The Prof G Pod with Scott Galloway - Prof G Markets: Target and Walmart Earnings, Hedge Funds and Pinterest, and Estée Lauder Buys Tom Ford

Episode Date: November 21, 2022

Description: This week on Prof G Markets, Scott explains why Target and Walmart had such contrasting earnings reports for the third quarter, and offers his insight on Target’s brand strategy. He then shares his thoughts on why hedge funds might be buying up shares of Pinterest, and whether hedge fund disclosures are worth paying attention to for the typical investor. Scott also examines Estée Lauder’s acquisition of Tom Ford, and gives advice to entrepreneurs on how to gauge when it’s time to sell a company. Show Notes: Target and Walmart Hedge funds and Pinterest Estée Lauder and Tom Ford Music: https://www.davidcuttermusic.com / @dcuttermusic Learn more about your ad choices. Visit podcastchoices.com/adchoices

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NMLS 1617539. This week's number, $218,000. That was the winning auction price for Steve Jobs' old Birkenstocks. The auction listing read, The cork and jute footbed retains the imprint of Steve Jobs' feet, which has been shaped after years of use. Well, Jesus isn't that great. And when I say Jesus, I mean, let's be honest, these are Jesus sandals.

In other news, tech icons don't live by the same rules as the rest of us. Welcome to Prop G Markets. Today, we're discussing earnings from Target and Walmart, hedge funds and their interest in Pinterest, and Estee Lauder's acquisition of Tom Ford. Here with the news is Prop G media analyst Ed Elson. Ed, how does it feel to be a Twitter celebrity? I noticed that before we started, you were complaining. You're a little bit of a diva. Did you get the calla lilies and the Haribo gummies that you wanted for your dressing room? Talk about the tweet that went around the world, Ed. Yeah, it was very weird because I tweet stuff all the time

and no one pays attention to it. And there was nothing different with this tweet. I was just complaining about crypto or whatever. And I woke up and I had like 40,000 likes. It was crazy. And what was the tweet? It was just, you know, giving credit to the people who were skeptical about crypto. And now they're sort of, you know, it feels like maybe they were right. What I found was interesting is a ton of people got very angry and weighed in and said, I've been saying, I mean, it's really interesting. People seem more interested in taking credit than actually illuminating people as to what the dangers are. Like a fight broke out on who deserved more or less credit around, you know, warning on this.

I tagged a few people who I thought were good, thoughtful, early skeptics, but I missed a bunch of people. And so all of the comments were like, you forgot me, you forgot me, which I actually think added to the virality because all these people were piling in wanting to take credit for it. Yeah, the other thing that was interesting was like it started very civil to begin with these very thoughtful responses. Not for long. Yeah, not for long. It's Twitter. Pissing match.

Tell us about what's going on in the news. Let's start with our weekly review of market vitals. The S&P 500 slumped through the week. The dollar lost some steam on signs that inflation may be easing. Bitcoin settled above 16,000, a two-year low as the crypto market roiled in the FTX drama. And the yield on 10-year treasuries fell in response to strong retail sales. Shifting to the headlines. UK inflation hit a new 41-year high of 11.1% as food, transportation, and energy prices soared. Amazon is the latest big tech company to announce layoffs. The retailer plans to cut around 10,000 employees. Meanwhile, Google is under pressure from one of its largest shareholders to cut back its workforce as well. And finally, the FTX collapse has caused a contagion in the wider crypto industry.

Major firms including Genesis, Gemini, and BlockFi have suspended or delayed withdrawals from their lending units. Meanwhile, FTX founder Sam Bankman-Fried claims he is trying to raise new funding to pay back FTX's customers. But the company's new CEO, who also ran Enron during its bankruptcy in 2001, told the court, quote, never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad to the concentration of control in the

hands of a very small group of inexperienced, unsophisticated, and potentially compromised individuals, this situation is unprecedented, end quote. So this story, it started as just another crypto meltdown, but it's starting to look like the meltdown of the entire industry. What do you think? Can the industry recover from this? Yeah, I think it will. I just think it's going to be a lot smaller. It's already recognized about a 70, 75% drawdown in value. This, I think, will be more spectacle than significant. And that is, when this was all unwinding, when FTX, which is the biggest sort of implosion to date, was unwinding, the NASDAQ had two of its best days in the last year. So the kind of the

crypto spectacle, if you will, is like a gnat hitting the windshield of a much bigger economy. I don't think it's the end of crypto. I just think crypto will ultimately go where it should go. And that is the technology, and David Yermack said this on our pod, the technology will melt into a technology that companies should use. But the speculation part of it, the casino part of it, will become smaller and smaller. And this technology has moved digital assets forward. There's got to be some enduring technology that comes out of this being, you know, having all these crypto Taliban tell everyone, including yours truly, that we just don't get it, that this is the future and it saves everything. And there is no industry that won't be impacted by that.

That kind of big gulp, ayahuasca, grande latte thinking has gone away. Last week was a big week for retail. Federal data showed overall U.S. retail sales increased 1.3% in October, and that's the largest jump in eight months, indicating that consumer demand is holding up despite inflation and recession fears. We also saw earnings from Walmart and Target, two similar businesses, but with very different results. By all metrics, Walmart was a beat. Sales rose 9% to $153 billion, higher than Wall Street's estimates, and earnings per share came in at $1.50 versus $1.32 expected. Meanwhile, at Target, sales slowed and profits declined by 50%.

Earnings were almost 30% lower than analysts' estimates. Target cited a few reasons for this. One, inflation. Walmart also mentioned that. Two, a general pullback from discretionary spending, that is, non-essential items like apparel and electronics. And three, interestingly, shoplifting. Target said theft incidents are up 50% year over year, and that this contributed to a $400 million loss in gross profit margin. Target shares fell

13% after that report, and Walmart shares rose 9%. So, Scott, it appears that overall retail's doing fine. But how do we rationalize the gulf between basically America's two biggest retailers here? Well, a lot of it is just product mix. And that is the majority of Walmart sales are about half, 46% come from grocery versus about $1 and $5 come from grocery for Target at 19%. And in an inflationary environment where your purchasing power goes down, you cut out more discretionary items that Target sells more of, whether it's beach towels or toys or whatever, but food is something you usually don't cut down on. And everything everywhere ends. Target had underperformed Walmart and then vastly overperformed it in terms of its stock price during the pandemic.

Easy to say now, but Target was more vulnerable because it had run up a lot. The other really interesting thing in this story is that kind of what you call organized theft. And it's the notion, and you see stories on this, where a bunch of people in a coordinated fashion sort of show up and just do a snatch and grab and overwhelm security, and there's nothing they can do. And I'm going to sound boomer on this. I think the algebra of deterrence has eroded. I wonder if a lot of people have decided that they just don't have that much to lose. Well, the thing that's interesting is Target mentioned this. I mean, 50% year over year, that's a huge number. But Walmart said nothing about this. I mean, they're attributing $400 million in losses from gross profit margin,

and Walmart didn't even mention it. And if you look at the numbers from last year, retail theft overall in the US increased only 4%. So it's up, but it doesn't seem like as dramatic as Target is presenting. Do you think it's possible that there's some sort of exaggeration here? You're highlighting a really important point and something that is endemic, consistent to all management. And that is, if their earnings had been up, if sales had been really strong, 80% of the

narrative would have been around the great decisions and strategies of me, the CEO. And then when things go wrong, it's things outside of my control. And people have this same flaw. And that is when you're killing it, you're going to credit your grit and your character. And when things aren't going well for you, you're going to blame the market. So never underestimate a CEO's ability to blame outside forces and creatively talk about reasons for his or her failure that are out of his or her control. I don't doubt that this organized theft is an issue, but at the end of the day, as you pointed

out, other retailers seem to be figuring it out. Would you have any advice for Target? I mean, do you think the answer for Target is just bring prices down? So I don't think they can out-Walmart Walmart. And I'm a big fan of role models. And that is almost everything in business has been done before or is being done. And so I'm a big fan.

I don't think there's anything wrong with saying, okay, let's copy that. And in consulting, we call it benchmarking. And I made a nice living basically benchmarking every successful company in the world and then showing up to everyone from Walmart to Williams-Sonoma and saying, here are some very interesting things happening at different consumer brands around the world and things you might want to adopt. I think targets, role models should be JetBlue. So they're probably never going to be as valuable or as big as Southwest. Southwest kind of has a lock on the value market.

Southwest does it better than anybody. Southwest buys orange paint. Why? Because they like that color, know it's a hideous color. But because that color, for some reason, gets discarded and they can buy it on the cheap. They're almost all 737s because they realize the cost efficiency of scale around having one type of plane. Chad Blue comes in and says, okay,

we're going to be value, but value with a little bit of humanity and a little bit of sexy, right? Kate Spade uniforms, Blue Tarot chips, leather seats. And maybe it's not 99 bucks, maybe it's 109, but it's got that same low-cost credibility, but with a little bit of sex appeal. And that's what I think about Target. I love Walmart because I know the people there. I think the management there, I think the CEO there, Doug McMillan, I think he's a high-character, outstanding leader. And almost everyone I've met at Walmart I've just really enjoyed. I think they're a good company.

I think they're a decent employer. But personally, I shop at Target. I love Target. I think they figure out how to give me some of that jet blue sex appeal. I like the feel of the stores. I like the way they surprise and delight people. I think they've done an interesting job buying some sort of out-of-fashion aspirational brands and going vertical. I don't think there's anything wrong with Target that can't be fixed with what's right with Target. A recent Bloomberg report showed that hedge funds have been buying up shares of social media company Pinterest in massive numbers. In the past quarter alone, hedge funds bought more than a billion dollars worth of Pinterest shares. That increased their holdings by 73% more than any other investment in the communications sector. This is coming after a relatively strong quarter for the company.

Pinterest reported 8% revenue growth in October. And at the same time, hedge funds are unwinding their positions in meta. Filings reveal that they sold more than $3 billion worth of meta stock in the third quarter. Scott, Pinterest is sort of a B-list social media company. So are hedge funds seeing something here that we aren't? Pinterest is sort of this human-centered search engine. And people are loyal to it. It's got a nice feel to it. It doesn't have all the toxic bullshit of Instagram. It just has a better, I don't know, cleaner feel to it. And you're right. It's part of the tier two. It's part of the bad news bears of social media.

It's Twitter. It's Pinterest. It's Snap. Are there any other subscale ones? Truth Social. Truth Social. There you go. Which, by the way, has shed about 40% of its value in the last week.

Couldn't have it do a nicer guy. Anyway, so I think people say, okay, Twitter's off the market. Snap is controlled by Evan Spiegel. Might Pinterest be looking for an out? The CEO, Ben Silverman, just stepped down. He's the controlling shareholder, I still believe. So again, and I hate these dual-class shareholder companies. If you want to know what's going to happen in Pinterest, ask Ben Silverman's wife because he gets to do whatever the fuck he wants. But if you think about it, the fact that it only gets $1.56 average revenue per user or ARPU versus $3.11 at Snap and $9.40 at Facebook probably is seen as opportunity right

now across the people investing in this. And I think what they're likely saying is that it looks cheap relative to where it was. Its stock has been cut in half. Could it be a potential acquisition? Might Ben be willing to sell it to, I don't know, a bigger media company or a Microsoft or name your favorite? Would Apple ever consider Pinterest? It seems to me if Apple wanted to ever be in social media

and take advantage of their custody of the consumer of their phone and iOS, that the only social media platform that has kind of the aspirational non-toxic feel would be Pinterest. I don't know if you remember last year, there were these rumors that PayPal would acquire Pinterest. And that was sort of floating around

the news for a couple of weeks. And then PayPal ended up denying the rumors. But you said back then that you thought it was a good idea. And you talked a lot about how it's sort of like PayPal would be acquiring eyeballs for their financial product. Do you think it's possible that these hedge funds are thinking the same way? Well, yeah. I mean, at the end of the day, they think that there's an acquisition, there's a floor on the stock price because of an acquisition premium. But here's the problem. There isn't a floor when it's controlled by one person because that one person is immune from shareholder pressure. The reason why I thought PayPal might acquire Pinterest is that if you looked at the payments guys last year, so PayPal at its peak was trading at triple where it is now.

It's got a $100 billion market cap now. It had a $300 billion market cap. So even when Pinterest was double where it was now, call it at 25 or 30, it would have been a 10% dilution for PayPal to acquire it. And what you had with these businesses was, the payments business, they're good businesses. What you have with Pinterest is a lot of goodwill and user engagement. So how do we transition or transfer or translate that goodwill and engagement into a better

business? Because the average revenue per user, the advertising business is a shitty business. But if you could take all of those users and all of that affinity and the fact that they probably already maybe have their credit card, maybe already have their identity, have already signed up, are used to a user interface and said, good news, you're part of the PayPal network. And if you click on this soapstone counter, you can use PayPal to pay for it. And if you sign up for PayPal, you get 20 bucks credit towards your next

purchase on Pinterest. It's just the majority of acquisitions when PayPal was trading at 300 billion in market cap would have been accretive. What do we mean by that? They could pay a lot of money for acquisitions. And as long as those companies were somewhat profitable, it was accretive because PayPal was trading at such extraordinary valuation. In sum, you want to go shopping when your stock is overvalued because you can use your inflated currency to go buy business. And at a third of a trillion dollars, PayPal had a big freaking credit card to go buy stuff. Does it make sense now? Maybe not, because PayPal's market cap is now below $100 billion, and they probably have to pay $25 billion. So is Pinterest worth 20% of PayPal? That gets to the point where when it was 10% of the price, that means it could have not worked out and it wouldn't be a career-ending injury. When you start talking about issuing a quarter of the company's shares to the holders of Pinterest, it best work out. You were also mentioning this idea of a takeover

premium earlier. Can you explain what that means? So there is a floor and someone would come in and acquire the company. Even if the business turned shitty and looked like it had nope, it went unprofitable and looked like it was never going to get out of it, there's enterprise value there because it is worth something to someone else. A company like Peloton, and I don't know, this might be losing money right now. And you think, okay, connected fitness, losing money, should trade at one times revenues. But here's the thing. At some point, big, big companies think that company's worth more than three or $4 billion to them just based on the attention they garner. So there's always a kind of a takeover premium built in. And that is the market goes, you know, at some point this

would get taken over. So the downside risk is somewhat limited. So the stock always trades a little above, not its fair market value, because that's part of fair market value, but trades a little bit above or sometimes substantially above where the metrics are. And finally, something I learned reading this story is I didn't realize hedge funds have to publicly disclose their trades. It's specifically hedge funds that manage more than $100 million in assets. Do you think this is activity that investors should be paying attention to, or is this a distraction? I think it's actually, I think transparency is great. I think it's really interesting to see who's buying and who's selling.

Because while you want to know what Berkshire Hathaway is buying, while you want to know what hedge funds are buying way they are incentivized is they get two and 20. And investors don't want to pay a hedge fund 2% of assets and a 20% commission on profits to go buy Apple. They're like, I can buy Apple pretty easily on my own boss. So they want a sort of an esoteric, unique viewpoint, mostly bullshit, web three, blah, blah, rap that convinces you that they have these economic models where they can outperform the market. As a result, they have to go into more esoteric and weird stuff, which has underperformed the S&P. So the alternative investment industry or the hedge fund industry over the last 10 years could best be described as expensive, but bad. Be clear, look at what they're buying, but don't kid yourself. They're not that much

smarter than anyone else, and sometimes they're less smart. We'll be right back after a quick break with a look at the largest deal in the luxury market this year. The Capital Ideas Podcast now features a series hosted by Capital Group CEO, Mike Gitlin. Through the words and experiences of investment professionals, you'll discover what differentiates their investment approach, what learnings have shifted their career trajectories, and how do they find their next great idea? Invest 30 minutes in an episode today. Subscribe wherever you get your podcasts. Published by Capital Client Group, Inc. what tools are right for you, and what privacy issues should you ultimately watch out for. And to help us out, we are joined by Kylie Robeson, the senior AI reporter for The Verge,

to give you a primer on how to integrate AI into your life. So tune into AI Basics, How and When to Use AI, a special series from Pivot sponsored by AWS, wherever you get your podcasts. We're back with Prof G Markets. Estee Lauder is acquiring luxury fashion house Tom Ford for roughly $2.8 billion. That's the largest acquisition in the cosmetic giant's 76-year history.

And the deal is expected to close in the first half of 2023. Estee Lauder is primarily a beauty company. It sells brands such as Clinique and MAC, but this acquisition will allow it to enter new categories and compete with larger, more diversified luxury companies such as LVMH. Scott, you're an expert in luxury. In 2010, you founded L2, which was a B2B research firm specializing in digital strategy, and it originally focused on luxury brands. In fact, I recently learned that L2, which was a B2B research firm specializing in digital strategy, and it originally focused

on luxury brands. In fact, I recently learned that L2 stands for Luxury Lab. What do you think? Is this a good idea? Yeah, I think it is. Estee Lauder is a really well-run company, and it's got a great heritage. They have fantastic brands. They attract really bright people. Fabrizio, the CEO there, is a very talented manager. In addition, this is probably a decent time to be playing offense, and that is to make acquisitions. This will likely be a great acquisition, I think, because one, they're not overpaying. It's a great brand. They will benefit from the capital and distribution and scale around supply chain and manufacturing that Estee Lauder Company brings to the deal. So I think this will be a win-win. Tom Ford becomes

a billionaire here. Estee Lauder has an $80 billion market cap. So if they pay $2.8 billion, they take about, what is that, about a 3% or 4% dilution. And we talk about where the greatest acquisition in tech was Instagram. They bought it for a billion dollars, now worth probably 100 to 200, 100 billion maybe, 100 billion of that 250 billion is probably Instagram. The best acquisition in beauty was probably a guy named John Dempsey, who was this creative icon in the beauty market, incredibly creative, strategic thinker. He was the driving force behind the acquisition of MAC Cosmetics. And I think they bought it for something like $30 or $50 million, and it ended up being a billion-dollar brand within just a few years. So Smashbox, they bought a bunch of really nice brands, and then they take these things. La Mer, an amazing brand. They take these

wonderful little artisanal brands that don't have a scale, the capital, or the distribution, and they blow them up. They blow them up. So I would be shocked if Tom Ford didn't see its sales go up double digits each year for the next five or six years. So I think Estee Lauder has been one of the best acquirers in the world of consumer. Tom Ford's a great brand. And one plus one equals three here. I like this one a lot. How do you value a luxury brand? And for that matter, how do you value any consumer brand? I mean, it's not like a SaaS business where you look at the sales and the users

and the profitability. There are all these strange, soft factors that you were describing, like with La Mer and with Mac. It's a great brand that has a lot of brand potential. From an M&A perspective, how do you put numbers on those metrics? Well, at the end of the day, companies aren't sold, they're bought. And it comes down to what the seller and the buyer, if they have an overlap in terms of what they're willing to buy or sell, ultimately that's what dictates the price. Now, as a means of zeroing in or a starting point, traditionally, every industry has general

metrics. A company that is growing at 50% a year trades at a huge multiple on revenues, and it's usually not profitable. A more mature company trades at a multiple on EBITDA, and there's industry averages. And they go up or down based on strategic fit, the brand equity. Tom Ford has a strong brand. They're buying it at what feels like a rich multiple on EBITDA. But Estee Lauder probably says, okay, we can turn this billion-dollar company into $5 billion in 10 years, which means it'll be worth more to us than it is to them on their own. But it's pretty straightforward. It's what are we willing to pay for it? And a lot of people do stupid things. I remember, I think it was Unilever It's, you know, what are we willing to pay for it? And a lot of people do stupid things.

I remember, I think it was Unilever paid a billion dollars for, what was the shave thing? Dollar Shave Club? Dollar Shave. And I said this. I'm not playing Monday Morning Quarterback. I said this right after they made the acquisition. I'm like, stupid. But they were hoping that this direct-to-consumer model would infect the entire Unilever organization.

No, it was just a cute little company that sold razors direct. It wasn't worth 50 million, much less a billion. So occasionally, occasionally you can kind of be like this hot little thing. I talked to a lot of entrepreneurs and my viewpoint, if you're a small company and you're hot for whatever reason, and the market is hot, I always grab them by the lapels and say, sell. Knowing when to sell is a real skill. And unfortunately, the optimism and consensual hallucination you enter into as a young entrepreneur. I was offered $55 million for my first company profit in 1998 by Sapient Nitro and Viant and Scient. We were doing $3

million in revenue. Someone offered me $55 million. I'm like, no, we're going to the moon. And I was full of myself. And unfortunately, I hadn't developed a kitchen cabinet. And then 2000 came, wham, right? And then 2002, we were doing 12 million in revenues, maybe 10 or 12 million in revenues, and ended up selling the company for 28. So instead of selling the company for 18 times revenues, I ended up selling it for about two and a half times revenues. Market dynamics will always trump individual performance. So if you ever have the opportunity to sell, look around and say, is the market at highs or lows? If it's at highs, have a bias towards selling. Because when things are jamming, when you're doing really well as an entrepreneur, guess what? That's exactly the right

time to sell. Why? Because potential acquirers will smell those same good smells. They'll come in and they'll go, Jesus Christ, this thing's on fire. And then when things look tough, when things are hard as an entrepreneur, you think, you know, I'll sell now. Well, guess what? That's when it's hard to sell because acquirers are smart and they'll come in and they'll see the same issues. So when do you want to try and sell as an entrepreneur? When you're least inclined to and when the market is high. Jesus Christ, let's just take a moment to talk about what a fucking Yoda I am right now. Oh, my God.

Thank God I did the meth. I should absolutely do meth before every pod. You must feel the force around you. Here, between you, me, the tree, the rock. I'm sorry, go ahead. Okay, thanks, Scott. Let's take a look at the week ahead. We'll see the purchasing managers indexes for US manufacturing and services sectors in November. Those are typically indicators of economic strength or weakness. And the retail earnings roundup isn't done yet. We've got earnings from Best Buy, Burlington, Dick's Sporting Goods, and Nordstrom before the Thanksgiving holiday weekend. Scott,

do you have any predictions? So Amazon is off about 45%. Amazon is the first company in history to shed more than a trillion dollars in market capitalization, which isn't a good feat, if you will. I think if Amazon goes down another 10% to 20% or its stock goes down another 10% to 20%, you're going to see one of two things happen. They'll either spin AWS or Jeff Bezos will reclaim the helm as CEO. That's all for this episode. Our producers are Claire Miller and Jason Stavers. Special thanks to Catherine Dillon, Ed Elson, Mia Silverio, and the Prop2 Media team. If you like what you heard, please follow, download, and subscribe.

Thank you for listening to Prop2 Markets from the Vox Media Podcast Network. We will catch you next week. What software do you use at work? White lies the tools we use to do it. So what is enterprise software anyway? What is productivity software? How will AI affect both? And how are these tools changing the way we use our computers to make stuff, communicate, and plan for the future? In this three-part special series, Decoder is surveying the IT landscape presented by AWS. Check it out wherever you get your podcasts.

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