Motley Fool Money - More Dealmaking On The Way?

Episode Date: May 23, 2022

It’s not quite Merger Monday, but it’s close! (0:25) Jason Moser discusses: - Starbucks becoming the latest U.S. business to exit Russia - VMWare shares popping 20% on reports it will be acquired by Broadcom - The chances more companies with deep pockets will start buying companies at lower valuations (13:55) Nick Sciple and Asit Sharma take a closer look at Funko and share some of the fundamental reasons they’re feeling bullish about a company that makes bobbleheads. Stocks discussed: SBUX, VMW, AVGO, FNKO, DIS, EBAY Host: Chris Hill Guests: Jason Moser, Nick Sciple, Asit Sharma Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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A week ago, when McDonald's announced, it's leaving Russia and we asked who's next. Today, we got the answer. Motleyful money starts now. I'm Chris Hill, and I'm joined by Motley Full Senior analyst Jason Moser. Happy Monday. Hey, happy Monday indeed. We have a merger Monday-esque story we're going to get to, but let's start with Starbucks. The coffee chain announced this morning, it is leaving Russia and will no longer have any kind of brand presence there. Starbucks committed to paying it.

it's Russian workers for six months and helping them transition to new jobs. But from a financial standpoint, Jason, this is not going to have as big an impact as what we talked about last week with McDonald's because for Starbucks, it's a smaller store count and a smaller percentage of their annual revenue. Yeah. Yeah, you're right. And this is this, I think Starbucks was the example that we used when we were talking about McDonald's. recently and thinking, okay, well, is there another restaurant that will follow suit? I mean, Starbucks seemed like an obvious candidate, just sort of giving them a chance to maybe weigh exactly what the reaction to McDonald's actions ultimately was.

I mean, to me, this makes a lot of sense. I mean, following McDonald's lead, generally speaking, right? They're just kind of look at this. They figure, like we said, the juice ain't worth the squeeze. And when you look at Starbucks's presence in Russia, I mean, this is going to have a negligible impact on the business, right? I mean, I think it's something less than 1% of the company's overall revenue. And remember when we were talking about McDonald's before, so McDonald's in Russia, or franchisees operate only 15% of the Russian locations. The company owned the rest. When you look at Starbucks's presence there, it's all licensed locations.

It's not like this is not one of those situations where the company actually owns these stores. But again, less than 1% of revenue. I mean, it seems like a very easy decision to make when you look at the big picture. Generally speaking, I think most of the free world is quite opposed to what Russia is doing, and rightly so. And so this is, I think, an opportunity for companies to take a little bit of a step back, assess not only where they're doing business and what makes the most sense from an economic perspective, but also what makes the most sense from just their core values perspective.

And I think with McDonald's, we talked about, you know, one of the core values there being integrity and just kind of doing the right thing. And Starbucks, clearly a business that's been built on that type of framework as well. So to me, this is a decision that it just feels like a no-brainer. They had suspended operations, I think, since March there. And this is really just kind of putting a stamp on the envelopes, so to speak. Where do you suppose the bar is now for businesses like McDonald's and Starbucks when thinking about entering new markets?

I'm just thinking, you know, five years down the line or something, you know, when things, you know, when hopefully the, what's happened. in Ukraine is long past the rearview mirror. Maybe someone else is in charge instead of Vladimir Putin. And they're trying to woo the McDonald's and the Starbucks of the world back. Like, no, no, no, it's going to be better this time around. Does it put these businesses a little bit more in the driver seat in terms of terms that they can dictate? Or is that just sort of negligible? I feel like it definitely puts the businesses in the driver's seat.

I mean, they've shown that they don't need to do business there if they don't want to, right? And, I mean, it certainly depends on the location and perhaps the business and where they source whatever they're sourcing. But for the most part, I mean, I think this really does. This really is just a testament to the businesses holding more leverage in this case. I mean, they can say, hey, listen, we just prefer to do business in a place that's going to stand for the things that we stand for. And it just really, it ultimately boils down to sort of determining that line. I mean, this is a very easy line, I think, for the most part, right? This isn't a very debatable issue.

I think that when you get into the more debatable issues, that's when it becomes a trickier decision. And that's something that, you know, that remains to be seen. But for the most part, I think ultimately, this gives, this puts, this puts countries, this puts the leadership of these countries on notice to ultimately say, you know, the companies are going to say, listen, we're going to do business and countries that stand for this, that do this, that, that take these types of actions. And they, they ultimately, I think, have the power whereas as opposed to the countries, particularly with leadership, such as Russia and Putin today, it's just a very easy decision for most companies to say,

nope, we don't really want to deal with you. You're way more trouble and your worth, and until things change materially and sustainably, right? I think that's really one of the bigger points is that you need to be able to see sort of a sustainable change, not something that's just sort of superficial, but something that's really more in-depth and meaningful and longer lasting. Cloud computing business, VMware, is reportedly in talks to be acquired by Chipmaker Broadcom. The talks are ongoing, so we don't know what kind of terms may be involved here, whether it's all cash, all stock, or a mix.

That information not being available, however, is not stopping some investors because shares of VMware are up 20 percent on these reports. So I guess we'll see, hopefully, in the coming days, if not. about weeks, whether or not this actually goes through. You and I were talking right before we started recording. Broadcom has grown in part through acquisition, so it is very much in the company's DNA. In that sense, maybe not that surprising that they would go after VMware. No, this does feel like it would be a complimentary deal if they're able to pull it off. Broadcom being more of a semiconductor-oriented business. To your point there on growth via acquisitions,

I mean, Broadcom certainly has grown via acquisitions over the last several years. You look at the business today, but they have $43.5 billion in Goodwill on the balance sheet, and that's basically doubled over the last five years. And ultimately, Goodwill, if you remember, I mean, goodwill is just, it's essentially overpaying for acquisitions, right? You're making acquisitions. It kind of represents what you pay beyond sort of the fair deal, so to speak, of that acquisition, right? Oftentimes, we'll see companies over time, they'll write down a lot of that goodwill.

We can discuss that, debate that for another time. Ultimately, as you see that goodwill number continue to creep up, you have to at least keep an eye on that, right? Because you start asking the question, I mean, is the company making good acquisitions? Is the company paying fair prices for these acquisitions? And so with $43.5 billion of goodwill on the balance sheet, it's at least worth considering that, hey, maybe at some point, Broadcom is going to roll. write down some of that goodwill. Who knows? Maybe they're making great acquisitions. We'll

have to wait and see. This, to me, seems like it could be actually a pretty good acquisition if it's able to happen. VMware being a company that's more focused on becoming a multi-cloud leader, right? They're focused more on the cloud computing market opportunity, and that's something where Broadcom could really benefit. And multi-cloud is ultimately just, it's that cloud computing where an organization just utilizes a combination of clouds, whether it's two or more public clouds or private clouds, a combination of public and private or edge clouds. It's ultimately bringing all of those cloud resources together for their customers. You look at how this is worked out for VMware, and it's so far, so good, right?

I mean, the company is moving more and more towards a SaaS model, which is something we've seen that's been obviously a big trend over here. past several years. If you look at the breakdown of the 2021, fiscal year 2022 revenue, you had about 25 percent of the business's revenue, which was from licensing, 50 percent from services, servicing, and then 25 percent from SaaS, that software as a service. It continues to become more and more of a subscription and servicing that subscription model. And I think that's ultimately a good thing. And so given the direction the world is headed, given the tailwinds, in the cloud computing space. I absolutely understand Broadcom's interest here. It probably

is not a bad time to consider doing a deal like this, given where valuations are right now. If you hadn't heard, Chris, we're kind of in the middle of the bear market. It's having a bit of an impact on some stock prices, not all, but most. Oh, I've noticed. So it's distinctly possible they could end up getting a VMware for a very respectable price, along with the fact that now that VMware, there was this big Dell relationship where Dell recently spun off its VMware stake last November, so there's a little bit of uncertainty that's been resolved there. So maybe that's why this interest really is developing now.

So yeah, I mean, it remains to be seen whether this deal actually happens or not, but it does feel like it would be a complimentary one for Broadcom. And I guess really then it just depends on what price they're willing to pay. Well, before I let you go, let's broaden this out a little bit. There are a lot of companies that, from a market cap standpoint, are less expensive than they were six months ago. There are also a lot of companies out there with cash on the balance sheet. Do you think we could be entering a period over the next three to six months where we see

more dealmaking going on, more acquisitions? It is not lost on me that there are no names attached to these reports. There are no analysts, there are no executives. I trust the reporting. I'm not going to, you know, if Reuters and CNBC are reporting this, I take them at their word. But it just makes me wonder if we're going to see this scenario play out multiple times over the next three to six months.

It feels like it should. I mean, it feels like logic dictates that it should, right? I mean, and I don't think it's going to be something where the obvious suspects are the acquirers, right? I don't think it's something where your alphabets and your Amazon's and your Microsofts. Granted, Microsoft is in the middle of trying to wrap up this Activision Blizzard deal. But for the most part, I mean, I feel like those are the companies that are really under the microscope of, of, of, of, of regulators right now. And so maybe there is this sort of lower level echelon. I mean, just that next step below, like your broad comms of the world, where they could get away with something like this without necessarily getting right there on regulators' radars there.

It does feel like it's something that should happen because you're right. I mean, valuations have come down considerably. And granted, I mean, we live in a world right now where it feels like every single headline is bad. It really does feel that way. It just feels like there's so much bad news out there right now that any, any spate of good news could really turn things around. It does feel like there should be more interest in making some deals happen right now, particularly for those sort of mid-large-cap companies that aren't necessarily on the radar of regulators, right? They have the financial resources. They have the wherewithal to get these deals done, and they don't necessarily have to worry about being on regulator's

radars. It'll definitely be interesting to see how the remainder of this year shakes out, because if these market conditions persist, it kind of feels like they will, at least for a little while, yeah, it definitely feels like we could hear more news like this. Jason Moser. Thanks so much for being here. Thank you. All right. Enough talk about companies involved in cloud computing and semiconductor chips. Can I interest you in a publicly traded business based on selling vinyl figurines? No, really. Nick Seiple and Asit Sharma are taking a closer look at Funco,

some fundamental reasons they're feeling bullish about bobbleheads and what a new investor group could mean for the company. Welcome in everybody. I'm Motley Fool Canada analyst Nick Seiple, and I'm here today to talk about why Funco could be a fun company for your portfolio. Joining me to help me do that is Motley Fool analyst Asset Charma. Asset, how's it going? Great, Nick. Good to see you and chat with you after a long time. Yeah, it's been a long time since we've been together in podcast land. It's great to be back here with you. And we've got a fun company to talk about today. So Funco, if folks aren't familiar with the company, you've probably seen their Funko Pop dolls, action figures, figurines, in stores, whether it's a bookstore or Target or a place like GameStop.

They're all over the place. They're one of the biggest pop culture merchandise providers really in the world. For folks who aren't familiar with Funco, what do they do? I like to think of Funko as a company that bridges the physical and digital divide. So, stuff that we experience first digitally, so movies, music and video games, bringing that into collectible format with their vinyl pop figures, their bobblehead figurines, and an array of other merchandise, which includes backpacks, keychains, you name it. This is a company that has very deep partnerships with big, big intellectual property giants like Disney, Netflix, Warner Brothers, Activision Blizzard.

They basically licensed the right to intellectual property and turn out these figurines, which they then distribute through big box retailers, through their own direct commerce channel, and for their products like backpacks through stores. And you can even buy them at Disney, which is a big, big part of this business. Loungefly has been a growing part of Funko's business? It's actually up to 16% of the business, up over 100% year over year in the most recent quarter, which is helping diversify the company's revenue. Traditionally, those Funko Pop vinyl figures that you mentioned really drove the vast majority of the business, and they still drive over half of the business today.

Historically, there's been some concern, just given that dependence on those Funko Pop products and that kind of being a single product company, that perhaps there's a little bit of a risk of Funko being a fad. However, they put up some really impressive growth numbers, Asc. So what do you make of that potential fad risk, the dependence on the pop products, and maybe prospects for diversification moving into the future? Yeah, I think this is a fair criticism of the company. Even today, if you look at their most recent quarter, their core collectible items make up about two-thirds of revenue. But as you mentioned, Nick, they've got now a good part of their business, which comes from an

acquisition they made of a company based in the UK, which is Lounge Fly, the one we've been mentioning. They've got some other revenue streams that branch all the way into NFT sales, although no one should hang their hat on that as an investment thesis. Call it Gravy if they make that more significant part of the business. These are some risks behind Funko. And I'll say, this company has some other risks behind it that traditionally have made it sort of a hard investment to really entertain, but those are falling away one by one.

First, it had a very large debt load about five years ago. If you look at the net income on their books going all the way back to, say, 2017, just the interest expense on their debt took out a big chunk of their earnings. They've gradually paid down the debt to a more reasonable level, so it's not affecting their income statement as much, and it's not quite the existential threat on their solvency or liquidity that it was in the past. Also, they had a big private equity investor, ACON investments, that at one point, they had a big, owned about 69% of this company. Over time, that private equity group, which has actually been

pretty helpful in helping this company grow its business and diversify, they've sold off their shares bit by bit by bit. We're going to talk about this last buyer that's come to buy shares from ACON in just a moment here. But also want to mention, they didn't have a wide enough distribution footprint. Management made the push to get into stores like Walmart and Target, and to push their products globally. Another thing is they just really didn't have a great cost structure on the bottom line. But here you look today, they've just moved into a million-square-foot distribution center, not their headquarters, but their distribution operation.

So on all fronts, this company is looking a lot more investable, and I think it is an interesting play. But Nick, what about this most recent investment? So Acon is now selling most of its shares to another group, which is made up of some pretty interesting players. Yeah, assets. So, if you look at the company today, some really promising growth numbers, 58% revenue growth year over year in 2021, a free cash flow, positive business, a business that's put some of those debt concerns behind it. And then again, you had this significant private equity investor, this overhang that we talk about sometimes when you have these large investors. Well, on the same day that Funko reported its first quarter earnings, it reported that ACON was

going to sell about 80% of its stake, a stake equivalent to 25%. percent of Funko's business to an investment consortium led by, among others, the Turing Group, which is led by Peter Ternan, a private equity investor that's invested in companies in the past like Barstool Sports. Another member of that investment consortium is former Disney CEO, Bob Eiger, someone who probably knows a thing or two about the IP licensing business. And then lastly, Rich Paul, who is LeBron James' sports agent as well, a significant super agent in the sports business. And so you had those investors buying a quarter of the company at $21 a share. If you look at where the company is trading today, it's about $19 a share. So we saw a little

bit of value out there. It looks like these private equity folks did too. And then not only that, these are folks you could argue can create potential additional value on top of just the value they recognize in the market at 21. Yeah, I agree, Nick. This isn't your group of like financial buyers who are just in there to see if they can squeeze some more out of the bottom line. These are, pretty forceful personalities in the business world. They want to bring their talent and their bona fides to bear here with Funko. And they are also extremely well-connected people who are used to the power of picking up the phone and getting deals done. I want to point out another

investor who's actually not an individual, but a company that's part of this consortium, which is eBay. eBay is now an investor in Funko. And the two companies have a new partnership where there'll be a nice secondary market for Funko's products on eBay, and the two companies will collaborate to create new products. Now, we didn't mention that the fun part of Funker, one of the really fun parts of Funko, is the fact that these collectibles can often rise in value. Having a secondary market on eBay only makes the whole proposition more valuable, although I should mention the same breath. Funko's aim is to have products that are affordable to everyone. But what do you think about all these big hitters coming in? Nick? Do you think they'll

be able to add some juice to this revenue picture and help with some really great creation of IP? Or might this be just a little hype here? Well, whether it's hype or not, it's something we'll have to find out what kind of results they produce. I will say I tend to follow the stuff that the Turnin Group does in the past. Again, the Barstle sports investment, they were really transformational in getting that company up to scale. They also have some other investment. in the kind of IP space, Crunchyroll, Golden Auctions, which is another kind of collectibles business. Obviously, Bob Eiger, Disney, a huge, huge driver of that side of the business. So I think there's lots of value to be created here as well.

And then, you know, there's some pie in the sky stuff, Al mentioned. It's not something that I would kind of build into the thesis or anything like that. But if you look back, I think it's 2019, there were some rumors that WarnerMedia was going to produce a Funko movie using the Funko IP kind of in the vein of what you've seen with the Transformers. or the Lego movie or the trolls movie, that sort of thing. I could see with folks like Bob Eiger and the Turning Group's actually been involved in the movie production business as well. Those folks get involved.

Maybe that makes that type of optionality more likely. But in any event, you have really smart, savvy investors that know a thing or two about the IP licensing business that have recognized Funko as a smart place to put their money. And listen, the Turnin Group is a private equity company. They're in the business of making money. They're not buying it just to be flashy. So to the extent, it's hype, you know, they put real dollars behind this, trying to make real money.

So I think these folks are smart. And listen, I thought the stock was attractive even before that kind of investment took place. So it's always nice to get a little bit of confirmation bias, too. Yeah, this is a company that looked like a value stock before and still does in some ways, even though it's had a nice pop. There's a pun for you who are fans of the company, a nice pop after the announcement with the first quarter earnings that you mentioned. And I'll also say, too, that this is a fun.

type of private equity investment because while you do have that PE angle, which is all about making the money, there's a lot of creative energy here. And for Funko, that's like oxygen for this company. They spent the last several years figuring out their distribution, getting their costs under control, getting that distribution that I talked about. Now it's time to capitalize on creative ideas and partnerships they can build. So I think all this is good. Any risks to the investment thesis that you see, Nick?

Well, I mean, one of the big ones is they don't own the IP. So to a certain extent, whether it's Lounge Fly or Funko Pops, they own the kind of design for the bag. They don't own the IP that's going into creating those products. So the relationships they have with those other parties are foundational to the business. So maintaining those relationships is always going to be a key. So that's one risk that pops to mind for me. What about you, Awesome.

I see a lot of the risk that I would. word over in the past, it slowly melted away. I talked about the balance sheet risk and the fact that they were controlled by this other group, and that gradually diminished. Now, the replacement group looks pretty capable. It will help revenue and earnings as well. But in the near term, you could see a little bit of deceleration from this very nice pace of revenue growth they've been enjoying. If we go into a recession that obviously hits the consumer discretionary spend, some would argue that because Because Funko's products are very accessible, maybe they don't lose that much, right?

Maybe people choose to buy some Funko collectibles after they've been forced to stay home and not take that vacation because of inflation. So that's yet to be seen, but that's a near-term risk. Longer term is the ever-present risk that people will just change the way they consume their pop culture. For the longest time, Funko has benefited from what they call Evergreen properties. So, properties like Star Wars, Harry Potter, the NFL, these deals that enable them to keep churning out products that never go out of style.

It could be that in the future, the younger generation moves to more digital products for collectibles. But here again, we mentioned they are getting a toehold in the NFT market, so at least they'll be able to maybe compensate if that risk of the physical product does become more prominent in the coming years. Yeah, I will say one thing, if you look at the consumer and, particularly, you'll be able to potential slowdowns as a result of the consumer weakening. One of the areas that I think about that's probably a place that's a big demand driver for this type of kind of fandom-based

pop culture content is Comic-Con. And those types of conventions, if you think about it, San Diego Comic-Con is the biggest one. That's been canceled the past two years. So while there are some headwinds when it comes to inflation, a potentially weakening consumer, there are some tailwinds when it comes to reopening. And some of these traditional demand drivers for these types of collectible products open. back up. So before we leave, Nick, I've sort of hinted at this, but I'll ask it as if I didn't know, do you or anyone in your family own any Funko products?

Yes. So we don't own any of the Funko Pop figurines, but we own three or four of the Funko Loungefly bags. So we've got a Marie one from the Aristot Cat's, and we've also got ones with the little mice from Cinderella. So whenever we go on our hikes in the park, or actually, we went to Disneyland Paris a month or two ago, those bags come with us. So, yeah, we represent a little bit. Awesome. Yeah, I have some in my house as well. Now, I personally don't own any products,

but my three sons love their Bobblehead Star Wars products, especially my oldest. He collected a few. After he went to college, my two younger sons took his passport photo and taped it on the front of the Bobblehead doll. You can't see it now because we're taping, and this is a radio-type show, but I'm showing it to Nick. When we walk by, we've tap the top of the bobblehead now, almost like, hey, call home. 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 ourselves stocks based solely on what you hear.

I'm Chris Hill. Thanks for listening. We'll see you tomorrow.