Motley Fool Money - Netflix Plummets, Lululemon Plans

Episode Date: April 20, 2022

For the first time in over a decade, Netflix had a quarterly net-loss of subscribers and shares fell more than 35%. (0:20) Tim Beyers discusses: - The growing competition in video streaming - Shares of Roku and Disney falling as well - How investors should think about the growth prospects for Netflix - Lululemon Athletica's plan to double its annual revenue in the next five years (15:30) Ricky Mulvey talks with Motley Fool senior analyst Sanmeet Deo about Xponential Fitness, a small-cap company rising in the boutique space. Stocks discussed: NFLX, ROKU, DIS, LULU, XPOF, PLNT Host: Chris Hill Guests: Tim Beyers, Sanmeet Deo Producer: Ricky Mulvey Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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which makes it so much easier to stay on track. And you can get unlimited expert help at no extra cost, even on nights and weekends during tax season. Visit turbotax.com to get matched with an expert today, only available with TurboTax full service experts. Today on Motley Full Money, Lulu Lemon has big plans for the next five years while Netflix is wrestling with the here and now. I'm Chris Hill, joined by Motley Full Senior analyst Tim Byers. Thanks for being here. Thanks for having me, Chris.

Fully caffeinated, ready to go. Likewise. And we both need it, because Netflix came out with their first quarter earnings report. And for the first time in more than a decade, Netflix lost subscribers. They also guided for a loss in subscribers in Q2. As you and I are talking in the middle of the trading day, here, the stock is down more than 35%. It is now trading at a multiple that is similar to the S&P 500 itself. So my question, whenever the drop is this big, is always the same, which is, how bad is that

this, is the business of Netflix 35% worse than it was the day before? No, I don't think so. Having said that, it would be wrong to say that this is a stark overreaction and we're just ignoring reality here. I don't know that it is an appropriate reaction. However, we should recognize that Netflix has clearly entered a period of transition. And so, So the question you want to ask, if you're an investor, is can management navigate that transition? There is, and there's a couple of schools of thought here, you could argue that the thesis is broken because what we thought Netflix was is not what it actually is. In other words, Netflix can grow at a really compounded rate, and even all of this really

tough competition from streaming competitors is not. not going to curtail its growth. They're going to be able to keep going as they've been going and not have to make material changes. I think we've learned from this quarter that that is not true. Now, you could take that piece of data and say, so the thesis is broken and I'm out. Or you could go, okay, well, the thesis is different now, is the different Netflix worth owning? And the answer to that, from my perspective, is yes. The landscape has certainly shifted over the last five years, let's call it. We're now in an environment, I say we.

Netflix is now in an environment where there's much greater competition. There are at least 10 services that have at least 15 million subscribers. Netflix is the clear leader with the total number of subscribers. But I do think that the guidance for Q2 is maybe if we're rank ordering the factors of what is shocking Wall Street analysts, it is the guide down. Because again, this hasn't happened. It's been a steady increase quarter over quarter for more than a decade, which is so impressive. But to your point, things have sort of shifted now, and maybe that's appropriate for investors. I'll just add that shares of Disney and Roku are down as well, not 35%, but both

those companies have earnings reports coming over the next few weeks. And I think what we're seeing today with those two stocks is, again, not inappropriate. It's investors saying, well, look, if the clear leader and subscribers is struggling, it stands to reason that smaller players would as well. There are a couple things I want to get to. Something that's getting a lot of attention is the comment that Netflix is now exploring lower-priced, ad-supported tiers. Does that make sense to you? Do you look at that and think, yes, you should absolutely do that, go full steam ahead? Or do you think that would be a mistake? No, I think it's very appropriate. I think everything's on the table. And I'll give you an area.

I was talking with our co-worker, somebody I work with on a couple of our real money portfolios, T.J. Piggott. And we were talking this morning. And he made the point, and I think he's absolutely right about this, is an ad-supported model in some territories isn't just a nice to have. It is essential. So, for example, the price of cable in India is $3 a month. There is no earthly way that Netflix can deliver a meaningful service to subscribers in the Indian subcontinent without some sort of subsidy.

And the easiest subsidy is advertising. And I think that it's not clear to me how ad sensitive that part of the world is in terms of streaming consumers. But if they're not insensitive to it, that is a model. that might work. And so you could imagine that being available in other parts of the world and even here in the US because there's some other data that we got. There's a lot of data we got during the call yesterday, Chris. I'm going to highlight just one, which is that there are 100 million roughly people who log into Netflix under somebody else's account. Netflix

wants to monetize that 100 million. I think we should as investors presume that that they're not going to be able to get all 100 million. But they will test and learn around price sensitive consumers and see if they can convert some of them, either by getting the existing subscriber to pay a little bit more for another household or taking that person who is freeloading on a password sharing, you know, password sharing and getting them onto a very low-priced advertising plan. Netflix has a very good test and learned culture, and they've been through these pivots before. That's the reason I'm unwilling to throw the baby out with the bathwater here, to use a really horrible phrase.

But Netflix has been here before, and you should be careful throwing out companies that have been through it before, made a successful pivot, especially with people who have been there before and done a successful pivot. Because when you do that, you are essentially saying, I don't believe you are capable of doing the thing you already did. One of the questions around Netflix, as they have methodically raised prices over the past decade, is, well, what's the upper limit of that? as they bump up against $20 a month, that sort of thing. So certainly an ad-supported model at a lower price point

would give them in some ways greater pricing flexibility. But do you think that other businesses, you know, the two that leap to mind are Apple and Disney where monthly subscriptions to their streaming services. And granted, they both have a lot less content than Netflix does. But for both of them, it's still under $10. Do you look at those two and think, boy, they've got more room to run than Netflix does? Room to run in terms of pricing or rooms to run in terms of growth?

Both. Room to run in terms of we have more ability to raise prices because we're starting at a lower point. Sure. We're not bumping up against $20 a month right now. And therefore, you know, and I guess. in some ways, maybe that increases the pressure a little bit on Disney to increase their subs. Yeah. Okay. I see where you're going with this. I mean, it is worth remembering that we don't know what the other streaming services look like in terms of profitability. We do know that Disney

Plus, for example, is not even remotely profitable. But we don't know about Paramount Plus. We don't know about Peacock. We don't know about Hulu, but you can hear from the Netflix call that the management of that company has some real admiration for what Hulu has been able to pull off. So if I had to guess if there was another streamer who had figured out the profitability mix, I would guess that it's Hulu. And Netflix becoming more like Hulu sounds somewhat attractive to me. Now, to answer your question, I think Disney Plus in particular, but also maybe less so Apple because they're not really relying on Apple TV being any kind of meaningful driver for the business. But Disney Plus is intended over time to actually be a material driver of that business

as cable degrades. Disney Plus has no choice but to raise prices to some level. level where the market will bear to see if they can actually turn profits on this. It's worth remembering that Netflix has already cracked that nut. It's worth remembering right now, it's going to go down, but as of now, Netflix has better than a 20% operating margin. Please bear in mind that in a quarter where they lost subscribers, they still drove up the average revenue per subscriber. They still grew revenue.

They still had enough free cash flow that they were able to pay off a cash acquisition, pay all their capital expenditures, and almost cover. They came within $150 million of covering a $700 million payment on the debt on their balance sheet. This is a company that if we're going to ding Netflix, we should at least acknowledge that given where they are. Financially, this is a very sound company. And they've cracked a nut that really nobody else has cracked. So before we throw them out, let's at least acknowledge that. Last thing, and then we'll move on. This is a stock that within the past 12 months

hits $700 a share. At the moment, it's around $220 a share. So that's a steep drop. Do you view this as a buying opportunity with the caveat that for anyone who's buying shares of Netflix today on this drop, their expectations need to be moderated from what Netflix was. Yes. Yeah. That is exactly right. You should, boy, do I hate using this word, Chris, but this is a little bit like the next Quickster moment. Can we not use that word ever again? But it's sort of like that in the sense of Netflix has admitted, hey, you know what? We did not give our streaming competitors nearly enough credit. We need to rethink things. And that's what they will do now. So if you are a buyer, and I have no objections to anybody who wants to be a buyer here, I would buy in very small amounts.

This is just me. I'd buy in very small amounts. I'd be buying over the course of time, and I'd be watching closely to see how the transition goes because you are buying this for the next 10 years. And I think there is something to that. Look, they are nowhere near penetrated on a global basis, what their actual subscriber base could be. They're nowhere even close to that. So, if you believe that they are a global TV brand, a literal global TV brand, then yes, I can absolutely see it. But you, I mean, buckle up. This is not going to be a simple or easy ride.

Before I let you go, Lulu Lemon Athletica doesn't report for another month or so. But they came out this morning with some goals. Lulu Lemon says it is aiming to double its annual revenue in the next five. years and the way they're planning to do that slash hoping to do that is with more international expansion growing their men's business taking another run at a membership model what do you think does any part of that stand out to you the I'll just say that the first two make perfect sense to me because that's part of how Lulu Lemon has grown over the past five years yeah the membership

model, I believe they tried something like that in 2018, and it did not work out well. Yeah, retail membership is, look, we should admit that Costco is a little bit of a mutant company in this area. Like a Costco membership, it pays for itself almost overnight. But that is the exception, not the rule. Here's what stands out to me, Chris. When you say double revenue in the next five, five, years. Can we just remember what that actually is? Not to get all mathy or anything, but here's your cold cup of coffee for the morning. That's 15 percent annualized revenue growth, which is good, but for a company that's been growing at 40 percent, please understand that Lulu Lemon just told

you in the nicest way possible that our revenue growth is going to slow dramatically. And we're going to expand the way we address the market, all of which is good. I'm not saying that 15% annualized growth is bad. I'm just saying that's a material slowdown. So everything in context, please. You're right. That is the nicest way possible to say our revenue growth is about to slow down. Tim Byers, great talking to you. Thanks for being here. Thanks, Chris. I'm a subscriber to a few streaming services, including Netflix. One industry that does not get my money on a monthly basis, however, is fitness. What can I say? Going for a run outside is free, which is one reason fitness is not an easy

industry to make money yet. But one small cap company called exponential fitness may have found a foothold in the boutique space. With more, here's Ricky Mulvey. If you drive past a strip mall, there's a decent chance you'll see an exponential fitness brand. The company owns 10 boutique gym brands, including Club Pilates, Pure Bar, Yoga 6, and Cycle Bar. Exponential Fitness, ticker XPOF, is about a $1 billion market cap company, and followed closely by Motley Full Senior analyst, Sanmete Deo. If you're interested in the fitness industry, this may be a company to put on your watch list. Sanmeet, good to see ya, ready to pump some iron.

Yeah, absolutely. Thanks for having you, Ricky. So I found out about this company because you did an interview with the CEO, Anthony Geisler. it made me to start looking into it. I do not own the stock yet. But why is exponential an interesting company to you? Well, you know, I've been following Club Pilates in Exponential for a while now. I own a boutique fitness brand myself, and Club Pilates was unfortunately not the one that I selected to do a franchise in. But, you know, since then, you know, it's become the largest global franchisor in a $20 billion boutique fitness industry. And this boutique fitness industry is the

fastest growing segment of the broader $97 billion global health and fitness industry, and it's projected to grow about 24.5% Kager from 2020 through 2025. Like you said, they have a platform of 10 fitness brands. You list off a bunch of them. It's class-based programming. They have strong community-type environment, delivering the classes through, you know, in-person, boutiques, small footprint studios, and also online channels, which they've really ramped up since COVID hit and recently. One of the things I really liked about is they grew and gained share through COVID with nearly a third of boutique studios closing.

It shows to their strength and how they've been able to sustain such an immense blow to that industry throughout that period of time. You mentioned their competitors closing. What was exponential fitness doing differently throughout the pandemic, especially with regard to their relationship with franchisees? One of the things that I was impressed with, and Anthony mentioned this on our interview, is he fought for, they fought for their franchisees to get through rent relief negotiations with landlords, with fighting the government to try to get funding, even though that wasn't as successful as they had hoped. I think they offered some royalty relief for the studios. They also, what was impressive was, now this was a bit of timing and also good planning, but, um, good, good planning, but, um,

They had already launched a studio to broadcast digital classes right before the pandemic had started. So they were already in the position to do so. And because they were, they were able to launch it right away once a pandemic hit. And their franchisees were able to get a ton of content that they could deliver to their customers online and really keep that membership-based, active and engaged and moving. Talking about the franchisee relationship, what's it mean for stuff? investors that these studios are not company owned and that it's a franchise model. A lot of attractive features of a franchisor model for investors is that it's an asset

light model. They have predictable recurring revenue. They're getting paid these fees every month based on the revenues that the franchisees make no matter what. The franchisor is able to have high gross margins and strong free cash flow potential because they're not taking on the ongoing capital requirements of building out the studios, repairing equipment, and taking on a lot of those expenses. They're very capital light in that sense. And also, the one advantage is they could rapidly scale with this franchise business model. They currently have about 2100 global studios open, and they have 400, 400 plus global licenses sold. So those are studios waiting to be kind of, or working on to be open.

So you can scale a business model very quickly as a franchisor versus having to open all of those yourself. I mean, you've owned a boutique fitness studio, Sunmeet. What are some ways that you monitor exponential's relationship with franchisees? This is one of those things that's more art than science because it's not going to be really listed in their financial documents as a public market investor. but a few of the things to kind of keep an eye on is, you know, are there franchisees owning multiple units? In Expendential's case, you know, some of these franchisees own multiple brands across the platform. So they might own a club Pilates and a rumble and a stretch bar. So the more these franchisees are willing to invest more into the brands and open more units and take on that risk is a good thing.

It means they're invested in the franchise and they're, you know, obviously they're, if they're going to invest more, then they're positive on the business. One of the things you could actually do is a bit of Scuddlewit is talk to owners. If you go to a studio, Club Pilates, try to see if you can talk to the manager or the owner and get a feel for, you know, what's it like working for this franchise? Are they supporting you through things? And, you know, get a little bit of feel for what their sense is in terms of that relationship. And then also just monitor the growth of the franchise. So monitor the staff at the corporate level with the growth of the franchisee units.

If it looks like the corporate level staff is not growing enough to support those franchisees, you know, may want to question that to the company and say, well, hey, do you have enough support staff to support these, you know, 2,100 studios they have opened and potentially 4,400 studios open. So a lot of key things there to kind of watch out for. Fitness is one of those industries that is notoriously difficult to grow in. This company's done a good job at it so far. But going forward, where do you see the meaningful growth for exponential fitness? Is it expanding internationally? Is it focusing on their existing brands? Is it adding more brands into the fold?

What are you looking for as an investor? You kind of hit on all of those. One of the main ways they've grown as thus far is from 2017 through 2021, their global, studios have grown at a K-Gerve about 27% and that's primarily from acquiring a ton of key boutique fitness verticals, businesses and gyms that are in a little different types of fitness categories. And you have yoga, you have stretching, you have bar, boxing, Pilates. Those are all very different brands that they, that the franchisees can have access to as well. So they will look to acquire new brands. They're always looking. The CEO mentioned that

they're always on the lookout. Obviously, grow their current studio base. It's estimated that they could grow to potentially about 7,900 locations in the U.S. alone. Whether that's being very ambitious or not is yet to see. What's the baseline for that? Oh, so they have about 2,100 global studios, about 1,800 U.S. studios or so. So it's a huge growth. But, You know, these are very small four-print stores. So it's like 1,500 to 2,000 square feet. So it's at these big box gyms that you're thinking of that have massive locations. Internationally is definitely something.

They have about 175 open now, 956 contractually obligated to open. They acquired a brand called BFT, which gave them a foothold in Australia, New Zealand, and Singapore. And then they're doing some innovative things in terms of driving, kind of system-wide sales and growing their A-UVs. X-PASS, which is similar to ClassPASS, where you can try out different offerings across the exponential brand portfolio.

And then X-plus, which they recently just kind of revamped and launched recently, where you can kind of drive, where it's basically a digital-only platform. So, you know, you can have digital access to all their brands on that one app or that saw on that website. What are some of the major risks you're continuing to watch with this company?

I actually think the customers are more fickle with fitness than they are with things like maybe restaurants or fashion. You know, there's always like a new type of fitness brand or class or something out there that people could try products that they could try to kind of get in shape. And they tend to want to have that quick fix and they don't stick to something. So it can be hard. to retain customers. And churn is definitely a huge issue with gym cons, particularly boutique fitness concepts, because they can run a little more expensive than some other typical

big box chain. SunMeet, Deo. Appreciate your time. And thanks for coming by the show. Yeah, thanks for having me. 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 on what you're here. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.