Motley Fool Hidden Gems Investing - CLEAR Looks Beyond Travel

Episode Date: December 21, 2023

It’s travel season but Clear wants you to think of them as far more than just the fast way through the airport. (00:21) Yasser El-Shimy and Deidre Woollard discuss: - If Warner Bros. Discovery and Paramount would be a win-win deal. - Potential other media mash-ups. - Challenges facing the used car business. (20:06) Sanmeet Deo talks with Ken Cornick, the co-founder, President, and Chief Financial Officer of CLEAR, an identity management company. This conversation was recorded on Dec. 8, 2023. Companies discussed: YOU, WBD, PARA, KMX, CVNA, AMZN, NFLX, DIS Claim your dividend report here: www.fool.com/dividends Host: Deidre Woollard Guests: Yasser El-Shimy, Sanmeet Deo, Ken Cornick Producers: Mary Long, Ricky Mulvey Engineers: Dan Boyd, Ricky Mulvey Learn more about your ad choices. Visit megaphone.fm/adchoices

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I'm doing well, Deidre. Thank you for having me. I wanted to talk to you today because, you know, we're headed toward the holiday. It's supposed to be quiet, but instead, man, it has been like an M&A bonanza lately. And this one that we're going to talk about, maybe it's been expected, but the rumor has it is that the CEOs of Warner Brothers Discovery and Paramount Global were in New York City talking about a potential merger. It kind of makes sense. You've got two of the smaller players in television and streaming, teaming up. Is this a win-win or a lose-lose? I'm afraid it might be more of the

latter. Lose-lose. You know, when you think about the streaming world, for example, you have Netflix that boosts over 200 million subscribers. Warner Brothers Discovery has about 95 million Paramount Plus, may have around 60 something million subscribers. Not exactly sure how many of those subscribers of Max and Paramount Plus overlap. So you don't know how many new Max subscribers Warner Brothers will be gaining out of this transaction. But even if you put them together, they are still not at the Netflix scale. And that is not even getting into the issue of profitability and how direct consumer for pretty much everyone not named Netflix has been a money hemorrhaging business. Now, Warner Brothers has shown some glimpses of positivity here, of hope

with their DTC offering. So they announced actually this year that their U.S. streaming business is now profitable and that they are targeting profitability for the overall direct to consumer business soon. They're moving in the positive direction for sure. But as I said earlier like this might be more of a lose-lose situation because you know in this situation two wrongs don't make a right we have two companies that are heavily indebted they carry a lot of debt on their balance sheets warner brothers has been moving to towards kind of paying down that that heavy debt it carried since its demerger from at&t so it had about 55 billion dollars of debt or so. Now it has close to $42 billion. It will gain that again, and then a little more if it

were to merge with Paramount. So that might kind of create a new entity with another kind of heavily leveraged balance sheet. Additionally, both companies have a lot of exposure to linear television. And as you and I know, we live in a world of cord cutting. Most people have been moving away from just watching TV the old way by subscribing to some cable company and just watching TV that way and moving towards streaming. So in this environment, adding more linear TV exposure may not be exactly what's needed to deal with all the challenges ahead. So I'm a little I'm a little concerned here. Well, I mean, on the plus side, there would be efficiencies of scale because there would definitely be some ways to cut costs. But as you mentioned, the debt on both

sides is certainly significant. And I'm pushing back a little bit on the streaming and the cord cutting thing. It may start to go the other way because there's definitely streaming fatigue and there's definitely a case of people not people looking at their at their bills especially right now the pressured consumer is seeing like oh my gosh i have like four streaming services and that's costing me more than than cable would have so maybe we we see that turn but as part of this rumor one of the other things i heard was that comcast might be a better dance partner for warner brothers discovery what do you think of that one i think you're absolutely correct if there is a deal to be done here, I strongly doubt it's going to be Warner Brothers and Paramount. I think it's

most likely going to be Comcast acquiring Warner Brothers. And notice I didn't say acquiring Paramount. I think the regulatory pressure against that deal, because both Comcast and Paramount own two broadcast channels, in this case NBC and CBS, so there might be too much of a you know, let's call scrutiny against such a deal. Whereas I think it might make more sense and perhaps we'll encounter less pressure, less resistance from regulators if Comcast Universal was to go after Warner Brothers Discovery with all the kind of the storied brands that Warner Brothers brings into the fold here. Also some sports rights, you know, we talk about the NBA, the NHL, are both carried by Warner Brothers channels. You have HBO, you have a lot of very

strong brands, HGTV, Animal Planet, and so on. I could go on. So there's definitely a lot of value in Warner Brothers Discovery. And I think only Comcast, out of all legacy, let's call it entertainment or communications businesses, that's the only company with the kind of balance sheet that might allow it to make such a transaction happen. Yeah, good point about the potential regulatory scrutiny. Of course, in that scenario, you leave Paramount out in the cold. There's some stuff going on behind the scenes there, too, because these rumors came out after the rumors that Sherry Redstone,

of course, Sumner Redstone's daughter, she was considering selling the shares of Paramount. She owns through National Amusements. She's got major voting shares, And she's been entertaining a couple of interesting suitors, including Bobby Kodak from, you know, the departing Activision CEO and David Ellison, of course, Larry Ellison's son and the CEO of Skydance Media. So if that doesn't, if Warner Brothers and Paramount don't get together, does Paramount sort of necessarily need to find itself another dance partner? I think that's the writing has been on the wall for a while for Paramount. Yeah.

paramount doesn't have the scale it doesn't have the kind of offering that is a that's between quotation air air quotes here must have i'm actually a subscriber to paramount plus and that's mostly because i watched italian soccer league uh which is carried exclusively by paramount plus but then again how many people in america uh want to watch italian soccer league uh not a lot They do have some, you know, NFL games that they carry. They do have some exclusive original shows that they have, like Yellowstone, which have done very well. But again, as you said earlier, we live in a world inundated with entertainment and TV

options. So if I have four, five, six different, you know, options out there now, I'm getting, you know, I'll just give you an example. I'm getting a discount on Netflix from my T-Mobile bill. I'm getting Apple TV Plus for free, again, being a T-Mobile customer. I'm getting Peacock from being an Instacart member. So we live in a world where streaming channels are being, and I get Prime Video from being an Amazon Prime member.

So we live in a world where streaming channels are being almost thrown away for free by these mega cap tech companies and others. You know, so in that kind of very, very competitive world, you know, you got to have either the scale or the content that will absolutely make you stand out and stand apart. And I think a problem that both Warner Brothers Discovery and to a much greater extent Paramount have is that they have not been able to create that scale from a direct consumer point of view. And they definitely, definitely need that scale in order to compete effectively. And they have already poured a lot of money into building out these offerings. So we'll see what happens. But ultimately, I think we are headed for consolidation in the sector.

I just don't think this is it. Well, let's move on from the land of the rumor to the land of the actual. We've still got earnings, and I know you've covered Carvana and also CarMax. They reported today earnings were mixed. It beat estimates, but so much of that is due to cost cutting, comparable same-store sales still down year over year. What do you think is next for the used car business in general, with the changing interest rate, what might that mean for that industry? Well, I would say this has been the dominant story over the past two years for the used car industry, so to speak. Laser focus on cost cutting, just trying to brace for the impact of this kind of almost unprecedented environment that we've entered into post-COVID. So on the

one hand, you effectively had a huge crisis of affordability that has taken the entire used car market by storm. So on the one hand, you have interest rates that are rising at a pace never seen before. You're moving from 0% interest rates almost to over 5% in no time. And that's just what the treasury is doing. So I imagine for a lot of borrowers, especially those who may not have pristine credit scores. Their effective interest rates when wanting to buy a car are much higher. So on the one hand, you have those higher rising rates, really negatively impacting affordability of cars. On the other hand, you also have higher car prices, and that was caused by all kinds of supply chain disruption that took place

during COVID that affected the availability of new cars for sale. So that created ever greater demand for used cars and pushed the prices of all available inventory up, up, and up. And while at the time that may have created a kind of a helpful impact on the top line for both CarMax and Carvana, the way down was also kind of problematic because, again, this has created a crisis of affordability. Now, as people, as Americans, have declining savings, you know, against the backdrop of just rising prices of everything, they also have to deal with higher car loan rates and higher average prices per car. And basically, that has pushed a lot of people to kind of sit on the sidelines. Now, average prices per unit and interest rates both

need to go down, you know, in order for CarMax to enjoy, you know, a full rebound, you know, if we can call it that. Used car dealers like CarMax are effectively targeting volume at the end of the day. So the faster they can turn around a sale, the better for the top and bottom lines in general, meaning that CarMax sources a car either from buying directly from a consumer or from buying from an auction, the faster they can turn that around and sell that car, the better for the company. And so you need volumes to come higher. And even though a price decline, so we're talking about average prices going down, even though a price decline may on its head seem like negative, it could actually be a catalyst for higher sales. And again, that would be better

for volume. So kudos to the management team for pushing gross profits per unit sold higher in this difficult environment. But again, these can only go so far and you'll need that rebound and transactions in order to make a stock like CarMax's kind of take off again and resume its upward march. One positive sign, though, is that they're buying cars again. For a long time, they stopped buying cars because it simply didn't make sense. And so they've started to do that again. But you're absolutely right. On the earnings call, they talked about that it's not really going to be possible for them to get back to the 2019 numbers just because cars aren't going to be that cheap again, which, you know, not great news for those of us who would like to have a new or

newer car. So it's an interesting industry because it's cyclical, but the cycles definitely seem to be changing where, you know, there's only so low you can go on used cars these days. And there isn't that like, there aren't as many of those really cheap cars out there anymore, it seems. No, there aren't. You have to look very hard. You have to definitely make compromises when you're buying a car. I mean, in fact, car prices of all sorts, both used and new, have been hitting all-time highs for a while.

They are starting to come down and they have effectively started coming down over the past two or three quarters. But again, so they might be down, you know, three, four or 5% year over year. Again, compared to 2019, they're up like 30, 40% still. And that is a problem

If you are going to have a resumption of a normal used car market, a normal cycle, let's call it that, you need car prices to go down and you need interest rates to go down. Luckily, the market seems to believe that interest rates are on their way down and that the Fed is done raising interest rates. So that should be helpful for companies like CarMax and Carvana. And you have been getting those kind of declines in used car prices. So, again, it's a grind, but if you are a CarMax or a Carvana investor, you know that the macro seems, at least for now, to be moving in the right direction, but it is still early days. Well, with both CarMax and Carvana, you're sort of necessarily omnichannel because they

have the stores, and with Carvana, you've got the fancy vending machine. But they also are seeing demand online. It kind of boggles my mind that people buy used cars online, but the younger generations especially are really comfortable with that. What do you see overall as kind of the future of these hybrid omni-channel used car dealers? So I'll tell you a personal story. I bought a used car from a dealership one time in my life, and I swore never again. and that and that has been my uh sort of and has been true since um i have since then bought and sold used cars three times uh via an online platform literally from you know from my phone

i could do it in five ten minutes and and voila you're done and it's a bit crazy in a way it's a bit scary in a way especially if you're you know not part of that younger generation who's much more comfortable with making purchases online, especially very expensive purchases as a car would be. It's the second biggest expense probably for most people after buying a home. Doing it online definitely is a big psychological hurdle for a lot of people. However, what we have seen and what Carvana, in fact, I think credit should go to Ernie Garcia III and the Carvana team for championing that kind of rule-breaking model of saying, yeah, we can do this online and we can create an e-commerce company for cars. So they have proven that the model works. Consumers

have gotten increasingly more comfortable with transacting that way. And then COVID came and everybody had to stay at home, but also they wanted to buy cars because they didn't want to take public transportation. They wanted their own means of transportation that's going to be, let's say, more hygienic than a public transportation method might be. And so they started buying cars online, left and right, and we have seen kind of like the incredible increase in sales for both Carvana and for CarMax's online offering through that period. this is kind of like the future uh this is an inevitable model i mean i remember reading the study that said most americans would rather have their taxes audited by the irs than go

into a dealership and you know i personally think it's absolutely true uh it's a dreadful experience just having to haggle over prices staying for hours and hours on end which you In some cases, they deliberately make you stay for hours so that they wear you down and kind of get the deal they want. And you have to make compromises. You can only buy from the available inventory that's on the lot. It doesn't give you a lot of options. So I personally think this is a paradigm of the future.

It's also one that needs to prove itself from a profitability perspective and from a unit economics perspective. I think both companies have made a lot of strides in that respect, but it is definitely not going to be as profitable, let's say, as the old model. And so that's why volume matters. That's why scale matters in this case. And I think both CarMax and Carvana are kind of national leaders in this respect. It's still a very fragmented market, the used car industry. CarMax is the biggest US car retailer in the whole country.

And they still have, I believe, less than 5% of the overall market. It's still a lot of those, you know, your neighborhood or your nearby local dealership. That's where most people still get their US cars from. They have a lot of work to do, but that's kind of like the future. And I believe we're getting there. Excellent. Well, thanks for your time today, Yasser. You're very welcome. Happy to be here.

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inspired you to get into this field and actually run a company? Yeah, we definitely have a unique background when it comes to running a company. when I say we, I'm talking about Karen, who is the CEO of Clear and my partner since around 2001, 2002. So, we've been partners for a long time. And we were in asset management, and we like to say equity long short. We don't use the hedge fund word always. But we, you know, really were exposed to a number of different businesses. And, you know, in terms of our style, we were value-oriented. We looked for secular themes. And we had concentrated positions and got to know management teams really well. And so, we observed, you know, really good and we observed

really bad. And coming out of the financial crisis, we really wanted to do something different. And we thought, you know what, let's control cash flows. Let's allocate capital ourselves. We found ourselves to be, we thought we were good capital allocators. And we thought, you know, this can't be that hard. Let's find a business to run and control the cash flows. And, you know, it'd be a lot of fun. So that was sort of how it happened. We didn't want to pick stocks and wanted to actually, you know, build a company. And so that was the genesis of finding a company to run. And we actually were really lucky. We were looking for businesses and we stumbled upon Clear, we actually were invested in a biometric roll-up. It was one of the few private companies

we were invested in. And that company was a service provider to the old Clear. And when I say the old Clear, the old Clear went away. It actually went bankrupt. And we bought Clear out of bankruptcy in 2010. And so, we discovered it just by having lunch with the management team of the company we were invested in. And we learned about Clear. And we actually had seen it in Grand Central. I remember a bunch of years back, it was probably in 2007, there was someone enrolling people into the Old Clear at Grand Central Station and sort of wondered what it was and didn't think much about it. And a couple of years later, we learned about it and we fell in love with the business because it was this interesting intersection between a subscription-based business where customers loved it, but it also played into this secular theme that we were big believers in identity. And we thought that identity was the future, and biometrics were the best way to prove one's identity. And so, it was this intersection of strong secular tailwind with a great business model.

Next-gen identity plus, I wanted to get to that. It sounds like it's going to be groundbreaking. So, I'd love to hear more about that. I know you talked a little bit about it on your last earnings call. But, yeah, tell us about that. Yeah, next-gen identity is going to be the strongest fidelity of identity at scale out there, digital identity. And, you know, the main difference there is we're going back to the source. So whether it's the, you know, the government with the e-chip on a passport or a state DMV, we're actually validating that a document's real from that source.

So it's a very, very strong identity. And we're in the process, we just started this past week, of upgrading members. We started on Saturday and we're making really great progress. And so that's going to be the unlock for our partnership to further integrate with TSA's NextGen hardware. So it's a big unlock for us. And it's also going to unlock our ability to go 100% face versus fingerprint and iris in the airports, which is going to be faster. It's going to be more seamless for our members and really unlock, you know, an even better experience than we deliver today. So we're really excited about NextGen Identity.

And it's also applicable to our B2B business, the Clear Verify business. So, very, very exciting. Yeah, you know, I've actually, even since I started researching the company, but I came across Clear during COVID with the health pass and putting in vaccine information health pass. And I started looking at the app. And, you know, it's a great interface. It's a great experience. But what are some of the challenges and opportunities you face with consumer adoption of your platform?

You know, is it, you know, is my information safe or hesitancy to use like technology? Yeah. So, you know, you started this question talking about health pass and what that really speaks to is that clear as a platform. And when we think about identity, yes, we can replace the driver's license and, you know, your passport and we can prove who you are. But we also think about what does identity mean, right? There's so much more to it.

So there's your health data, right? There's your frequent flyer status, there's your boarding passes. So there's a lot more information about you that we can essentially bind to your identity and unlock further experiences. Health Pass is a great example during COVID, which thankfully is not a thing anymore. You know, to your question about barriers to adoption, I think with any technology, the biggest barrier to adoption is really inertia, right? Even if you're giving something away for free, and our app is free, you can download the

Clear app and you can enroll as a member into the Clear ecosystem for free. If there's any friction involved, it's a challenge getting consumers to adopt it. And that's why you need compelling use cases. And that's why the airport, Clear Plus, was such a great way for us to start because it's just obvious. No one wants to wait in line. Everyone wants a great experience at the airport. It's a great use case. And so that gets a consumer over that inertia hump, if you will. And so I think that's been the biggest challenge to the competitive landscape out there that maybe are trying to do similar things, which is getting someone to do something and act is really, really hard, even if it's free. And so you have to provide compelling reasons for them to do

it. And so we are at around 20 million members on the platform. And I think we're really the only ones at scale that have been able to drive it because of our use cases. And building out those use cases, not just in the airport and within travel, but expanding into financial services, expanding within healthcare, the more use cases, we call it the flywheel, the more use cases we provide, the more people will join, right? The more members that we have on the platform, the more compelling it is to bring on new partners for other additional use cases. And that flywheel continues to get going. And then we have an acceleration in the business over time. So, what have been some of your biggest challenges in scaling and deploying your technology

in sectors outside of aviation? You've made quite a bit of a runway, pun intended, I guess, in aviation. But how about outside of aviation? I know there's some other sectors that you're really digging into. Yeah. So, our focus areas, there's three focus areas, really, in terms of verticals and digital marketplace would be one of them, LinkedIn, is our sort of marquee customer there where we've rolled out verified identity on the LinkedIn platform. So if you're a Clear member, you can verify your identity using essentially your selfie. And as I mentioned earlier, about a third of the people going through that process are already Clear members and so are able to just, you know, with no friction, verify their identity

on LinkedIn. And then if you're not yet a member of Clear and you want to verify your identity on LinkedIn, you actually, within the LinkedIn app, can say verify with Clear, and you go through our process, our enrollment process, and you become a free Clear platform member and part of our ecosystem, and then you're able to use various services that we offer. So, that's digital marketplace. On the healthcare side, we have a number of customers that we've been, you know, building up our business there. We have, you know, University of Health, sorry, University of Miami Health Systems in Miami would be an example there of a health system that is using Clear for account creation, password resets, and things of that nature. And we're really removing a lot of

friction and costs from the system. And we have a number of customers there as well on the healthcare side. And then on financial services, that's a very established identity vertical. And so when you think about KYC or know your customer, that's a regulatory-driven use case where financial services, when they're onboarding new customers, they have to, or from a regulatory standpoint, they have to verify the identity of those consumers. And their biggest challenge is that there's like a 40% drop-off because it's a fairly heavy process. There's a 40% drop-off of people onboarding. And so if you're trying to get someone to sign up for a credit card, if you're JP Morgan Chase, for example, that's real money that you're losing if people are dropping off. On the other hand, they have to make sure they're reducing fraud. And so there's that balancing act.

And so we call it the digital fast lane. We want to create the digital fast lane just like we have the physical fast lane in the airport where you can onboard someone onto financial services, reduce friction, and reduce fraud. It's back to that and. We think we can do both. and we can think we can do it well. What would be a use case that you're aiming for that people might just think is crazy, but you believe could actually happen? It's like a moonshot use case. You know, I think probably no one would, no one would have thought of us for healthcare a year or two ago. So I think in and of itself, just the whole idea that we've taken clear outside of the

airport, I think is surprising to many. I mean, my view is, you know, we want to get rid of the wallet. I don't want to have to carry a wallet around, but I brought, you know, in some cases, it'd be great to not even carry a phone, right? Be able to go through life just with your face, right? Proving who you are. Your credit card is associated with your identity. I can pay for stuff. I don't even need my key, right? It just recognizes me to get into my apartment. So our vision, right, is to go from, you know, let's just say you travel and use it once a month. We want using clear 12 times a day. We want sort of ubiquity. We want ubiquitous use cases all around you where you can use your identity and just unlock friction-free experiences.

It's rare to see a growth company pay a dividend and repurchase shares and have a declining share account on top of that, which you guys do. How do you balance these returns of capital with investing for the huge growth that you have ahead with all these use cases and all the growth ahead? If you read our prospectus, our S1, Karen and I took great care to write a shareholder letter there. And actually, every quarter, we write a shareholder letter to try to give insights into how we think about running the business, how we think about capital allocation, which is what you just asked. And so, we're in a fortunate position where we can do the and, right? We can grow our top line. We can grow free cash flow. We can return cash to shareholders. We have a strong

balance sheet and we're generating free cash flow. So, our view is, as former capital allocators on the public market side. And again, going back to we saw good, we saw bad, we saw great capital allocators, we saw poor capital allocators. Our view is we can do it all because we have a great business. The Clear Plus aviation business is growing. It's top line and it is generating free cash flow. We're reinvesting some of that into Clear Verified, but there's still a lot of cash left over. And so as shareholders ourselves, we're owner operators. We love the fact that we of optionality, right? We can pay a regular dividend. We've paid special dividends. We can buy back stock opportunistically. So we, you know, we are big believers in being opportunistic

capital allocators. And that's what we are. 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 only on what you hear. I'm Deidre Willard. Thanks for listening. We'll see you tomorrow.