think that is harder than it looks. So, yeah, it's of a little more interest than it was when they IPO-ed. But it's not one I don't think that I'm going to jump in just yet. I'm patient enough to give it another few quarters. We also had some fresh results from the House of Mouse last week telling that Disney reported, and it didn't make conversation on the show last week, Asit.

really a battleground stock in a lot of ways, which is surprising for a household name. But Disney has been an in-the-eye-of-beholder type company, some people looking at some struggles with leadership, some struggles on the streaming side, and saying that they need clarity before they really feel like there's a strong investment case here. It looked like, in the results, the Disney Plus offering and the company's streaming ambitions starting to come together and answer some of those questions. Yeah, I think so. They're a quarter ahead of schedule for the total DTC business, which includes Netflix, to turn a profit. They turned a marginal profit this quarter.

For those of you who've been keeping track, this was the big question mark that lots of investors posed to find clarity. Well, if it becomes profitable, I will be more interested. But at the same time, Disney talked about slowing domestic activity in its parks and experiences segment. And I think that threw up another bit of caution for investors. When you have a business that has multiple drivers, this can often happen where one is hitting the marks or exceeding the marks as to management's projection, and then another may be subject to macro factors. But again, balancing that out, we have suddenly a booming box office at Disney. Inside Out 2 is the most successful animated film of all time. Now, it's probably going to hit $1.5 billion.

That's not taking into account even Deadpool and Wolverine, which is going to be the highest-rated opening for an R-rated movie of all time and is on track for $1 billion in revenue. These are some supports to the Disney thesis. But investors aren't going to be super excited about this company until they see it hitting in all the major categories. That's what happens when you hit this world where you're perceived as being in turnaround. Now, if they had been in turnaround, a quarter like this, I think the reaction would have been much more positive. Finally, of course, we've got the overhang of succession. Bob Iger has a few years now to find the right successor this time, not one that he's going to have to reel back in and take over the seat again.

Looking at some of the major segments from them, I think you mentioned Inside Out and Deadpool and Wolverine. That's a check, I think, for studios and the return of the big hits. We know that that flows through. It fuels the merchandise business. It fuels their parks business as they are able to capitalize on those characters and that IP and bring it into in-person experiences. The streaming unit, first quarterly profit, that sounds like a check to me ahead of schedule. We're also seeing some positive signs with subscribers over there. So, it really does seem like the market is punishing them for that theme parks business. Is this something where these are macro factors, and we've talked quite a bit about travel

and experiences, a lot of that being pulled forward and a lot of that starting to lag a little bit, consumer being stretched a little bit tighter, or is there anything Disney-specific here that's concerning to you? I don't think there's anything Disney-specific here. I think they're in the early cycles of a new investment phase. Management hasn't talked this up as much recently, but certainly last year, early this year, the theme was, we're going to over-invest in parks and experiences versus last time. We're going to over-invest in our cruise lines. That takes some years to play out. For those who own Disney or think

of buying this, I don't think this is a one-year story where you'll see a turnaround and the share price, really recovering a lot of ground. I do think within a three to five-year period, people will begin to appreciate this picture much more. You want to be investing in times where you've got maybe lower traffic to parks. This could last, I don't know, another few quarters, depends. If we hit a mild recession, maybe it's another two to three-quarter drag. But at the same time, the investments will expand the total capacity of Disney to take in visitors, to buff up attractions. The thing that we shouldn't lose sight of either is, they've invested a lot in yield management at the parks over the past few years. That's

invisible to most of us. But the technology that Disney is using now to manage the revenue in the parks and to manage the profits is much better than it was pre-COVID. During COVID, when everything was slumping, that's when they put the money into the system. I think they'll get a yield out of that when that business picks up a bit. But there is that element of uncertainty, because no one knows how long the domestic economy is going to feel soft and consumers will feel like they're pulling back. When you take a step back on the Disney chart, we're essentially looking at a lost decade for investors. I think shares are roughly around where they were in 2014, with some highs and lows in between. It sounds

like, from your perspective, we're looking at something where, if you have the three, maybe five-plus-year time horizon, this looks attractive and looks like a decent opportunity to be adding shares. But you can't be impatient with this one. This is not something that we're going to see some meaningful turnaround in the next couple of months. I think that's correct, Dylan. When you have turnaround stories, a lot of times, the turnaround is predicated on all the pieces coming together and revenue, for example, is the big signal to investors. This isn't going to be that case. This is going to be an earnings-per-share story, an earnings growth story. I'll just mention here, their new target

for adjusted earnings-per-share growth as of this latest report is 30%. I think Disney has the capability of growing its earnings-per-share every year 15% to 20% at least. When the market finally grasps that, you'll have a company that has the elements for a double in share price every five years. Traditionally, Disney was a great investment and kept this math going. You're right, they had a lost decade, but I think the pieces are coming together now. Just that one overhang, and it may be a year from now or two years before we can say that that's gone, is what happens next after Iger. That's one more reason why there's some compression on the multiples of this favorite large-cap company and invaluable

brand in the marketplace. It's going to be the question until we have an answer. Right, Asit? Who's next? Absolutely. Asit Sharma, thanks for joining me today. Dylan, thank you so much. This was a lot of fun. And what better way than with a delicious Pret Organic Coffee, starting at just $1 all day, every day, now until December 31st. You gotta try Pret First at A&W. At participating A&W locations in Ontario. Coming up on the show, Wayfair stock skyrocketed during the pandemic. but today, the online furniture store is down nearly 90% from highs.

Jason Moser and Mary Long discuss whether the company's future is brighter than its past. Dimo, you've joined me today and agreed to talk about Wayfair, the furniture e-commerce company, and I wanted to pick your brain on this because I have been a customer of Wayfair. Almost every time I have ordered something from the company, it has arrived at my door broken or blemished in some capacity. And I've had experienced amazing customer service. Like I always either get a refund or it gets, or gets sent another product. But that experience got me thinking, how is this company possibly making money? It turns out they might not be. Well, yeah, that's a wow. Yeah. I mean, I would say we're, I mean, we're pretty frequent customers of Wayfair as well. It's,

it's, it's a unique model, but that stinks to hear that stuff is coming to your doorstep broken and or damaged. It stinks. But again, it has, it has been made good. Like I've got a second product or I've been fully refunded and I've thought, okay, I guess I'll keep coming back. But from, from a distance, this, this is an e-commerce company, right? And so that aspect of it has earned it comparisons to Amazon because you can buy things online and it's shipped to your door. But unlike Amazon, Wayfair uses a dropshipping approach. What does that mean? Yeah. So that's interesting you use the Amazon reference there, particularly given the issues with things coming maybe damaged or whatnot. And it's good to hear that they are making it right.

I mean, if you're going to follow anyone's lead there, I mean, Amazon's mission really is to be the most customer-centric company on the face of the earth. Maybe Wayfair is trying to do that same thing. Ultimately, like they say, the customer is always right. You want to make sure the customer is made whole there. With Wayfair, it is a little bit different. I've always referred to Wayfair as more like a network. It connects consumers with suppliers all over the place. When you mentioned the word dropshipping, it's a business model. It's just where the seller doesn't really keep products in stock, but ultimately just purchases them from a third party to fulfill the orders. Yeah. And if you look at their 10K, they even mentioned this,

right? Their primary method of fulfillment is the drop ship network, where they ultimately just integrate their technology into their supplier's backend technology. And that allows them to process the order, send the information directly to the supplier's warehouse. Then they arrange for the shipment. And depending on the size of the package, the delivery is made through one of several different options there. So ultimately, what it all boils down to is when you look at Wayfair and you think of it as a retailer, that's not quite what it is in the sense they don't really carry inventory. And that's the interesting part about this business. It's not the owner of merchandise. If you look at their balance sheet, and typically with a retailer, when you look at

their balance sheet, a traditional retailer is going to have a lot of inventory on the balance sheet. It's going to represent a fairly high percentage of the total assets. But in Wayfair's case, inventory is only around 2% of the total assets on the balance sheet. Now, if you compare that to something like a Target, I was just looking up Target's recent numbers here, and of their total assets, I mean, inventory is closer to 20%. So yeah, Wayfair, that's the unique part of this business. They don't really own what they're selling us. They're just figuring out a way to get it to us. Another unique part of the business is the specialization in furniture, because some furniture pieces can be small, but a lot of them are large, bulky items that are

kind of by their nature, very hard to ship. Hence some of the problems that I mentioned up front, right? Yep. It's expensive, but easy to break stuff. Wayfair operates 18 fulfillment centers, 38 delivery centers. Is that, is its moat perhaps in that logistics network? Is that an asset or something to that that's favorable for the company? Well, I think that's ultimately what they, what they're trying to do, right? I mean, I would never underestimate the power of a good distribution network. I mean, I think we, we talk often about how Coca-Cola, for example, has been so successful. And one of the main reasons why is because they just got this amazing distribution network. And so I think in the case of something like Wayfair, absolutely building

that distribution network out is a part of the strategy. That's what will differentiate this company. And going back to Amazon, again, we've seen through the years how much Amazon has benefited from building out its distribution capabilities. But what comes with that, it takes a lot of time, it takes a lot of capital. You got to spend a lot and you got to do a lot. It's a lot of hard work to build out that distribution. And then to your point on home goods, that makes it even a little bit more difficult. I mean, let's be very clear. What Wayfair is doing is not easy. And maybe through time, that's what will separate them, what will differentiate them. But when you look at home goods, generally speaking, they have a low value to weight ratio. And what that means

ultimately is the shipping cost, right? The shipping cost to revenue metric. It's not working in the company's favor. They're shipping very big, bulky, heavy items. And it costs a lot of money to do that. And they're not making a whole heck of a lot of money to do it. So on the one hand, it's like, well, do I really want to do this? But on the other hand, again, you can see if you build out that big network and that capability, well, you can absolutely build out a competitive position by doing so because it's just so hard to do. To put some numbers around that, when you look at Wayfair, the shipping and fulfillment costs for this business over the last three years, you're looking at 2023, 2022, and 2021, those shipping and fulfillment costs were

$1.9 billion, $2.2 billion, and $2.1 billion. Ultimately, generally speaking, that represents about 18% of revenue, which is pretty high. So, yeah, let's talk a bit about those numbers because this is a stock that peaked in the pandemic when, okay, everyone's going online. You can't buy stuff in stores. At the time, it crossed $14 billion in revenue. It actually turned a profit in 2020. That has not happened again since. What needs to happen for Wayfair to reach consistent profitability moving forward? Well, I think part of it is going to be time. I think it takes a little bit of time to really build out this kind of a business. A lot of it is going to be really about customers, right?

Getting those customers to come in and utilize the Wayfair network and then to come back and keep doing it. But when you look at it from the business model perspective, part of the thesis with Wayfair, it's always been at some point that they're going to be able to cut back on things like marketing and ad spend. And so a lot of this boils down to kind of controlling what they can control, right-sizing the business, making sure that they're doing as much with what they have. Right. And then also continuing to realize the operating leverage on something they refer to as S O T G and a, or

selling operations, technology, general and administrative expenses. And so those are expenses that, you know, for, for building this business, it costs a lot of money for them to, build out this customer base. It costs a lot of money for them to advertise and market and acquire new customers. And so, eventually, they want to be able to boil it down to having customers continue to come back and buy more stuff. They don't want to acquire new customers. They want to keep the customers that they do acquire. And then, ultimately, I think a lot of it will also just come down to improving the unit economics to the extent that they're able to. Expanding their gross margin through making their logistics and their supplier services as efficient and as

effective as they can be, making sure the wholesale economics work, and ultimately, the merchandise mix as well. I think in this day and age, especially with something like Wayfair technology, and yes, Mary, I'm going to go ahead and say it, AI. AI is going to be a part of this to an extent. AI will play a role here. Hopefully, that is something that will continue to help make their business, the predictive analytics and things like that, a little bit more efficient, a little bit more effective. And ultimately, the idea is that will help bring down some of those costs. But it's absolutely a difficult road to hoe. I mean, what they're doing is not easy. You mentioned earlier the idea of right-sizing this business. And CEO

Niraj Shah dubbed last year, 2023, the year of the reset for Wayfair. So basically, what that looked like in practice was doing an organizational restructure, laying a lot of people off, but also improving on delivery times, tightening that operational structure. The company reported second quarter earnings about a week ago. Headlines from that, revenue down year over year, still posting a net loss, but that loss was slightly less than it was a year ago. I know that it's still pretty early to tell, but based on what you're seeing thus far, has the reset worked? I think it's definitely headed in the right direction. They seem to believe so, obviously. I think it's going to be a lot easier to determine this, though,

in better economic conditions. I mean, this isn't the greatest time in the world to be a home furnishings provider, right? I mean, this is a very discretionary type of business, right? These are not things that we necessarily need as much as things that we kind of want. And so, when you look at the conditions today in regard to inflation, I mean, clearly the consumer is very stretched. Interest rates are high. I mean, it's not a great time, I think, in the near term to at least determine whether this is working out so well for them. I think it's going to be very interesting to see the market's reaction to a stock like this when interest rates start ticking back down. Because when you look back over the last three years, they were very abnormal, right?

they've created a lot of interesting situations with a lot of businesses. And so, as things are normalizing now, I think that really explains a little bit in regard to Wayfair's top line sort of ebb and flow. But I think, yeah, generally speaking, I think things are working, right? I think it's just, this is a business that is absolutely going to do better in better economic times. We've talked about the future possibilities of Wayfair and for Wayfair, but if you look at the stock chart today, things are pretty bleak from that peak that we saw at the pandemic. Do you feel like this is a buying opportunity? Are you keeping an eye on it for the future? Where do you fall on that? The volatility with the stock has been

phenomenal, to say the least. It's seen some real highs and some real lows. I'll be very upfront here. I own a handful of shares myself. This is a company where, again, it's not something where it's a big position in my portfolio. It's what I would call one of those high-flyer ideas where we typically use the allocation guidance for something like this. Maybe it would represent 1% to 2% of your overall portfolio. But to me, when you look at the overall home furnishings market, the market opportunity that's there, which, globally speaking, is just in the hundreds of billions of dollars. Wayfair is not going to capture all that, of course. But it just goes to show you that there is a lot of market out there to capture. And they do something a little bit

different than Amazon. They've proven themselves to be a little bit Amazon-resistant, I think. It's similar to Etsy in that regard. So, again, I own a handful of shares myself. I do think it's one worth holding. It's going to be interesting to me to see over the years how this business develops. We've got leadership there that really, it's a business that's run by the co-founders. The co-founders still own a good chunk of the company. I think between Conine and Shaw, they still own close to 9% of the shares each. They're clearly bought in and think that what they're doing is the right thing and it's worth hanging on to. It's not something where I would make it an outsized position in my portfolio. But if you're an investor interested

in e-commerce opportunities, Wayfair is clearly a company that is not going anywhere. It does feel like they're making progress. It's something that's going to take a lot of time because, again, they have to continue investing in that distribution, that fulfillment. But they've done a tremendous job of building up that brand through the years. I think we probably all could hum that song in the back of her mind. They apparently got just what we need. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.