Motley Fool Hidden Gems Investing - Big Banks vs. Apple & PayPal

Episode Date: January 23, 2023

Major banks are teaming up like The Avengers to take on powerful forces: Apple Wallet and PayPal. (0:21) Jason Moser discusses: - Spotify becoming the latest company to announce layoffs - Seven large banks combining forces to create a digital wallet product - How and why Apple and PayPal have such a large lead in this industry (12:40) Asit Sharma and Rickey Mulvey discuss corporate governance and an under-the-radar pop culture company going through some fundamental changes.  Our new report, "5 Pullback Stocks" is available for free to Stock Advisor members. To access the report just go to www.fool.com/Pullback. Stocks discussed: SPOT, WFC, BAC, JPM, COF, PNC, USB, TFC, AAPL, PYPL, DIS, MSGS, PG, FNKO Host: Chris Hill Guest: Jason Moser, Asit Sharma Producer: Ricky Mulvey Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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It's like the Avengers, but instead of superpowers, they've got Excel spreadsheets. Motley Fool Money starts now. I'm Chris Hill. Joining me today, Motley Fool Senior Analyst Jason Moser. Thanks for being here. Hey, hey. Thanks for having me. We're going to get to the big banks in a minute, but let's start with Spotify.

The audio streaming company became the latest to announce layoffs in what is now becoming a common refrain. Spotify CEO Daniel Ek said the company was overly ambitious in its hiring and investments during the pandemic and is going to be reducing headcount by 6%, which is about 600 employees. And this one hits a little bit closer to home for me because we've been working with Spotify as our partner on the new Stock Advisor Roundtable podcast, and they've been fantastic to work with. So hopefully this next stage goes as smoothly as it possibly can for them. But at a higher level, Jason, this is really what we've been seeing over the past couple of months, and we are almost certainly going to be seeing more of this.

Yeah. I mean, it sounds like, I think we're sounding like a broken record, right? I mean, this is going to be a theme for the first half of the year, and we say that I think every week. It's not surprising to see this, it's just one more domino to fall, I guess. This is coming, as Eck puts it, from the angle of efficiency and eliminating redundancies, which makes a lot of sense. I think a lot of businesses out there are suffering from that right now. When you consider some of the metrics that matter here, it makes a lot of sense. Now, in his memo, he did note that in 2022, the growth in Spotify's operating expenses outpaced the revenue growth by a factor of two. With a business like this,

you don't want to see that, that's a no-no. If you look at over the stretch of time here, how they've grown their employee base versus how they've grown their business, it starts lot more sense too. If you go back to 2018, their 20F quotes an average of 3,651 employees over the course of the year. In 2021, that number goes to 6,617. If you look at now, it's around 9,800. With expectations of $12.7 billion in revenue, we start to get an idea of the efficiencies that this company is ringing out. Unfortunately, it's going in the opposite direction of what investors should be hoping for. If you look at 2018 and 2021, for example, the revenue per employee clocks in at around $1.6 million and that's fine. You look at now though, that number is going to come in closer

to $1.3 million and the bottom line remains challenged. Now, part of that is because of content costs. Content costs are always going to be the shadow that looms large over this business, but they don't need a bloated employee base adding salt to that wound, so to speak, and that's what gets us to where we are today with these job cuts. I like how you put the timeframe on it because it really does seem like the way everyone is talking. When I say everyone, I'm talking about everyone. I'm talking about company executives, Wall Street analysts, analysts here at The Motley Fool. There really does seem to be this expectation that the second half of the year has the potential

to be better, both in terms of what we see out of the stock market and where companies are in terms of their own sizing. I know some people sort of bristle at the term right-sizing, but it really does seem like we are setting up for that second half. Do you think we're going to start hearing more? We talk about how there's the old adage, sell in May and go away. Do you think that's going to get bumped up? I'm sort of stealing myself for economists and certainly some Wall Street analysts saying, you know what, just sit on the sidelines until we hit July 1st. Yeah. I mean, last year was like, selling May, selling June, selling July, selling August. It's just this perpetual selling that's

been going on. It's certainly understandable. I was thinking about this this morning, you try to gauge how far forward the market really does look, because we're at a point right now, obviously, the consumer is in a tough spot and that spot is only getting tougher. You have these projections that the consumer is going to, quote-unquote, run out of money by the middle of the year. If you think about it from that perspective, then if we're looking at that sort of timeline, then how is the market assessing that? Because you're right, I mean, we see a lot of job cuts coming through here over the last several months. It's no news that the consumer is in a tougher spot. And at some point, we get to a bottom,

right? It definitely, every day it starts to look like we're getting closer and closer to that bottom. Then how far forward is the market looking? If we get to a point in the middle of the year, if that prognostication holds and the consumer runs out of money in the middle of the year and really has to start battening down the hatches and becoming a bit more thoughtful about how they spend, and if we get to that point where these businesses have ultimately right-sized themselves to the degree that it makes sense, do we see more optimism, more glass half full perspective here in the back half of the year. Going into this year, that has been my mindset. It's what I wrote out in my investor letter for my services here.

It seems that we're set up for a challenging first half of the year, but if this plays out the way that it looks like it is going to play out, yeah, I think it makes a lot of sense that the market would start to take a little bit more of an optimistic look on things for the back half of the year and going into 2024. Obviously, there are a lot of factors at play, but I can definitely see a world where that works out. The battle for your wallet has entered a new stage. Bank of America, JPMorgan Chase, Wells Fargo, Capital One, PNC, Truist, and U.S. Bancorp are all teaming up to create a new digital wallet product to compete against PayPal, and Apple Wallet. The goal is to make this new product available in the second half of the

year. I have a few thoughts on this, Jason. I guess my first one is good luck. Yeah, that's a good first one. What are your other thoughts? I'll get to my other thoughts in a second. Let's start with this, though, on a more serious note. What was your thought when you saw this story? So, one of the first thoughts was good luck. But really, to take that a little bit further, I don't blame them for doing this. I think it's the right thing to do. I think it could be a day late, a dollar short, as they say. I mean, this is something that should have been happening a long time ago. And now, what we've got is, we've got some

companies that have really made a lot of headway. They've invested a lot of money in this space over the course of many years. They're so far ahead of where these banks are in regard to this digital wallet style offering. It's not to say the banks can't realize success from this, but it is going to be a slog. When you look at the numbers, I like to look at Zelle as an idea of where this could go. I think Zelle has been successful. I think Zelle is a fine offering and it serves a very good purpose and clearly people are using it. If you look at the numbers there, the fourth quarter of 2022, Bank of America announced that they had 18.2 million active Zelle users that sent and received 273 million transfers worth $81 billion.

If you go back to the same quarter in 2019, that was 9.7 million users with 95 million payments and about $24 billion in volume. Clearly, it's a platform, it's a service that is growing. I don't think it's the greatest platform in the world. I said earlier, I tried to use Zelle a couple of separate times to transfer money. Never worked, couldn't get the accounts linked up. was more hassle than it was worth. Listen, man, I'll try it a couple of times, when it stops, I'm out, I'm done. Because I know there are other platforms out there that work, PayPal, Venmo,

Block, Cash App, all that stuff that's already out there, and that's what they're going to have to really deal with. You look at PayPal, the third quarter of 2022, they put $340 billion through that network. Venmo alone was just $64 billion of that, 430 million users and 5.6 billion transactions. That's just for the quarter. Then you look at other companies like Block, you look at what Apple Pay is doing. I think it's a very competitive space. Again, I don't blame the banks at all for trying to get their share, but changing consumer behavior is really difficult when it becomes so ingrained. We've been using these tools, Cash App, Apple Pay, PayPal, Venmo, we've been using them for so long, and what's even more, our kids are using them. You've got

a whole new generation of potential customers coming online here that probably aren't going to really buy into that service because they're already so used to using these other platforms. Again, not to say it can't be successful, it's just going to be a really, really long slog, I'm glad you hit the point about essentially not blaming them for trying this, because they're not just going to sit on the sidelines and say, well, this hasn't worked, we're just giving up altogether. You look at the combined customer base of the seven banks, that's a huge reach, that's a huge potential built-in customer base. On the flip side, the phrase too many cooks in the kitchen did pop into my head when I was thinking about this, just everything from the

interface. If they can pull this off in any meaningful way, you're going to have to tip your cap to them because you think about customer interface and even things like branding, just how this gets branded, how this gets rolled out to customers. This isn't just a high bar, this is actually a series of high bars when you consider that it is seven separate banks all trying to work together and get on the same page. Yes, some are bigger than others and presumably they'll have more sway and more say in this conversation, but this is going to be tough to pull off. Yeah, and I'm glad you keyed in on that. That's going to be a big challenge. There's a singularity of vision with your PayPals and your Apples and your blocks of the world.

This is a consortium of competitors coming together to try to do something together, which can be difficult. It just can be difficult to do. Then further, I think the bigger question you have to ask yourself is really, what are they going to do better? What are they going to do that really differentiates them from the PayPal's and Apple's blocks of the world in the investments and capabilities that they've already developed. Those two things alone right there, those are big questions that need to be answered. How will these banks be able to really work? Can they work together enough? Then furthermore, what are they going to do necessarily better than these others? I don't know. We'll have to wait and see there. It's going to be interesting to find

out in the second half of the year. Jason Moser, thanks for being here. Jason Moser. Thank you. If you're the type of investor who keeps a watchlist of stocks that you're waiting to pull back a bit from their highs, then you might be interested in the list of five stocks that our team of analysts has put together. It's companies whose stocks have fallen recently, but they've got strong fundamentals and catalysts to set them up for future success. All of the details and analysis are in a new report called Five Pullback Stocks. It's free to Stock Advisor members. Just go to fool.com slash pullback to access the report. That's fool.com slash pullback.

A public company CEO has got plenty on his or her plate without having to worry about activist investors. Let's face it, Bob Iger isn't exactly thrilled about Nelson Peltz's push to join Disney's board, but shareholders might be a little happier. Asit Sharma joins Ricky Mulvey to talk corporate governance and one lesser known pop culture company that's going through some fundamental changes. It's corporate governance day. Yeah, that makes it sound like we're about take you through some mandatory workplace training or a nice trip to the dentist, but hopefully we've got some good takeaways for investors. Asit, when I think of corporate governance, it's basically who's on the board, what are the controls, how are you handling CEO

succession planning, and anything I missed there before we keep moving? That's going to be our focus today, Ricky. There are more objectives. There is that whole ESG component that's increasingly important to many investors. But at the heart of it, that's where my mind goes when I think about corporate governance. It goes first, okay, who's on the board? Why are they on the board? What is this board trying to achieve? How effective are they? Is there anything smarmy here that I should be looking for? That type of thing. I think you nailed it. It's also something that I think when it's become a buzzword when there are numerical points attached to it, when this is

a qualitative measurement. The big corporate governance story right now is Nelson Peltz's latest battle at Disney. He thinks management has essentially got too rich of a compensation plan. He would like to see him cut expenses, get streaming to profitability. Then just some criticisms about acquisition specifically around the Fox deal. Bob Iger has not welcomed these criticisms, CEO of Disney. In your mind, is Nelson Peltz telling Disney anything they don't know right now too? Ricky, he's not telling the board anything they don't already know. He's not telling other shareholders things that they're not already aware of. Nelson Peltz is lobbying for a seat on Disney's board. He's got this proxy challenge,

shareholders will have to vote on him as an independent director in an upcoming proxy voting process. But as controversial as many people find Nelson Peltz, I don't think this is such a bad thing for Disney shareholders. You have a voice who is quite experienced, who's calling out things to try to hold the board accountable. These are issues everyone is aware of. I want to point out, if you look at Disney's rebuttal to Tryon Management's press release, Trine Management is the company that Nelson Peltz essentially runs. They list action items that Bob Iger has taken care of. These are reorganizing the leadership structure to put more decision-making back into the hands of creative teams, implementing cost reduction plans,

prioritizing streaming profitability, and improving the guest experience at the parks by providing more value and flexibility, i.e. not jacking up prices so much and maybe decreasing them in some places. Well, these are all reversals almost to the last of initiatives that Bob Chapek, who was Bob Iger's handpicked successor, put into place. Nelson Peltz has a point where he says, look, the succession planning at this company really hasn't worked out. We have another stint with an extremely capable CEO. In fact, on the Stock Advisor team, we think that Bob Iger is going to perform. But what happens next? He's got two years to not only turn the company around, but to find his successor. Maybe you want a loud and prominent

voice holding you to that, holding your feet to the fire on those items. Allegedly. Bob Iger says he's only sticking around for two years, but I think he's kicked the can on that before. I also find that history is repeating itself a little bit with the Nelson Peltz at Disney story, because you have an outsider telling management things that in some cases they already know, in some cases things they very much disagree with. Management saying, Nelson Peltz, you have no experience in this category. This is exactly what happened at Procter & Gamble, I think it would be about five years ago during the proxy battle there. Peltz goes on the board of Procter & Gamble after kicking and screaming by shareholders

and the board. Then it seems by my observation that it wasn't the atom bomb that shareholders and Procter & Gamble employees worried that it would be. Totally, Ricky. We've seen this time and again. It's like a pattern. Nelson Peltz tends to get under the skin of boards of the companies he wants to join up and help lead on the board level. They seem to have a visceral reaction to him, but he's mellowed out with age. He's got a lot to bring. He's got what's called a TSR approach, total shareholder return approach, which advocates for good capital allocation, good management. He's like the crazy dad. When you go in middle school to a friend's house for the first time and the dad's making all kinds of bad dad jokes and just looks a little off.

You tell your friend, don't worry about him, he's actually pretty normal if you remove all this weird stuff, and that's the experience. These companies fight, sometimes viciously, to keep them off the board. A few years later, they write up a nice little blurb that Trion Management puts on the top of its website about what a collaborative guy he is and how good he's been for the company's performance. I guess the flip side of that is, that's usually when he's leaving the board as well. You've done a great job and we're so happy to see you go. One of the last things I'll say on this, I think it's one of the funniest moments when Peltz goes on CNBC saying, I do have media experience in criticizing the corporate governance

of Disney. He explains that he served on the board of Madison Square Garden, the Madison Square Garden Group, which if you follow that company, is not exactly the exemplar of good corporate governance under CEO James Dolan, who just for one example, banned a New York Knicks fan for life when the fan shouted at him above the tunnel, sell the team. I don't know if that counts. He's also implemented facial recognition technology in a lot of their venues to keep out the entire law firms of any firm that may have a suit against him. Anyway, with that context, when David Faber pressed Pelts on his experience at MSG, he said, at least the hockey team is doing well. It is a little bit of a game for him, which

for many of the people who work at these companies and for the Board of Directors, I can understand why they might not take that well. I want to go to a less talked about corporate governance story. We've talked about the big headline, but this is one where Bob Iger is also involved and it's a pop culture company, and that is Funko, which makes the vinyl bobbleheads. It has the branded backpacks and it's replaced its CEO, Andrew Perlmutter, who is still on the board. It's bringing back an old CEO after a really bad quarter with declining margins and some cloudy guidance. What's your take on what's going on at Funko? When you see these shifting seats, do you see it as short-term impatience or do you like seeing a board reminding

the executive team that they work for shareholders here? It's interesting because Brian Mariotti, who was the former CEO and took an interim position, I think from around August of 2021, as this creative visionary. He's been with this company for many years. He comes back as of December of last year to lead the company again. As you mentioned, the CEO who hasn't been in the chair very long, Andrew Perlmutter, he stays both on the board and on the executive team now as president. There's a little bit of backstory here in that Funko grew fairly rapidly over the past few years, even during the COVID years. It acquired a company called Loungefly, and that company started taking off. They have never quite had the operations piece in their

company that they needed as they've expanded. They're backfilling that over time. They're going to put a COO in or add this position to the management team. Another part of this story is that the Chief Financial Officer, Jennifer Jung, I hope I pronounced that correctly, is stepping down. They're going to find a new CFO. The combination of a newish CFO and then a person who'd been around for a while and was expected to be a great CEO, that didn't work out, especially given all the macro events that happened last year with the spike in inflation and then consumers pulling back. They whiffed on what the holiday season would look like. That's not great for a small company like Funko, which by the way, Ricky, has just moved all its

distribution to this big fancy new distribution center because you don't want to be holding inventory that will be slower moving in the spring and in the summer. I think that rattled shareholders. The board decided to bring back Brian Mariotti because he's been pretty good managing inventory levels. I think they still need both to keep Brian Mariotti involved on a strategic level. They've got to fill in an operations piece here, but I think the company will be fine. As for the short-termism, it's hard to say because you've got a problem here that you really want to rectify quickly. You want to make sure that they don't start mismanaging inventory quarter after quarter. It makes sense on one level, but it doesn't solve the problem

of how they're going to strengthen their operations long-term. This is a company which has seen, as you pointed out or alluded to, quite a bit of investment. The Chernin Group invested in Funko last year. Bob Iger now owns part of the company. They've got some really prominent people who have stepped in and taken an interest in this company. So I think the board wants to make sure it's best positioned to move forward in a way that's going to be productive both for the business results and for shareholders. Yeah. When we talk about shareholders of this company, it's really the churning group, which owns 25% of the shares outstanding. So In some ways, that's what you're seeing, I think, a heavy response to is the demands

from that particular investment group, which I guess has more sway, especially for these much smaller cap companies where it's pretty hard to own 25% of Disney, but for a company like Funko, which is trading around, I think, a little over $500 million, you can see those activist investors take a much, much larger stake. True. I just want to interject there that boards and management teams also show a lot more visible perspiration when you're worried as that major shareholder that comes in and you want to change or shake up at the sea level. You can always interject. That's what you're here for, Asit. Investing-y question,

Funko is trading at about 0.5 times sales. It's been profitable on a free cash flow basis before, still profitable on an operating income basis as margins decline a little bit. Share count, I also want to point out under this current board has increased by 20% year over year. Is this company, I know you followed it for a while, is it more interesting to you now or does it look more like a value trap? I want to be consistent with something I said recently in an internal presentation to some of our members for a service I work on at The Motley Fool, which is they've got to prove what's going on with this new distribution footprint and what's going on with the inventory before we make any judgment calls. I'm pretty positive on this little

company. I like their licensing model. I like the fact that they license from companies like Disney and they've got Star Wars IP that they can slap on products. At the same time, this model begs that you manage your product very carefully. We have to take a pause here. Now, the stock has recovered from the hit that it took back in, I think, the late November timeframe somewhat. It went all the way down to $7 a share. It's up close to $12. That midpoint between the bottom and where it was trading before, I feel fairly positive that Brian Mariotti will be able to write things for whatever this temporary period is. I think they will smooth out the logistical growing pains of new distribution. That should be anyway a lot more efficient

versus the multi-warehouse approach they had before. But with these cases, you have to put up the numbers and you have to show investors that you can get back off the mat when you've had a stumble. I have to reserve a little bit of what would be some enthusiastic response on this company that I like very much. We'll see how that inventory count looks next quarter, what the margins look like, and what the outlook is for the rest of this year. Maybe next time we'll take a deep dive into the dual-class share structure, but that's all on corporate governance for today. Asit Sharma, appreciate your time and always great chatting with you. Ricky, I can't believe we had this

mandatory fund together. Yes. 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.