Both the cable and retail industries have entered a state of massive upheaval.
Retail has been struggling for years against Amazon, which has changed the rules of the game. It's no longer enough to be convenient with just an OK price. The bar has been raised.
Cable faces a similar problem, even if it's earlier in the game. Consumers have begun to slowly reject the current distribution model, which involves paying cable companies for access to more content than they actually want.
In this episode of Industry Focus: Consumer Goods, host Vincent Shen is joined by Motley Fool contributor Daniel Kline to discuss Walmart's (NYSE:WMT) decision to buy Jet.com for $3.3 billion, and Time Warner's (NYSE:TWX) reasons for paying $583 million for a 10% stake in Hulu.
A full transcript follows the video.
This podcast was recorded on Aug. 9, 2016.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. I'm Vincent Shen, your host. It is Tuesday, August 9th. Joining via Skype from Connecticut this time around. Right, Dan?
Daniel Kline: I believe it's the third state I've done this podcast from.
Shen: Yes, and that's all within the past couple of weeks, too, not like over a few months. How goes it, Dan?
Kline: It's crazy. This is actually the last thing I do in my house before getting in the car and driving to West Palm Beach for "a permanent move."
Shen: I have to say thanks again for joining us, because I know you have this and then a nice long, long, long drive ahead of you. I've done that drive before.
Kline: I'm pumped up on cold brew, and one of the other Fools in our Slack board told me about caffeinated gum, so I think I'm ready for the journey.
Shen: Getting to our topics today for the listeners, we have some M&A, or merger and acquisitions related topics on tap. Before we dive into that first story Dan, and this is relevant, I promise to listeners, I want to ask you this, what is your preferred streaming video service? Netflix (NASDAQ:NFLX)? Amazon? Hulu? Maybe Sling TV?
Kline: The funny thing is ... So, I use Netflix. I pay for all three. I have Hulu and I have Amazon Prime, but I'm one of those people that got Amazon Prime because I buy things from Amazon. I can't say I've used their video service at all. I got Hulu to watch The Mindy Project six months ago and still have never used it because I'm halfway through the second season of Daredevil. I've traditionally been a big regular television full cable subscriber. I'm actually, when we move, going to give Sony's PlayStation Vue a try.
I've also tested Sling TV. What I don't like about Sling TV is it's limited. It's a skinny bundle. It's a great price, but the Sony package for -- I don't know, $49, it varies based on market -- you get about a hundred channels, and it hits most of the things I would want. I'm going to be losing out on some of the regional sports and other things I would have paid for on cable, but when it comes to the pure streaming, that seems a good bet. And Netflix, the originals, it just has so much more stuff than anybody else does.
Shen: You are still a traditional cable subscriber?
Kline: I am until tomorrow technically.
Shen: Okay. I've wanted to ask this, and I find it was really interesting because with our first story, and here's the lead-in, this news came out last week: Time Warner taking over a minority stake in Hulu. We're kind of seeing these worlds blend together. In just the example you gave with your own personal experience, you are a traditional cable subscriber, but you had these other streaming services, and all of this is kind of coming together for your personal experience and personal consumption of all this content, too. Time Warner we've covered from several different angles over the past few episodes. They announced last week taking a 10% ownership position in Hulu for prices about, I think it was $580 million, so that values---
Kline: Yeah, $550, $580, somewhere around there.
Shen: Hulu valuation coming in at about $6 billion. For anyone who isn't familiar with Hulu, just some quick backstory, the service started in 2008. It's a joint venture started by some media and entertainment heavy-hitters. Think Walt Disney, 21st Century Fox, Comcast, NBCUniversal, and now of course Time Warner. At the moment, Hulu has three offerings, but even that will be changing -- we can touch on that later -- has basically a free streaming option where you get to watch a full slate of ads with that. You have a $7.99 per month subscription option with limited ads. Then if you want to pay full price, it's $11.99 completely ad-free. The thing is, the key development with this Time Warner buyout, it seems to me at least, is the live-streaming service that Hulu plans to offer in 2017.
Dan, how are these two companies, the joint venture owners thinking about this deal and the new service?
Kline: It's important to note that Time Warner is buying in only for the live-streaming service. Time Warner has a big issue with the way Hulu operates now, which is they make current episodes of recent shows from its partners, not all shows because of ownership on the individual shows, but most Fox shows, most ABC shows, most NBC shows, you get 24 hours after a show airs, you can watch it and the last three or four episodes, maybe four or five in some cases on the $7.99 service, and in some cases on the free service. Time Warner thinks that's undervaluing its programming, especially because the numbers are not big enough that it's a major advertising source.
Time Warner will not be contributing to that part of the service. What they're paying for is distribution. They see the amount of homes that have cable slowly getting smaller. Cable is dying, but it's going to take a long time at the current pace. What you have happening is they're paying this money so five years from now, when these types of services, Sling and PlayStation Vue, and the various cable networks, cable services not offering boxes but actually having pure digital, I think what you're going to see is by owning a piece of this, they guarantee themselves a place at the table. They're not going to have the contentious negotiations they have with the satellite providers over Sling or with Comcast every time rights to TBS and TNT and CNN come up. This is really just buying them access to homes as the cable role changes.
Shen: Hulu, next year -- just to clarify what exactly they're going to be offering and Time Warner is buying into -- is a live streaming service that will actually include live television, which is a little bit different from what it currently does, which is more similar to Netflix.
Kline: Basically, they're copying Sling, except because some of their partners are networks, Sling does not have any traditional broadcast networks. It sort of the most popular cable channels for younger people. What's happening here with Hulu is they're going to have some of the Fox, NBC, ABC programming. Maybe my mom can get it, and she'll still get the Nightly News. I don't think my mom watches the Nightly News, but if her mom was still alive, she would watch the Nightly News and maybe would have to get this type of product.
Shen: There's not as many details as I was hoping there would be otherwise for the Hulu services coming out next year, but I think it's helpful for listeners just to give some context in terms of how far Hulu has come since it started back in 2008. Compare just for some basic contexts, Netflix, the leader here, has about 40 or over 40 million domestic subscribers that generate about $6.8 billion of revenue in 2015. The most recent numbers I could find for Hulu, for example, over 10 million subscribers, so a smaller base for sure, generated revenue of $1 billion in 2013. That grew pretty quickly to about $1.6 or $1.7 billion last year.
The thing is, both of these companies, and this includes Amazon, too, all these streaming services fighting for content, they've been spending a lot of money for not only their original programming that all three have become known for, but also $5-$6 billion spent by Netflix in 2016 expected. The most recent number I could find for Hulu is about $1.5 billion in 2015.
Kline: A lot of that is going to Seinfeld.
Shen: Yes, I think it was like $700,000 or $1 million per episode for that.
Kline: I think that's the differentiator between the two. Netflix is a service aimed at people in their 20s and 30s who maybe never had cable. Whereas Hulu, the content is really the stuff you would watch if you had a cable subscription a couple of days later, 24 hours later plus a few originals that feel like network shows. It's not groundbreaking in the way that Netflix is. It's sort of a familiar angle. It's when an older generation says, "You know what? I'm not paying $150 to Comcast anymore, but I still want to watch Law & Order.
Hulu is trying to keep that model, and the challenge is not pushing cable subscribers away -- that's the last thing Comcast would want -- but also keeping as many of them that were going to leave anyway on the one that they own. You'll do better as Time Warner being a partner in Hulu than licensing your content to DISH or to Sony or the 20 other services like this that are going to start in the next few months.
Shen: There's an interesting dynamic here because, as we mentioned, the joint venture owners for Hulu are the really big companies like Disney, you mentioned Comcast, NBC, Universal. This news just came out yesterday, actually, where I mentioned that first service is free to access Hulu content or some of the Hulu library, but it's supported by ads. They're actually getting rid of that entirely.
Kline: The interesting thing is they're actually just moving it to Yahoo!. They announced a partnership deal. They're "unconfusing" the Hulu brand. Basically, Hulu is going to have two products. It's going to have a subscription product where you get access to next-day content from the original partners and not Time Warner, and then it's going to have a live-streaming television service. Having the free product on top of it, which inflated their viewer numbers by another 40 million, but didn't really make them a lot of money because it's really difficult to sell ads on three people watching a Seinfeld from 15 years ago and 17 people watching Family Guy. It becomes a very tough model to prove to advertisers that there's value. They're sort of just shunting that off and taking it off the Hulu brand, which makes sense. It will make it a lot easier for them to sell their two services that make sense.
Shen: Stepping back now and looking at this in terms of some of the changes that are obviously happening to the industry, big picture, what do you think is going to be happening maybe next year, or with these developments as deals like these between Time Warner, Hulu, and Hulu service coming out next year? What do you think that's going to mean?
Kline: I think it's the wild west. It think you're going to see every major cable company start a service that doesn't require a cable box in order to keep broadband customers. What's going to happen is you're going to have two or three years where there's 15 choices, and then you'll see consolidation again. There's no need for there to be Sling and Vue and whatever they call super Hulu. If Amazon enters that space, if Apple enters that space -- a lot of players are going to come here. Eventually, you're going to see it's just going to be like cable, where it doesn't really matter if you have Frontier or you have Comcast, pretty much you're getting the same offer. Maybe it becomes priced in customer service, but there's going to be a lot of announcements and a lot of new companies, or existing companies going into the space because the cable box is slowly going away.
Shen: All right. Thanks a lot, Dan! I want to move onto our second segment now, which is related at least in that this is another industry that's kind of going through a lot of transition, some growing pains. It has had, I guess, quite a bit of disruptive innovation -- people like to use that term -- and that's retail. This week, it was confirmed that Walmart is pivoting its e-commerce strategy once again by acquiring Jet.com for $3.3 billion.
Let me stop right there and provide background again for Jet, because this is one where in my, I guess, unscientific sampling of friends and fellow Fools, not everyone is really familiar with this company, frankly. It makes sense considering how young it is. It's only just over a year old at this point, and it's been scooped up for a pretty hefty price, there, I think one of the biggest e-commerce start-up price tags in history.
Kline: They have crazy multiple on sales. They do about $1 billion in sales and they sold for $3.3 billion. You don't see money-losing companies get that kind of deal very often.
Shen: That billion dollars is gross merchandise volume. Basically, the value of everything they sell on the site, but their revenue is actually just a piece of that, too, so it's a bit crazier than that.
Kline: To finish what you were saying, Jet.com was built as an Amazon competitor. What Walmart is buying is partly their CEO, a guy named Marc Lore, who also started the company that owned Diapers.com, which Amazon bought. Jet.com used sort of a different method than what Amazon does. As a customer on Jet, you would build your order, and the more things you bought, the cheaper your price would get because it would be cheaper for them to deliver it to you. It's worth noting that Amazon does that after a fashion with add-on items. I think even Target and Walmart do it a little bit. The idea is to get you to go on and not just impulsively buy something, but to really do your shopping and build up your orders. It's a fledgling company, but they have been adding, I think the number is 400,000 shoppers a month?
Shen: Yes, that's the number.
Kline: It's growing, but this has to be the biggest gap. Walmart is No. 2 when it comes to online retailers. I believe the numbers are about $100 billion for Amazon and about $13 billion for Walmart? This is Coke and Pepsi, except Pepsi is Royal Crown soda. It's a very small player in the space comparatively.
Shen: I think this is an interesting deal, and we can get in more detail what Walmart is getting here with this acquisition. I think the CEO or the co-founder of Jet.com, Marc Lore, who you mentioned, he's a big part of the story, he's going to be joining Walmart following the acquisition. He's going to lead Walmart's e-commerce efforts going forward, and Jet.com and Walmart.com will still operate separately at that.
Kline: We joked about this before, but one: I think Walmart is lighting money on fire, here. I don't think there's anything that they couldn't have duplicated in the six months for $0.5 billion. They're spending a huge amount of money to get a guy. I get it, Marc Lore has been successful, he's been one of the few that has been able to compete with Amazon, but I don't see why Walmart is buying it. I look at it, say, 18 months from now, there's going to be the inevitable press conference where Marc Lore stands up and says, "We've decided to eliminate the Jet.com brand and just focus on our core brand of Walmart.com, but of course we're going to be integrating the technology." It doesn't seem like these deals ever end up with one company operating two distinct products in the same space.
Shen: I love the fact that if you see Amazon as the arch rival to Walmart, it's going to be as Lore, you mentioned the company that he started previously, Quidsi, which owned a portfolio of stores like Diapers.com and Soap.com, that guy got bought by Amazon for about $550 million in 2010. Lore was actually at Amazon for two years, then he left, kicked out Jet.com, and now lo and behold, he's going to be end up at Walmart.
Kline: He's really good at raising money, but he hasn't shown that he's really good at building sales. That's what troubles me about this.
Shen: To touch on that specifically from what I could find, Jet.com has raised about $800 million through various rounds of funding and financing from a lot of actually investors from his previous ventures. He obviously has a strong track record. Something just to keep in mind is the fact that they have their smart card where the more you buy, the cheaper it can be for shoppers. I think there have been quite a few analyses and studies from some industry followers and from shoppers themselves that have found it.
A lot of Jet.com prices are competitive and better than Amazon, which is usually seen as the price leader. That was the strategy that base has used to claim so much market share and to develop such a leadership position. Basically, it comes down to the fulfillment in the logistics, and the way they tie the shipping, and how much you buy. You take Walmart, and they have this huge network of stores and warehouses. They can basically take that technology and leverage it to Walmart scale.
Kline: The challenge for Walmart has always been that fulfilling what a store needs versus an individual order is a massive change. This probably speeds that up, but there's going to be huge growing pains. I don't see how they're buying enough customers to have this make sense. If they had paid Mark Lore's investors back at a 25% premium and then given him a huge deal to come in and run their digital, this would have made sense, but they're buying a brand most people haven't heard of. The second people realize Jet.com is a Walmart brand, it loses some its cache. I think it's fair to say there's a Target and Amazon customer that looks at Walmart and goes, "Ugh, I don't want anything to do with Walmart." I think that's going to taint the sort of hip, millennial brand. It's very hard to stay cool when you're associated with Walmart.
Shen: That's a very good point, because I think previously, with Lore's older venture with Quidsi, for example, I think a really loyal shopper following that he had was among younger urban shoppers. Then with Jet.com, they've been spending like $20 or $25 million a month advertising. A lot of that's targeting not only millennials, but they're trying to basically generate more repeat shoppers. I think I have some data from Slice and BI Intelligence dating back to February that indicated Jet.com was having a hard time generating repeat business -- over two-thirds of their sales were coming from new customers. You mentioned the 400,000 people signing up, or essentially shopping with them with each month. It's just interesting to kind of see that dynamic there.
Kline: The problem they come up against is Amazon has, and I don't know the recent number, but it's roughly 225 million credit cards on file. However, [something like 63 million] Prime members, they don't share the numbers, so it's always a guess. They've made the process so easy, that I buy on Amazon from my phone, I can buy things verbally from my Echo. As an Amazon customer, why would I switch? Because diapers are $0.02 less, I don't need diapers. Any device I was going to buy, anything, if Amazon is within the ballpark, I'm not going to shop around.
Maybe I'll jump on Jet.com and buy a TV because it's $100 cheaper, but I'm probably not going to switch. That's a very, very difficult behavior for any new company to win over. I would think that an awful lot of Amazon customers just find it a little bit cooler to buy from Amazon than to buy from Walmart. They can be No. 2. If they're trying to be No. 2, they can be a bigger No. 2, but this is like me challenging for the heavy weight championship -- it's not going to work out well.
Shen: With all that in mind, I'm a little skeptical, as you are, just based on the price tag. $300 million in cash, $30 million in Walmart stock, and I think a lot of that is going to be dedicated, it's basically incentives for management. $300 million, sorry about that.
Kline: In stock.
Shen: Yeah, in stock.
Kline: And three billion in cash.
Shen: Exactly. For Walmart, their e-commerce efforts in their physical year 2015 they were seeing some pretty strong progress. Year over year, quarterly growth was anywhere from 21% to 27%. Then the following year, so last year, in their fiscal 2016, it kind of started to fall from the high teens to below 10%. In the most recent quarter, it came in at just 7% globally. That deceleration definitely has people concerned because it's lagging even the broad economy, where e-commerce is, I think, still growing double-digit rates every quarter.
Kline: They need to catch up to Amazon in terms of fulfillment. If you buy anything from Amazon, it is going to show up in two days, including on Sunday. Walmart doesn't even promise that. I think they'll sell it to you for an extra price. The days when you place an order and it takes three to five shipping days, Amazon has created a new standard, and people have proven willing. I'll buy batteries from Amazon because I could wait 48 hours with my remote control not working. I'm not going to wait a week. That's really where Walmart has to catch up, and Jet can help with that. This will make the Walmart customer have a better experience on Walmart.com and on Jet.com after six months, a year of integration, but I don't see it winning over new business. This may help them as they lose sales in the store to their own website fulfill and keep those customers happy. That is an important step.
Shen: Something else that I wanted to mention too is I'm curious to see how they blend, how it really impacts Walmart because I know they I think it's called their shipping pass where you basically pay a flat fee for the year and you get two-day shipping, and this is really just very similar to Prime to be more competitive with Amazon with those really incredible fulfillment speeds, and how they kind of blend that with the fact that Jet.com has some of this infrastructure, some of this technology in terms of optimizing and making as cheap as possible for their shoppers and the smart card and everything.
Kline: That's why I say it ultimately has to be one brand. It seems crazy to me that you would make Jet.com the online version of Walmart, so that's not going to happen. Eventually, this will become a Walmart.com powered by Jet, and then Jet will be down in the corner, and then Jet won't exist anymore. Hopefully, they can integrate the technology because if they do, they have to get faster. Walmart has an incredible network. Amazon has its warehouses, but Walmart has a store in most of the country, something like every five miles. Their ability to ship to stores, to ship to you from a store, if they can figure that out, and obviously there's a lot of programming and algorithms, we've talked before about how Amazon knows what you're going to buy in a local warehouse before you order it, if Walmart can figure that out and Jet helps them, then maybe they bridge some of that shipping divide, and that will at least stop them from bleeding customers just because Amazon can get things faster.
Shen: I have to say, I just have to admit that I'm a little curious, too, to see, you have this small upstart company just hitting about $1 billion in their gross merchandise volume in their first, they've launched July 2015, so just about a year of existence, has Amazon kind of been paying attention, at the very least. Walmart jumps in, huge resources. I'm really curious to see where things go, even if the price tag may be a little high. Maybe hopes are a little too high, but overall, definitely an interesting deal.
Kline: It's definitely possible that this gets Walmart back on the growth path from ramping down to ramping up, but I think Amazon is watching this and laughing. This is not a competitor. This is my little league team challenging the Red Socks. It's not going to do that, but they can become a better No. 2. The other thing they can do is crowd out some of the other players. If I'm Amazon, I'm not worried. If I'm Target, I'm a little bit nervous. If I'm Kohl's, maybe I'm nervous. This is sort of Walmart saying, "We're in second place, let's consolidate." And almost any price is worth it to do that.
Shen: Thanks a lot, Dan, for your input here, and good luck with your drive for today.
Kline: I appreciate it, thank you.
Shen: Yeah, no problem. That is all from us today. You can continue the conversation via Twitter @MFIndustryFocus, or send us any questions or comments by email firstname.lastname@example.org, and of course, we have our other great podcasts from The Motley Fool that you can check out at Fool.com/podcasts. People in the program may own companies discussed on the show. The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell or sell anything based solely on what you hear on the program. Thanks for listening, and Fool on!
Daniel Kline owns shares of Apple. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com, Apple, Netflix, Time Warner, and Walt Disney. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Yahoo!. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.