Motley Fool Hidden Gems Investing - Musk/Twitter Back On?

Episode Date: October 5, 2022

Elon Musk says he's going to buy Twitter at the original price, and this time he means it! (0:21) Bill Mann discusses: - His belief that the Musk/Twitter deal will get done - Forward guidance being the thing he'll be watching in the upcoming earnings season - Why he believes stagflation is the biggest risk to the economy right now (10:50) If you think SaaS companies are efficient, can we interest you in a retailer that that sells gently-used goods?  Jim Gillies discusses a small cap business that's been rewarding shareholders. Got questions about stocks? Call the Motley Fool Money Hotline at 703-254-1445. Stocks discussed: TWTR, TSLA, WINA, EBAY  Host: Chris Hill Guests: Bill Mann, Jim Gillies Producer: Ricky Mulvey Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Chris Hill. Breaking news, world's richest guy decides he will buy that company he had second thoughts about. Motley Fool Money starts now. I'm Chris Hill, joining me today, Motley Fool Senior Analyst, Bill Mann. Thanks for being here. Bill Mann. Hey, Chris, what's happening? You know, money never sleeps. So, on we go. On Monday, shares of Twitter rose 22% after Elon Musk said, you know what, I think I actually will buy this company at the original

price that I agreed to way back when. And today, we are getting word that not all of the T's have been crossed and not all of the I's have been dotted. The agreement is not a done deal. And I'm curious what you think as you're watching all of this play out. So, the tease in the eyes were, he provided a letter to both the Chancery judge in Delaware, who would be overseeing the case that would be coming up, the trial that would be upcoming, and basically saying, everything's good, pending $13 billion in financing that I put into place before. And pending financing is actually a term that you would expect to see in any deal. But this is Elon Musk we're talking about, who has tried to wiggle his way out of the deal. And so

immediately, people have gone to the place of, what does pending mean? And to me, it's pretty straightforward. He's got to get the financing in place. I know, world's richest guy, he doesn't have $13 billion or $44 billion in a checking account. He has to create and get that capital because the shareholders of Twitter expect to be paid in cash for their shares. Essentially, what we're waiting on is a pro forma thing, but given the fact that there has been all sorts of tomfoolery from Elon Musk from about two weeks after he agreed to the deal. I think that people are looking at it and just keeping interest to see what happens next. If you are in the financing business, if you're, insert name of a large Wall Street

are you calling him up and saying, hey, we'd be interested in talking about helping you finance this deal? Or because of everything you just said about Elon Musk and everything we all have witnessed over the past six months, do you just say, you know what, we're going to sit this one out because we're just not sure? I'm trying to figure out how to answer that question without mocking you. Because, Chris, I don't know if you've met investment bankers before, but some of them would sell their grandmothers in order to get to a couple of bucks. So, no, no, absolutely not. They will be all over this. $13 billion in financing on a $44 billion deal. Oh, no, no. They would hang up on anybody for this deal. So, I would not worry about that.

The funny thing to me was, in thinking about the terms by which this might get scuppered would be, and Matt Levine from Bloomberg pointed this out. He said, well, we are contingent on the deal getting done. So, there is the possibility that what Elon Musk is doing is simply pushing the case down the road by pretending to cooperate. But then there's also the potential that one of the banks themselves might say, well, we're not sure we can do this deal because of the bots, which would be unbelievable to have happen. But no, to me, this deal is getting done, it's getting done under these terms, it's getting done soon, regardless of those contingencies. Chris Hilliard. Shares of Tesla are down 41% year-to-date. If you are a Tesla shareholder,

are you hoping that this deal getting done means hopefully Musk can just sort of turn the keys of Twitter over to someone else and get back to the business of Tesla? Or what are you hoping for if you're a Tesla shareholder at this point? You know, I'm not sure that one has a whole lot to do with the other, because Elon Musk has made it clear that the big problems that he wants to solve are throwing metal into space and changing how the world moves from point A to point B. Those are his big issues. I see Elon Musk, now that the potential for legal action has decreased turning this over to other people. Yeah, you may have some more attention paid to the other parts of his empire by Musk from here on out. I'm not sure that the 41% down and Elon

Musk being distracted by Twitter are necessarily a one-to-one relationship. I think it's pretty clear to say, you know, for someone whose net worth is in the nine digits, do I have that right? Yes. No, 12 digits. Yeah, I think it's more digits. 12 digits. That's a lot of digits. He's had a tough year. Oh, well, let me get out my tiny violin. That's right. Let me get out my tiny violin for the wealthiest person on the planet. Right, exactly. No, I think that's absolutely true. But he has taken some pretty substantial hits, including the other day being told where he could stick it by the foreign minister of Ukraine after he came up with a plan that was basically like, let's just sing Kumbaya and sort

it all out. I think that he's probably looking forward to being in any way viewed as a savior at Twitter at this point. Earnings season starts in, let's call it 10 days. Once that happens, we will start getting actual results and forward-looking commentary from the biggest, most important companies in the country. Until then, it feels like everyone on Wall Street is just grasping, untethered, looking for something to latch onto to give them a sense of where the economy is going, where the market is going. What What are you watching between now and earnings season? What are you watching to give you a sense of where the economy is going? Well, I think one of the biggest things

that's happening right now, and this is not necessarily earnings-driven and it's not necessarily being driven by that schedule, the 13-week schedule. I do have some words to say about I think the biggest thing that's going on right now is, at what point? Yesterday, the OPEC countries came out and said that they're going to essentially be slashing their quotas by about 2 million barrels of oil per day. And we are already in an energy deficit and going into a much bigger one. So the only solutions there are a reduction of energy consumption or an increase of supply. And to me, the biggest risk that we have economically right now in the U.S. is stagflation. And stagflation generally comes when you've got uncontrolled energy costs that are

that are sucking up the oxygen for other parts of the economy. It's a big, big issue to me. Now, in terms of company earnings themselves, really what I'm looking for is companies coming out and saying, even if the news is bad, that they finally are having some form of visibility for what's going to happen over the next year. I think that people forget that in 2020, in 2021, because we were in the midst of a pandemic, companies, and they're guessing all the time, but they had really almost no way of putting finger holds on what the next steps were going to be because the exogenous events were too big and too uncontrollable and too unpredictable. So now you have companies and by their hundreds that are sitting on either still have supply

chain issues, or they have inventory issues because they've produced too much. I think you're going to see this quarter, for the first time, companies, even if the news, again, is bad, having some semblance of an idea of what's coming up next. And we're going to start learning about it, starting with the first earnings report here in a couple of days. Bill Mann, always great talking to you. Thanks for being here. Thanks, Chris. Part of the attraction of SaaS companies is they're efficient. If you're looking for an efficient business, how about a retailer that sells gently used goods? Jim Gillies has a

look at a small cap franchisor that's been quietly rewarding shareholders. With more, here's Ricky Mulvey. I think we're going to talk about one of the most underrated companies in the full universe. It's got a 94% gross margin. It's got a market cap of about $11 million per employee. Those metrics beat Salesforce, Meta, HubSpot, Atlassian, Adobe, and Zoom, and it sells gently used goods. We're talking about Winmark with Jim Gillies, Winmark superfan. Thanks for talking about the franchisor with me today. I will say, Ricky, you've given me something new to think about. I've never thought of comparing the gross margin from Windmark

to Salesforce, Adobe, and all of the other tech titans. Thank you for that. Happy to look at different stocks and numbers and trying to make comparisons that don't exist. This is a company that owns Play It Again Sports, Plato's Closet, Once Upon a Child, among other brands. It's got about 1,250 locations and a $750 million market cap. This is a smaller company. I would say a lot of people sleep on it. But Jim Gillies, why is Winmark an interesting company to you? Boy, that's a wide-open question. No. 1, I do like franchise companies. You've mentioned they are the franchisor of Five Gently Used. I'm not sure if I stole that from Winmark years ago or if I coined it. Gently used goods,

you mentioned Play It Again Sports, they also have Play This Closet, Once Upon a Child, Music Go Round, Style Encore. Play It Again Sports, of course, is selling gently used or even new sporting goods. Play This Closet is teen clothing, predominantly female-focused. Once Upon a Child, obviously, children's gear. Children grow to things quickly and they need a lot of stuff. Musical Round is the smallest concept, musical instruments. You can get rid of that piano or that saxophone you're never playing. Style Encore is more women's business and casual attire. It's more upscale than Plato's Closet. But the reason I like franchising is, I'm going to sell you a system, I'm going to sell

you a concept. You are then going to give me 5%, 6% of your sales, gross that is, not net, you're going to give me 5%, 6% of your sales off the top as a royalty every month, plus I'm going to get you to contribute to a fund for advertising. Franchising models tend to be extraordinarily capital light. I'm not building the store, I'm not responsible for putting in the computer systems or what have you, I'm not even responsible for the lease, that's your job if you're the franchisee working with me. Now, maybe I can use my cloud the franchisor to get you a better lease rate. It's a win-win solution there. But these franchising companies, there's a bunch of restaurant franchisors as well out there that I like,

but the common denominator is they produce a lot of cash for not much capital invested. If you've got winning concepts, they are often winning stocks. WinMark, no pun intended, happens to be a long-term winning stock. The company itself has a couple of interesting angles. In some growing franchises, it's trying to grow that style, Encore brand. It also has an interesting store credit system, where you trade, let's say you go to Play It Again Sports, you trade your softball glove in and we'll either give you $10 cash, $15 in store credit. It's also starting to pay a dividend, a little above 1%. Oh, we're going to talk about the dividend, Ricky.

Then I think you just picked where this conversation is going. What should investors watch of those three things that I just mentioned? Well, first off, the store credit system is excellent. I have used Play It Again Sports a lot. I've got kids in hockey. I've got kids in skiing. We have availed ourselves of the store credit system once or twice at the local Play It Again Sports. And yes, I always go for credit because you get more, and I guess I'm a value investor through and through. They started paying a dividend in 2010. They started paying a dividend At $0.02 a quarter, whoop-de-doo, the stock is $216 this morning. So, $0.02 a quarter, who cares? A year later, they bumped it to $0.03 a quarter. A year later, they bumped it to $0.04

a quarter. A year later, they bumped it to $0.05 a quarter, and you can probably see where this is going. A year later, they bumped it to $0.07, then $0.10, then I believe $0.15, then I believe $0.25. I think they paused a little bit for the start of the pandemic, then they bumped it to $0.45 a quarter, and now they are paying $0.70 a quarter. So, the dividend in just over a decade is up 35-fold. I haven't done the compounded growth of a 35-fold gainer in 11 years, but suffice to say, it's high. What's interesting about that is, if you bought the shares, and full disclosure, I am an owner and I have owned shares here since before they started paying a dividend. I think my cost basis is around $21 a share, so you can

hate me now or hate me later, it's your choice. But $0.70 a quarter, now what they're paying, or $2.80 a year, $2.80 a year is, what, 14% of my cost basis per year? That's a nice little thing. But wait, there's more. Winmark also has this habit of declaring a special dividend periodically. In 2012, they paid a $5 special dividend. In 2014, they paid another $5 special dividend. In 2020, they paid a $3. And then at the end of 2021, they paid a $7.50. So if you add up the special dividends, which have come on top of the regular dividend, I think they paid $20.50 in special dividends over the years. Basically, my cost basis before we hit dividends. Again, they can pay all of these specials, they can pay this ridiculously growing regular dividend

because of the nature we talked about earlier. This is a franchising business that requires very little capital. As you said, there's $11 million per employee in revenue, very little capital maintained. There's not much to do with the cash that this business generates aside from return it to shareholders. At its root, that's what we want out of any investment. It's wonderful to build castles to the sky, and I would love to be part of the next big thing in human evolution as we go forward. No, in my investing stuff, you pay me my money, this is great. I get my money back and I own a business that's still growing. What's not to like? And then the last piece of the dividend, you might say, well, okay, it's up 35 times in value,

plus those specials. Surely, the dividend growth is done. And what I would say to you, as I'm looking for. Over the past 12 months, the company has produced about $41 million in free cash flow, just over $41 million. They've paid $35 million almost in dividends. That looks like it's tapped out. Most of their free cash flow is going to dividends, except, don't forget, there was that giant $7.50 special dividend there. Just the regular dividend, if we maintain just the regular dividend going forward, it requires just shy of $10 million to pay per year. Not only have they been paying this dividend and this rapidly growing dividend with all specials, they've also been buying back their own shares. Since the end of 2009, the company has bought back roughly a third

to their shares. Even as the dividend goes up, there's less shares they have to pay the dividend on, which then provides another driver for potential dividend hikes in the future. If you get Jim Gillies talking about dividends, you're going to start running low on time. I'm going to skip ahead a few questions. Exactly. Keep going. One, I want to talk a little bit about competitive threats to the business. This might be concern trolling. I don't know if it's a real threat. But when I went to played against sports to buy my used softball glove. I noticed that a lot of the goods there were new. According to FranchiseChatter.com, 70% of the inventory it played against sports

is brand new. That seems to go against the grain or the promise, if you will, of a used goods reseller. Do you know if that practice is common across its other franchises? Do you think that that strategy now opens WinMark up to having more competitors like the internet, sporting goods, those types of outlets? First off, I don't believe it is common at that level across all concepts. I believe Play It Against Sports is more of a one-off on that front. As someone who has taken used skis into Play It Against Sports and walked out with new skis, my son and daughter a few years ago, yes, absolutely, there is new gear there. And it's reasonably priced. My second part of that answer would be,

Ricky, take your used skis, take your used baseball glove, go to Dick's Sporting Goods and ask them what kind of credit they're going to give you. And the answer is going to start with a zero and end with a zero. They'll probably tell me to leave. Yeah. That's kind of the secret sauce, is, people are going in and they are taking their gently used goods. Again, I'm a lifelong skier, my kids are so far lifelong skiers, but when your kid is two years old versus your kid is 18 years old, their gear is very different size, used, blah, blah, blah. I have probably traded in three or four pairs of skis over the years for each kid as they've grown up. I think I may make it in a weird

way. But a company like eBay, for example, eBay back in the day was auctions-only. That's how it was. Now, most goods on eBay are buy-now, and they've made that transition. There is room for multiple business models within a single concept. But I think the real hook and the largest concept is Plato's Closet, followed by Once Upon a Child, Play It Against kind of in the middle. And then, Style Encore and Musico ran it very small. But the real hook is used goods and the store credit system. And then, anytime you're talking about a small-cap company, you want to pay close attention to leadership. I think Winmark has fewer than 100 employees. What should investors know about CEO Brett Heffs?

Brett Heffs has been an able and, I think, a good successor to the man that got me interested in Windmark back in the day. The man's name is John Morgan. He'd already made a fortune, frankly, in the small-ticket leasing business, but he needed something to do. So, in 2000, he comes in, he buys, I think, about 13% of the company at about $7 a share. Then John Morgan, who is now retired. We're going to get to Brett Heps. Morgan spends the next 14 years buying shares on the open market. At one point, he owned nearly a third of the company, putting his money where his mouth is publicly. He installed this shareholder capital return structure, structure, lean expense structure, and Brett Heffs was his basically hand-picked understudy.

In 2016, I believe, Morgan kicked himself upstairs from the CEO chair to the executive chairman. Brett Heffs, who had been there under Morgan for a while, gets promoted to the CEO slot. He has maintained the same culture, essentially, going forward, even after the exit of John Morgan. What they've done essentially is, you've already mentioned, they run fairly lean employees. You look at things like their compensation across the senior executives. I think the CEO total compensation is about 10 or 11 times the average employee, which most companies are in the 300s or something. That's come along with 20%, 21% annualized shareholder returns for the past decade. But as well, with Brett Hepps, I believe Hepps

and the CFO, equal salaries, equal bonuses, equal equity awards. I believe the Chief Marketing Officer, same deal, or I think we may have changed her over in the last year or so. But there is this, where we are all going to win together attitude, which is very much a John Morgan thing that was brought in. Then again, Heffs, he was company president, I think, 2011 to 2016. He worked in admin and finance before that. He has been CFO from 2002, all of it under Morgan. He got the catbird seat to understudy for Morgan. Morgan set up a great culture and has continued it. You can't ask for more than that. Jim Gillies, appreciate your time and your insight. Chris Hill

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.