Motley Fool Hidden Gems Investing - McDonald's Exits Russia (Who's Next?)

Episode Date: May 16, 2022

If you were hoping to start the week with a hostile takeover, you're in luck! (0:30) Jason Moser discusses: - JetBlue Airways going hostile in its pursuit of Spirit Airlines - McDonald's leaving a major market for the first time in its history - The prospect of other major restaurant chains following McDonald's and closing up shop in Russia (10:35) Jason and Matt Frankel take a closer at how Twilio makes money and one of the company's competitive advantages. Stocks discussed: JBLU, SAVE, ULCC, MCD, DPZ, SBUX, TWLO, ABNB, CRM, UBER Host: Chris Hill Guests: Jason Moser, Matt Frankel Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Great news! The Federal EV Rebate is back! Eligible customers get up to $5,000 with the Federal EVAP Rebate on select 2027 Volt and 2026 Equinox EV models. Visit your local Chevrolet dealer today for more details. For the first time in its history, McDonald's is leaving a major market. Motley Fool Money starts now. Chris Hill I'm Chris Hill and I'm joined by Motley Fool senior analyst Jason Moser. Thanks for being here. Jason Moser Hey, happy Monday.

Chris Hill Happy Monday indeed. We're going to get to McDonald's in a second, but I want to start very quickly with the airline industry. JetBlue is ramping up its all-cash bid for Spirit Airlines. Before it was a friendly takeover and now it is officially hostile, which shouldn't make me happy, but it does. Spirit officially rejected the bid from JetBlue earlier this month. They said, we're going ahead with our plans to merge with Frontier, a fellow low-cost airline. I don't have an investing interest, I don't own shares of any of these companies. But I look at this, Jason, and beyond just the popcorn entertainment value of a hostile takeover, am I wrong to think that JetBlue, if they go ahead

and they make this happen with Spirit, that it makes them more competitive with the larger airlines, the Americans, the Deltas of the world? Because if that's the case, I feel like that is is potentially a win for people who want to fly from one place to the other and not pay a lot of money. I feel like you're definitely on the right path. I too have no interest in this, no dog in this race, so to speak. It's an interesting situation. There's a lot of drama behind this because when you look at the Spirit Frontier deal. The Spirit Frontier deal is inferior to the offer that JetBlue made. JetBlue actually made financially a better offer than the Spirit Frontier deal would be.

I certainly can understand why they feel the need to go hostile. I guess they're going to submit this tender offer and see if they could win over the favor of shareholders there. In theory, yeah, you should see this merger in either which way this merger works out, whether it's Spirit and Frontier or JetBlue. It would ultimately, I think, result in what the fifth largest carrier in the country. In theory, yes, that would mean they should compete a little bit more with the bigs, and that makes sense. Now, the reason why this seems to not be happening, the reason why there seems to be so much drama, Spirit, they ultimately said, no thanks to JetBlue. They have some concerns with JetBlue and the regulatory environment.

They're feeling like that ultimately combining with JetBlue might actually result in higher prices because they feel like they're going to be moving away from that low-cost provider into that other echelon of provider like the bigs. You look at JetBlue, JetBlue has I think a partnership with American, I believe it is a relationship with American in some capacity. Maybe that was part of the concern there, is the feeling that ultimately this would eliminate competition and ultimately offerings on that low-cost provider side. That's where all the drama comes from, and there is a lot of drama with this. It remains to be seen how it ultimately all shakes out. But yeah, it doesn't seem like the story is going to

end anytime soon, and it really does feel like JetBlue knows what it wants. It's trying figure out exactly how to get it. If the tender offer is something that works, yeah, then we'll see how the regulatory side plays out because that's not a hurdle altogether. Let's move on to McDonald's. Earlier this year, McDonald's paused its operations in Russia due to its invasion of Ukraine. Today, the company announced it will sell its business and exit Russia entirely. They've got more than 800 restaurants, most of those are company-owned. We'll get to the ripple effects in a second, but if you're a shareholder of McDonald's, how should you feel about this? Because they're going to take a charge on this somewhere in

the neighborhood of probably north of a billion dollars, so you don't like to see that. On the flip side, it does provide some certainty in an area that was up in the air. Yeah. To me, this feels like a pretty easy decision. They can make this decision, and it appears, you know, it looks like they can take a stance on something that really pretty much the whole world is on board with, right? I mean, we all kind of feel like what's going on over there in Ukraine right now is unacceptable. And so, they don't have to really worry about repercussions there in taking sides, so to speak, because really, it seems like everybody for the most part around the world is on the same side on this one. But also,

I mean, you look at it also, frankly, it's not the greatest line of business for them anyway. You referred to the company-owned dynamic there, and I think that's important to note, because when you look at McDonald's as a business, franchise restaurants represent 93% of McDonald's restaurants around the world. But if you look at Russia, franchises operate only 15% of the Russian locations, the company owns the rest. That matters because ultimately, when you look at McDonald's financials, you see how this all breaks down. In 2021, they did $9.8 billion in company-owned restaurant sales, not system-wide sales, I'm talking about their revenue. The operating expenses involved there were $8 billion. Now, if you

at revenue from franchise restaurants, that was closer to $13 billion. Operating expenses there, which are primarily just occupancy expenses, those were $2.3 billion. It feels like they were looking at this from two different angles saying, you know what? Maybe they weren't all that thrilled with this line of the business anyway. It's a lower margin business. Maybe the juice isn't really worth the squeeze anymore, given the geopolitical upheaval that's going on over the past several months. You put all that together, I look at this and it seems like it's a pretty easy decision for management to make. It's worth noting they're retaining their trademarks there in Russia. I would look at this and say, you know what, they're making this decision now,

it's probably not a threat or anything like that. They're just saying, look, we're going to go ahead do this. Now, if the geopolitical environment years from now looks considerably different, they feel like the risk has diminished somewhat, then they, I think, would always have that option to consider opening back up there if they were wanted. But it feels like a pretty easy decision for them to make. I definitely would not consider this a thesis-changing event by any stretch when you consider the global nature of McDonald's. System-wide sales, I mean, system-wide sales in 2021, they did $112 billion in system-wide sales, right? And so, when you look at Ukraine and Russia, those markets represent in total about 2%

of those system-wide sales. So, nothing really that's going to hit them in the pocketbook, so to speak. Yes, they'll take a charge. Yes, they'll present adjusted earnings. And ultimately, it does look like their guidance, for the most part, remains the same, and they will continue opening stores around the world, just not in Russia. Does the spotlight now shift to businesses like Burger King, Domino's, Starbucks, and others? It seems like a natural question for shareholders and Wall Street analysts

to ask, well, here's the worldwide leader, they're leaving Russia, what are you going to do? Yeah. I mean, it's a fair question, and that's really anyone's guess as to how companies will ultimately deal with this. I mean, you look at Starbucks, for example, I believe they have halted operations, at least in Russia for the time being. I don't know that I've seen anything where they said they're actually shutting down. But again, it's difficult in certain instances for companies to take stances. I mean, if it's a debatable issue, it becomes a much riskier proposition. This really isn't that risky of a proposition because it's not really a debatable issue. I think most of the world is on board with the notion that this

really is unacceptable and Russia shouldn't be doing what it's doing. There isn't that risk. I think that probably gives these leadership teams at all of these different food and beverage operators, it gives them the opportunity to at least examine those lines of business more closely to see really if, like I said earlier, is the juice really worth the squeeze? Because if it's not, then they can go ahead and make that business decision while also getting a chance to really stand for the values that they espouse. I think this really falls in line. When you look at McDonald's, their core values are serve, inclusion, integrity, community, family. It feels like this one really falls squarely on the integrity value, which for them is ultimately do the right thing.

I feel like they feel like they're doing the right thing. And I think most people would side with that. And so for businesses considering this, I think they're taking a very close look at how McDonald's deals with this. They're taking a very close look at how the investor community and the rest of the world responds. And that will probably help dictate the course of action for some of these others in the next several weeks to months, assuming this continues to drag on. Thanks for being here. Thank you. Actually, Jason Moser is sticking around because he and Matt Frankel are taking a closer

look at Twilio. Now, you may not know Twilio, but if you've ever ordered an Uber, you've experienced its technology. Twilio helps send the notification saying, your ride is here. Shares are down 60% year-to-date, and the guys are focusing in on how Twilio makes money, the risks for investors moving forward, and one of Twilio's underappreciated competitive advantages. We love to dig into companies here. We love to learn a little bit more about what they do and why they pique our interest. This week we're digging a little bit more into Twilio. This is a company I'm sure many listeners are familiar with, and many likely own. I know I own it. Matt, I feel pretty darn good

about that, even in this market sell-off we're witnessing. Let's take a few minutes to dig into Twilio. Let's learn a little bit more about the business, what it does, and why it might present an opportunity for investors. Just very, very high level, though, to get started here. What does Twilio do? This is a stock that's been on my watchlist for a long time now. I don't own it yet, but especially at the current prices, I'm pretty sure I'm going to be a Twilio shareholder before too long. They're a software-as-a-service company. Their mission is to bring the way companies communicate with their customers into the 21st century. Just to give you a few examples, most people listening have been

a user of Twilio's software without even knowing it. If you've booked an Uber and you get the a little push notification that your driver is arriving, that's something that Twilio has provided them. If you make a restaurant reservation through Yelp, that's something that Twilio does. If you get an automated message from Airbnb confirming your booking, that's a Twilio product. They build out these communications tools designed to help businesses interact with their customers better. Quite honestly, people expect more from the companies that they do business with than they ever have before. Nobody wants to pick up a phone and call a helpline these days. Nobody wants to have to go to a website to see if their pizza is on the way.

Nobody wants to have, you know, they want a quick notification on their smartphone. They want something that's automated, fast, tells the story, and that they don't have to go out of their way to do. And Twilio kind of helps companies fulfill this essential need of their business. Yeah. I'm glad you made, I think, a great point there in that a lot of people, most of us, probably all of us to an extent, are probably using Twilio technology or benefiting from Twilio technology and never even realizing that's the case. To me, those oftentimes are really some of the most compelling investments because we see the convenience at our fingertips, yet we don't really understand the infrastructure and the work that's going on behind the scenes,

and that really is what Twilio is doing. They do this through these APIs, these application program interfaces that just enable them to ultimately build out the communications infrastructure for this digital economy that we're really evolving into. To me, it's always struck me as a necessity at this point. Businesses need to be able to incorporate this technology into their models or they'll fall by the wayside. Then you have the opportunity, you have the option, you can either try to build that functionality and capability yourself or you can go to expert providers. It feels like Twilio is certainly building up that reputation as an expert provider. We'll talk a little bit more about some of the customers

in its universe there. But we always like to look at how these businesses make money. I think it's one thing to really, it's very important to understand how a business makes its money, because that can really paint a picture as to what the future may hold. And when we look at Twilio, obviously, a lot of customers, a lot of big customers, but how does Twilio make its money? Well, it's a subscription model. The companies that use it pay Twilio for integrating their product into their platform. It's a recurring revenue model, which is like most software-as-a-service companies run. And like most software-as-a-service companies, it's a high-margin revenue stream. Twilio's gross margin is well over 50%, and it should get

even better as it scales. It's a fee model, and it's fee income that grows with the customers. As customers are growing and are using Twilio more to communicate with their customers, they're actually spending more on Twilio's products and services over time. The average customer that's been with Twilio for a year is spending 30% more than they were a year ago on Twilio. It's a nice, not only recurring revenue, but it's a very expandable relationship. I think you make an astute observation there. You got a dual threat there. There's a subscription side to the business, but there's also that usage-based model. As its relationship grows with its consumers, that usage-based model really comes into play. I think actually,

the majority of its revenue does come from the usage-based side, which to me is encouraging, given the direction we're headed in this digital economy and communications becoming paramount for so many of these businesses. The more they're using Twilio's products and services, well, the more they're benefiting, of course, and of course, the more Twilio is benefiting as well. When we talk about some of these clients, some of these customers that Twilio works with, there's a litany of them. They have over 250,000, I think over 260,000 active customer accounts today now, but some of these clients are massive. Airbnb, Stripe, Salesforce, just to name a few. When companies of that stature start incorporating technology like Twilio's into their models,

into their infrastructure, it feels to me like as time goes on, there's a stickiness that develops there where it just becomes less and less likely that companies are going to want to switch over to a different provider, particularly if the services that they're getting from Twilio are delivering. And it feels like at this point, those services are delivering. So maybe as time goes on, we start to see some switching costs develop there. Yeah. You made a good point. The kind of counterpoint to that is it makes Twilio's revenue kind of top-heavy. Kind of like the problem that the S&P index funds rely on Amazon, Microsoft, Apple for a lot of their market cap, Twilio relies on its big customers for an outsized portion of its revenue.

DoorDash is another one that uses Twilio for customer notifications. The top 10 customers in Twilio's out of those 256,000 account for 12% of the revenue. That's a pretty concentrated top 10 out of 256,000. Hopefully, some of those other 255,990 will become some of these big customers one day. For now, it is a top-heavy business model that creates a little bit of risk. Yeah. It's certainly top-heavy, usage-based. It's great when times are good, but it's also worth remembering, when times do get tough, if that usage goes down, that definitely is going to impact Twilio's financials. That's going to impact business performance. I think one of the nice things about that usage-based

approach. There's a very low cost of entry for new customers. New customers can try Twilio out without really having to invest much of anything to give it a shot. There's a little time and a little work in incorporating it. But ultimately, it's a pretty easy entry for new customers. They don't have to commit a lot upfront. Then if they discover that the relationship is working, that they're gaining value from that relationship, then they expand that relationship, they add on services and functionalities, and that certainly can grow the relationship there. How do we feel about leadership here? This is a founder-led business in Twilio. Anything stand out to you in regard to leadership here?

Their founder is a pretty impressive guy, Jeff Lawson. If you just look at a little bit of his resume, he was a founding executive of StubHub. He was one of the original project managers when Amazon launched AWS. Really high percentage of success in these high-growth startup businesses. StubHub, I just used StubHub yesterday. It's the biggest ticket platform in the world, outside of the Ticketmasters. AWS speaks for itself, and he was the original product manager on it. He's a highly invested CEO. He owns about 4% of the company. His employees like him. That's one thing that really stands out. People really underestimate. I always get a lot of questions about, why do I always mention Glassdoor reviews when

I do a review? The employee satisfaction reviews. Especially in the highly competitive tech industry, that's such an underappreciated competitive advantage, because being able to attract and retain top talent is everything, and it's not just about pay. Today's tech workers will not put up with a crappy work environment in exchange for a great salary. They just won't. Everyone's offering a great salary in tech. He has a 93% approval rating among his employees. So many reviews specifically call out the great corporate culture and great benefits, things like that. That's a really overlooked competitive advantage that Twilio has going for it. Great leadership team, great board of directors, former Amazon and Oracle

executives are on there. Some ex-politicians are on there. Really interesting group of people to to make decisions behind the scenes. Ultimately, this looks like a business with a lot of potential. Clearly, the stock has just taken a beating here over the last several weeks, as has everything. To me, I don't know, that's not a signal that this is a bad or failing business. Everything is really taking a beating, of course. But when you look at the market opportunity for a business like Twilio today, management sees this total addressable market reaching $87 billion by 2023, just next year. A business that's chalked up here, I think just a little over $3 billion in revenue over the last 12 months. It's also a team that

sees growing organic revenue at 30% or better annually here over the next three years. You've got a business with a lot going for it, a tremendous market opportunity, feels like leadership that is committed to building products and services that customers want. I think you know where I stand on this one as an owner of the shares already, Matt. I feel like I know the answer. It sounds like you feel pretty good about this one too. Your bottom-line takeaway on this when you feel bullish, you feel bearish on Twilio, you're still on the fence? All the things you just said, plus the fact that the stock is down about 75% from the highs, doesn't hurt. It's toward the top of my watch list. I will probably become a Twilio shareholder

once I have some free capital to do so in the next few weeks. I'm a fan of the business. I think we're still in the early stages of the digital transformation. Twilio has a lot to gain from it. 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.