A few weeks ago, Industry Focus: Financials host Gaby Lapera shared that her New Year's resolution was to buy five new stocks, one from each sector on the Industry Focus podcast.
This week, she's interviewing each show's host about which stocks from their sectors they think are good candidates for long-term investors. In today's Tech episode, Gaby talks with tech experts Dylan Lewis and Sarah Priestley about Shopify (SHOP +3.32%) and Facebook (FB +1.81%).
Find out what both companies do and how they make money, what makes them such compelling buys for long-term investors, some of their most important risks to be aware of, what investors should know about their growth horizon before buying in, and much more.
A full transcript follows the video.
This podcast was recorded on Feb. 10, 2017.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, February 10th, and we're talking tech, and desperately vying for Gaby Lapera's approval. I'm your host, Dylan Lewis, and I'm joined in the studio by Fool.com tech editor, Sarah Priestley, and the host of the Financials show, Gaby Lapera. So, Gaby, pretty awesome to have you on the show. I haven't done -- I don't know if Sarah has -- anything with you before. Do you want to give people a little background on why you're here?
Gaby Lapera: Yes. My name is Gaby Lapera, and I don't own any stocks. This is where you say, "Hi, Gaby!" [laughs]
Lewis: Hi, Gaby. This is your confessional?
Lapera: I don't own any stocks, and that's kind of pathetic for someone who has worked at The Motley Fool for a whole year and a half, almost two years, a year and three quarters. So, I made it my New Year's resolution to buy five stocks, one for each sector Industry Focus. Originally, I was going to talk to you guys off the air, and be like, "Educate me about your sector." But then we decided, why not do it live? So here we are. But I want to remind our listeners that this is not personal advice for me. Dylan is not going to say, "Hey Gaby, I know you like to slack off at work, so I'm pitching you Facebook."
Lewis: That would totally make sense, though. And, yes, I am picking you, Facebook. [laughs]
Lapera: So, this is more just, stocks that they like, potentially that they already own, and they think that everyone should have a little think about. This isn't personal advice for you, because Dylan probably doesn't know you. Maybe he does, probably not.
Lewis: Probably not.
Lapera: Sarah might know you. She knows more people.
Sarah Priestley: Potentially.
Lewis: Sarah has her eyes everywhere.
Lapera: Yeah, so, keep in mind, no personal advice. We also have some disclosure stuff that if you have listened to every other show this week, you can probably fast-forward the next 15 to 30 seconds while I tell you about it, because it's the same stuff you've heard on every show this week so far. The Motley Fool has a disclosure policy, and we must publicly disclose if a contributor has an interest in any of the stocks mentioned, which is any of us on the show. Additionally, Fool employees work under trading restrictions. We must hold stocks for at least 10 days, because we are not about that day-trading life. We also cannot write about a stock in the period of two market days before to two market days after purchasing or selling the stock, which means that no one on this show has purchased or sold any stocks that we're going to talk about today. Not a shock for me because I haven't bought any stocks yet. But very good on you guys for exercising self-control. [laughs]
Lewis: One of the things, before we get into the stock discussion, that I thought was really great about this week -- I don't know if you listen to the episode I did with Michael Douglass about New Year's resolutions, but we talked about the idea of having an accountability buddy on your resolutions. You, whether you realize it or not --
Lapera: I have 10.
Lewis: Ten, yeah. So, that was an expertly crafted resolution by you, because you basically outsourced all of the motivation to other people.
Lapera: Oh, no, I am an expert at that. That's management tier.
Lewis: So, if you're struggling to set up your resolutions even now or you're wondering how to get them done, take notes from Gaby Lapera, who managed to rope in 10 people to help her out with her stock buying decisions for 2017.
Lapera: I'm just very well liked around the office.
Lewis: I guess so. This is going to be a fun show. I think the idea of doing a theme week and having analysts pitch stuff is really awesome. To get us started, I think Sarah is going to go first in talking about Shopify.
Priestley: Yeah. I am very bullish, like a lot of Fools here, on Shopify. I would like to give you a little bit of background about the company and tell you what they do. I apologize if you already know.
Lapera: No, I don't actually. Tell me what they do.
Priestley: Shopify IPO'd in 2015 for $1.27 billion. Their current market cap is $4.9 billion, so, still pretty small. The company was founded in 2006 by Tobias Lütke . I think that's how you say his name. I'm very sorry if that's not how you say his name.
Lewis: That sounds right.
Priestley: So, he is now chairman and CEO, but originally the company was founded as a snowboarding company. But they found they couldn't find any online store software that would work for small companies at the time. You're talking around 2004, remember if we can. It was all for big companies that wanted to establish an online presence. There was nothing that was custom to small companies. So, they discovered this glaring hole in the e-commerce market, and they believed that future businesses will be created online and almost online only. And obviously, that was pretty futuristic of them. That's exactly what we have now, if you look at Etsy and a lot of other companies. So, in 2006, they launched Shopify. Lütke described Shopify as the only platform you need to build your empire. I would say, given their offerings, that's pretty true. The company has 325,000 merchants currently using their platform. There's mostly small and medium businesses, but there's some bigger names that you'll recognize. There's some Amazon web stores, Tesla, Johnny Cupcakes... Does anybody know them?
Lewis: The Boston chain? Yes! I know Johnny Cupcakes, having spent five years in Boston.
Lapera: That sounds like a mob member.
Lewis: Well, they're T-shirts, but also, it's kind of a cupcake place, too? It's something like that.
Priestley: I know the way that they present their T-shirts is that they wrap them and they give them to you in a cupcake box, which I think is pretty cool. If they do cupcakes, I will definitely sample them, too. [laughs]
Lewis: Yeah, that's a very popular joint on either Boylston or Newbury Street, but one of the main shopping strips in Boston. I don't know if they have any other locations.
Priestley: I'm there next weekend. I'll check it out.
Lapera: I'm not kidding. Johnny Cupcakes sounds like someone who will whack you.
Lewis: We'll take you out through the back, go see Johnny Cupcakes. [laughs]
Priestley: Wikipedia Shop also uses them, and the Los Angeles Lakers. But the important thing with this is that when you go on to these sites, you would not know that you are using the Shopify platform, and that's completely deliberate. Shopify says, "Our job is to make our merchants look their very best in every interaction they have with their customers," and I would say that's completely true. When you go on their sites, you have no idea. It's not branded with Shopify. They're giving merchants everything that they need behind the scenes.
So, what do they actually do? It's a cloud-based platform and it allows customers to add to the functionality that they need to sell on multiple platforms, so, web, mobile, social media, Facebook, Twitter, Pinterest, and even physical retail locations. They offer analytics in real time, and they really offer a plethora of things, but I'll just touch on a few. Sales analytics by channel and customer, Inventory management, discount and gift cards, order processing, customer management -- so, this is really data tilling to better understand your customer preferences and build relationships -- and, importantly, payment processing. In the U.S., Canada, the U.K., and Australia, that's fully integrated with their platform. Think PayPal, Square, those kinds of companies. And where it's not available, or the company has a preferred payment processing partner like Visa, which I'm sure you're very familiar with, the platform connects with those payment gateways seamlessly.
You can do it all by yourself if you're a merchant. You can set up online. Desktop and mobile, they have 150 customizable storefront designs, and they are optimized for SEO and social media. They also serve physical locations with point of sale. You get all the same integration with all of the analytics that you would if it was online. So, yeah, they make it super easy for you to operate as a small to medium business and grow to be a huge business, too.
Lapera: That was, I think, one of the most coherent stock pitches that I have received.
Lewis: I really regret letting Sarah go first.
Priestley: You're being too nice.
Lapera: Do you want to tell me about your company? I don't know if I need to hear about it, but... [laughs]
Lewis: [laughs] Before we get into my pitch on Facebook, why don't we talk a little bit about some of the things that Sarah likes about Shopify?
Priestley: The crux of my argument on Shopify is basically that it's a really comprehensive platform. So, you can grow from being a tiny start-up to a multi-billion -- no, multi-million. I'm pretty sure they don't have any billion dollar companies on there yet. But, they completely offer everything, and that cradle to grave functionality is incredibly rare, and I would say that is, probably, their biggest competitive advantage. The company is yet unprofitable, and that's something that you really need to bear in mind. If you invest in them, you're investing in their growth story. They intend to grow in two ways -- that's to grow the number of merchants that they serve, and to grow the amount of revenue that those merchants transact.
The last one is long-term instrumental to their success because it's symbiotic. If they can offer their merchants this full suite of products to make them successful, their ecosystem becomes super sticky, the customers are unlikely to leave. And as they grow, Shopify grows, which is the perfect recipe. So, Lütke is aware of this, and he frequently references investments to help merchants sell better. You often hear this, "meet merchants where they are" or "meet customers where they are." This is the definition of this. He says they have launched Apple Pay, [...] Messenger, and a brand-new Shopify app that lets merchants set up and run their entire business from their mobile phone. And this is what they've done recently. So, all these investments are to bolster the offering, continually, that they have for their customers, and to stay ahead of the game.
And as far as the opportunity to grow their base, their addressable market is absolutely phenomenal. According to a 2014 survey -- that sounds outdated, but it's the most comprehensive recent study -- there were 47 million small-to-medium businesses globally, and 10 million operate in Shopify's core markets. So, bear in mind, they have a little over 325,000 merchants right now. That is a tiny fraction of their potential market, in a really growing space. The e-commerce space grew 11% in the first half of 2016. Experts estimate that in just the holiday season, e-commerce is going to grow by 11% to almost $100 billion.
Lapera: That's crazy. I saw a study the other day saying that for every $4 spent in America, $1 is spent on Amazon in America.
Priestley: Amazon is the top dog in this arena, and Shopify is, I guess, a competitor for them, even though they share some similarities.
Lewis: And actually, for as much as we think about e-commerce being pretty ubiquitous and something that we interact with all the time -- I mean, I order stuff off of Amazon all the time -- its penetration is actually fairly low, especially worldwide. I think it's somewhere in the single digits or very low double digits. This is still, in a lot of ways, a trend that has a huge runway.
Priestley: It really does. And I feel like we're in the kind of cycle where small-to-medium businesses are being empowered, people are focusing on craft. If you look, Etsy, Pinterest, and those kinds of small organizations that are really fostering individual entrepreneurs, it's all working together. And I really feel like Shopify has the platform, as you can see, Tesla has their storefront with them, they can go all the way through the spectrum of different business sizes. So, personally, I think that what they offer is really compelling. And they increased their number of merchants 60% year over year last quarter, so obviously there's a lot of people that agree. Their merchandise volume 100% increase year over year. They're making some fantastic momentum.
Lapera: Are there problems, Sarah? Tell me the truth.
Priestley: There are problems.
Lewis: You want to talk problems now? Or do you want to talk problems at the end?
Priestley: I can talk problems at the end. I want to give you your moment in the light. [laughs]
Lewis: All right. Gaby, second half of the show.
Lapera: I'm ready.
Lewis: It is my turn to wow you. I don't know if you've ever heard of this company...
Lapera: [laughs] OK.
Lewis: ... it's Facebook. Formerly The Facebook. [laughs] But I'm guessing that you and many of our listeners are fairly familiar. For anyone who isn't, Facebook is basically the umbrella company for a bunch of different social platforms. Facebook, their namesake one, being the main one, but also Instagram, Facebook Messenger, another one of their main properties, and WhatsApp. So, really, this is a company that's looking to connect to people, build online engagement, create these communities and platforms where people can exchange content, exchange ideas, connect with each other. They finance all of that through advertisements. That's how they make the bulk of their money. So, if you want to look at how the numbers break down for them, advertising makes up 98% of the company's revenue as of the most recent closed quarter earlier this month. Within that, mobile makes up 84% of that revenue, and that's up 80% year over year. To give you an idea of the growth rate -- because this is a business that's kind of in a little bit of a different phase than Shopify -- they are, at this point, just under a $400 billion market cap company. Shopify, for comparison, is a $5 billion market cap company. Facebook posted Q4 year-over-year growth, revenuewise, of 51%, and on EPS (earnings per share), was 124% growth.
Lapera: That's incredible. So, Warren Buffett -- oh my God, I can't believe I'm doing this.
Lewis: Do it!
Lapera: I complained about, on every single show, someone said something about Warren Buffett, and now it's me.
Lewis: I heard you do that, so I intentionally wanted to leave him out of this discussion. Not that he would ever invest in Facebook.
Lapera: (groans) See, I love Warren Buffett. He's a nice guy. He actually lives in Nebraska. I lived near him at one point.
Lewis: You guys were practically neighbors.
Lapera: I drove past his house one time. But, no, Warren Buffett, one of the things that he talks about is, when a company gets really big, it's really hard for them to post astronomical growth. And that's pretty astronomical growth for a company that's really big already.
Lewis: Yes. Those are gaudy growth rates, and I think in the future, those will come down a little bit. We can talk about some of the reasons for that a little bit later on. But a lot of the reasons that I really like them as a company is in spite of the fact that they are already a $400 billion market cap company, roughly, they have a ton of growth coming their way, and there's a lot to really like with their business. So, I mentioned the revenue and EPS growth. But, if you look at their namesake platform, last quarter Facebook recorded 1.86 billion monthly active users, 1.23 billion daily active users. That's good for 17% and 18% increase year over year. So, think about the denominators that those are increasing on, it's kind of crazy. Also, to put the number in context, there's about 7 billion people in the world, about half of them have access to the internet, and about half of those people are on Facebook monthly.
Lapera: We also tape the shows on video, if you ever want to see what we look like, Dylan's eyes are twinkling right now. [laughs]
Lewis: Yes. I get excited. [laughs] But, the point with that is, what really drives a business for them is users coming onto the platform, so growing that user base, and having them spend more time on the platform, because those two metrics allow them to have more ads appear in people's feeds. So, when you see a business that already has a user base in the billions still adding more at a double-digit clip, I think that's pretty impressive. If you want to look at some of the growth opportunities for them with users, I think there's still some pretty big potential in the Asia-Pacific and rest of world regions. Most recently, those were up 25% and 19% year over year. So, a lot to like there. I will caution that, in terms of the average revenue per user for those regions, or the value of those users, the strongest markets adwise are U.S., Europe, and Canada, because the consumer buying power is the strongest there, so the ad rates are commensurate with that. So, those might not necessarily be the same value in average revenue per user, but there's still a very long runway in a lot of those markets.
Beyond Facebook's core platform, though, one of the other reasons I really like the business is the scope of their properties and some of the opportunities that that opens up for them. I mentioned that they have Facebook, WhatsApp, Messenger, and Instagram. Facebook, WhatsApp, and Messenger all have over a billion monthly active users. Instagram has over 500 million monthly active users. And a lot of those platforms benefit from what we call in tech the network effect. I don't know if this is something you're familiar with, Gaby, but the idea is, as each property grows, the value proposition for that property to users is stronger, and it's more compelling to non-users. So, if I'm on Facebook and Sarah is on Facebook and we're two best friends, you're probably going to want to join Facebook.
Lapera: Sure.
Lewis: Right?
Lapera: That's true, that's how I ended up on Facebook, that's exactly what happened.
Lewis: If that's how we're all communicating, if that's how we're all posting pictures. Exactly, you just get sucked into it. That's something that you enjoy when you have those critical masses of users like they have on all these different platforms. Something to be kind of excited about is, when we look at the company's financials here, really, Facebook and Instagram are the two properties that they monetize. So, I think we are more or less at full monetization with Facebook. There will be growth, naturally, with user base growth. But in terms of ad load, we're kind of at the saturation point there. Instagram, they're still rolling stuff out. There's still some ramp there. But with WhatsApp and Messenger, they're still in really early days. And those are properties that have, combined, 1.5 billion monthly active users. So, if they can crack that nut and understand how to monetize those users effectively, I think the growth runway is fairly long for those other properties. So, I think that's something to like.
The last thing that I really love with this business is they're managed in a very Foolish way. Mark Zuckerberg and Facebook's management really likes to think with a three- to 10-year outlook and approach. They're very good in their quarterly calls about keeping investors in the loop about what the priorities are for that roadmap. Most recently, they talked a little bit about three years, looking to improve and expand the community they have continue to grow users, and continue to double down on pushes like live video, things that will engage people in their feeds, get people to come to the platform and interact with them more. Five years out, the main priorities, and, over the next five years is how you can think about that, Messenger and WhatsApp monetization, doing some more work with video and search, things like that. And more broadly, in 10 years, I don't know if you've heard about internet.org, it's a non-profit that's largely funded by Facebook. That whole non-profit is aimed at growing access to the internet worldwide. Like I mentioned before, there's about three billion people that have access to the internet of seven billion in the world. Obviously, there's a lot of benevolence to wanting to make the entire world access the internet and have all the information and agency that enables. As those people come online, there's also the element of, well, they're probably going to be fairly familiar with Facebook. So, the 10-year plan for them is to continue to grow access to the internet and bring those people into their ecosystem as they do. Some of the other stuff that they're targeting, which is a little bit farther afield from their current businesses but could be really interesting down the road, is investments in artificial intelligence. Right now, a lot of that is being used to tailor their news feeds and really provide people with the content that's most relevant to them. Then, they've made some splashes into virtual reality. I don't know if you heard about the acquisition of Oculus a couple years ago?
Lapera: No. [laughs]
Lewis: Well, it's a little different than what they typically do, getting into hardware and virtual reality. I think the market there isn't nearly as clear, and it's not really certain what the opportunity will be, or what adoption might be for consumers. But that's another field that they're playing in. With all of this long-term thinking, at the end of the day, it's going to be Mark Zuckerberg's show to run. The company and management has been very clear in setting themselves up so that he will maintain his controlling stake in Facebook. A little while back, they announced that they wanted to do at 3:1 stock split. What that will basically do is give existing shareholders two class C shares for every A and B they own. The class Cs will be non-voting, and Zuckerberg will be able to give away, via his charitable efforts, the C shares, and maintain his super-voting B shares and control of the company. So, you have a management that thinks long-term, and you have the corporate set up where they are going to be able to continue to think long-term without really having to worry about any major shareholder coming in and pushing them around. So, I really like that as well.
I've been talking quite a bit, so I think maybe, it might be time for us to open this up a little bit, talk concerns or any questions that you may have about some of these businesses.
Lapera: I have questions. I have so many questions. And if you guys think of any questions for each other while I'm talking, feel free to jump into the fray. I think it gets boring when one person talks for a really long time.
Lewis: Yes, I can take a hint. [laughs]
Lapera: [laughs] But, no. Sarah, Shopify versus Etsy, can you explain the difference to me?
Priestley: Etsy is a marketplace platform. Think about eBay, but more specifically niche to crafts and things like that. So, essentially, you rent a store or you have a store, and they take a percentage of the transaction. This is completely different in the sense that Shopify is what you would have if you wanted to have your own brand.
Lapera: So, you're hosting your own content.
Priestley: You're hosting all of your own content, it keeps you complete control, you can track your sales, you get all of that back-end facility, and it's the payment processing, too, which is actually kind of tricky for companies to establish by themselves. There's a lot of fintech companies coming into the space now, as we know, as you know probably better than us. But, yeah, that's probably one of the key things the company offers.
Lewis: And, actually, on that point, I think there might be a lot of people who test out early concepts for craft-oriented businesses or niche businesses within Etsy, and then realize that there's traction there, and then switch over to a Shopify because the offering is stronger and they want to be able to build themselves out in their internet presence.
Priestley: The other thing that Shopify does is they have a buy button. I don't know if you use Pinterest or Etsy, but there's a buy button, even on Twitter. And Shopify embeds those, and that's another thing that they offer.
Lapera: Another question: Does Shopify take a percentage of the sales, or are they just making money on licensing fees?
Priestley: No, they take a percentage of the sales. That transaction volume, they're taking a cut of the transaction volume.
Lewis: So, that's a business that scales as the customers succeed, which is nice. You have the growth of acquiring new vendors, but you also have, as those vendors scale and become increasingly larger businesses, them enjoying the business success as well.
Priestley: That's the merchant solutions revenue. That's fees from sales, and that was up 115% last quarter.
Lapera: Last question: Remind me of someone, a customer, that uses Shopify.
Priestley: Tesla.
Lapera: Tesla.
Lewis: Gaby is punching Tesla into her computer.
Lapera: I am looking them up. There's a shop button, which I just clicked on. You can buy a very sexy leather jacket and charging accessories.
Lewis: It's pretty slick.
Lapera: I would have no idea that Tesla didn't make this themselves.
Priestley: Absolutely, and that's the whole point. The whole point is, they're empowering merchants. And they're really making it hard to leave, because it would be difficult for customers to move away and replicate that exactly as it was before.
Lapera: That interesting. I wouldn't have expected Tesla to rely on a third party. It's not like they don't have the tech expertise to make it themselves.
Priestley: Yeah, but it can save companies a huge amount. One of the reasons that Shopify is unprofitable is stock-based compensation. The reason that a lot of tech companies use stock-based compensation is because they don't have much money at the time, and they use it to attract talent. And a lot of that talent is developers and tech people. So, if anybody out there is about to make their college choices, think carefully about the tech space. So, yes, that's one of the things that use, and if a company can outsource, essentially. And it really is pretty idiot-proof. I mean, bless him, my husband set up -- [laughs] no, I'm kidding. He's very intelligent. But it's a very easy platform to use. And if they don't have to hire somebody to do that, that's a cost saving on that point.
Lewis: Shopify's tag line could be "let us do the share-based compensation for you." [laughs]
Priestley: [laughs] It really could be.
Lapera: That's really funny. I had dinner with a friend last night, and she was saying that she has been offered a job where a lot of it is share-based compensation, and it's for a company that hasn't had an IPO yet. And it's like, "Well? What do you do there?"
Lewis: Do you like their prospects?
Lapera: I don't know. I think it's actually a company that you have probably talked about. Uber.
Lewis: Interesting. We will couch that for another episode.
Lapera: Anyway. I mean, we could do a personal finance crossover episode, Should You Accept A Job With Share-Based Compensation?
Lewis: It could be something for Motley Fool Answers.
Lapera: That would be a great idea. Questions for you now. Unless you have any questions for Sarah?
Lewis: No, I'm not going to cross-examine her. [laughs]
Lapera: You said 98% of the company's revenue comes from ads. Is that a problem with people increasingly using ad blockers?
Lewis: It depends. When you look at desktop traffic, yes. That said, a very small portion of internet browsers use ad blockers. But I personally use Adblock Plus, so a lot of ads that would be popping in, whether they be through Google or through Facebook, don't appear. But, when we're talking mobile and the shift to mobile, and I talked about how 80% of their ad revenue was coming in via mobile at this point, because people are coming to Facebook on mobile via the Facebook app, that is a walled garden that mobile ad blockers cannot get into. So, that is not something that is impacting most of that traffic. And because general consumer trends are pushing that way, it's not something that I'm super worried about.
Lapera: Interesting. I had not thought about mobile ad blocking it all. I'm not sure how that would work in the ecosystem of your phone. I do have a question about, you talked about them expanding, how they only have a seventh of the world's population using their platform. But there are countries where there is no Facebook. China, for example, they have their own social media platforms. Do you think that would be a problem in any other setting for their expansion? Do you think they would just buy those companies?
Lewis: No, I think that's a legitimate risk. One of the things that, in addition to these regional upstarts that we have, the idea of demographic shifts maybe pushing people out of Facebook, or having them not come in to Facebook, is something that I'm a little worried about. I think about how, Facebook has been in the U.S. for 10 years at this point. In the tech world, that's an eternity. That's a long time. You think about how you might have looked at Myspace or something back in the day and been like, "Ah, I'm not a part of that," and instead gone to Facebook. I think there's the risk not only internationally of their being more entrenched platforms that are specific to certain countries, maybe, and have really great traction there, but I'm a little bit more worried about people that are coming onto the internet now, younger folks, maybe early teens, looking at the offerings that are out there in the social networking world and instead deciding to go with maybe Snapchat, rather than going to Facebook, because they see Facebook as this old, dowdy --
Lapera: It's an old person thing.
Lewis: -- internet relic. Like, "Oh, my parents are on Facebook, I don't want to be on Facebook."
Lapera: My grandma is on Facebook. [laughs]
Lewis: Both my parents are on Facebook. I'm not friends with my dad. Interesting. [laughs] But one of the things I'm really excited about with that is, Snap will be going public. So, we will be getting some color on their business and customer acquisitions, hopefully. You can watch those two track each other. To mitigate some of that, Facebook has been pretty good recently about bringing in Snapchat-style functionality.
Lapera: Like Facebook Live, right?
Lewis: Kind of.
Lapera: Is that a thing?
Lewis: Facebook Live is a thing.
Lapera: I've seen that advertise on bus shelters.
Lewis: Yes. They are pushing that like crazy. But the Snapchat-style functionality of stories and little posts and things like that that are disappearing, that is...
Priestley: [laughs] Who does that remind us of? I don't know...
Lewis: [laughs] Yeah, right? That is being brought to the Instagram and Facebook Messenger platforms. So, I think they're seeing what resonates with people and bringing it there as a point to attract them to these platforms. That was a roundabout way of answering your question.
Lapera: No, that was a really good answer. That made me think about things that I hadn't thought about before, so I really appreciate that. My last question is actually about internet regulation. This is for whoever wants to answer it, I guess, but you made me think of it when you were talking about the 10-year plan to get more people on the internet. In the past and likely again, there have been bills that talked about internet throttling and stuff. That could be a problem for online businesses. What do you see? Do you see potential future regulations as a problem? Do you think we're moving away from that as a society? This is a touchy-feely question, I know, but I'm interested in hearing your opinions on this.
Lewis: When I think about regulation and Facebook's 10 year plan, I tend to focus on the net neutrality side of the internet.org offering.
Lapera: Do you want to explain net neutrality really quick? It's complicated.
Lewis: Absolutely. Net neutrality is basically a free and open internet, and the idea that people are not getting restricted versions of the internet, or censored versions of the internet. Some of the push back that Facebook has met with in India when they were trying to roll out internet.org there and build out connectivity is, the suite that is part of internet.org is basically, you have access to these at the time, it was like 30 or 40 platforms, and they were a mix of messaging, social networking, job hunting, news, that kind of stuff. But it was a curated package of all these different internet properties. And the regulatory push back they got was, "Well, that's not the internet. That is a hand-picked version of the internet. If people come online and see that, they might confuse Facebook for the internet, and that's it. And they might not realize that there's all of this indexed world out there that they can explore, and it might lend itself to some monopolistic forces." I think, with the big tech pushes from Facebook, and Alphabet is getting into this as well, the benefits from having more of the world connected probably outweigh the competitive risks of having it being pushed by major tech titans that have an interest in staying entrenched in that space. I think those will probably win out. They might have to do it in a watered-down way that gives people more access generally. But I'm more worried about the net neutrality side of stuff than internet throttling, if that makes sense.
Lapera: No, that's totally fine. It's an interesting thing. And every time it has come up recently, it has been defeated. But there's a new administration, we'll see what happens.
Lewis: And the domestic side of that is a whole nother host of issues. We could spend a whole episode on that. [laughs]
Lapera: There you go. Do you have anything you'd like to say about that?
Priestley: No, I completely agree. It's interesting because back home in the U.K., there's a lot of companies threatening to leave because the actual internet infrastructure isn't as good as they would like. So, you have those issues, too, which I realize is separate from that big macro issue. But, I would say the U.S. is in a particularly good place with the wireless and online infrastructure.
Lapera: Yeah, it was wild, I studied abroad in Australia for a few months, and this was many years ago, many many moons. It was wild because here, there was wifi on campus everywhere, and you paid one set amount and you had access to the internet. And sure, you could pay more for faster speeds. But there, you literally paid for how much data you used. The more data you wanted to use, the more you had to pay. Here, it's the faster, the more you pay, but they don't put a cap on your data, in theory, for your computer internet. It's interesting.
Lewis: And not to plug Facebook again in this conversation --
Priestley: You know, I feel like you're getting a lot more airtime. [laughs]
Lewis: Speak up, then. [laughs] But with the focus on mobile, and that being where a lot of their revenue is coming from, most people first come online, in a lot of developing areas, via mobile devices and not desktop.
Lapera: Which do have data caps.
Lewis: Which do have data caps. But there's also data caps and very often wifi connectivity. So, you have two ways to approach. That's another thing to think about. Anything you're worried about with Shopify, Sarah?
Priestley: Yes. As I said, I'll be really quick about it, but the big thing to bear in mind, and obviously, we always encourage everybody to do their own background and stuff, but the company is not profitable. They lost $9.5 million in the third quarter despite making really healthy gross margins. They had 79% on their subscription business, 26.5% on the merchant solutions, but a negative net margin of 10%. We're $27 million last year to date. And the reason for that is SG&A, which is sales, general, and administrative costs and stock based compensation. I will say, SG&A is trending down as a percentage of revenue. It was 84% in 2012, it was 58% in 2015. I will caveat that by saying that 2016 is probably going to trend up slightly. Again, stock based compensation, we've already talked about it. It's regular, it's a usual thing to see for these high-growth tech companies. But we are starting to see some companies pull back especially in the cyber security sector and things like that. So, it's something to be mindful of. Liquidity, they're carrying debt. I wouldn't worry about their debt ratio. In terms of valuation, obviously, they don't have any earnings, so traditional metrics like P/E, we can't use, but price-to-sales is 13, and it's 3.9 average for software and services. If you take Square, which we referenced, I don't know how familiar you are, but it's kind of a similar payment processing, theirs is 10. So, it's not crazy, but you're going to pay a premium for the growth story here.
But, the bottom line is, it's exactly what you're paying for, it's potential growth. And honestly, Dylan, you've made such a compelling argument for Facebook. They really do have a lot more growth left in them, and it's a safer, more stable long-term bet. I honestly believe that this has a long way to go because I think the platform is just so compelling, and there's so many more entrepreneurs coming onto the market, there's a lot of innovative solutions that are being developed. Even it could convince large companies to switch to its platform, too. So, yeah, that's my pitch. Bear in mind the fact that they're not profitable, so valuing them is tricky, and you really have to convince yourself about the stewardship and the growth story.
Lapera: OK. I know that I'm going to go home and check on their debt, because I'm wild about debt. It's just a side effect of having been on the Financials show so long, but I'm just like, what is it? What's the interest rate? In what form is it? I want to know. [laughs] But, I'm not going to pelt those questions at you. I do have a question, though, which is, do you own Shopify?
Priestley: No. But I will soon.
Lewis: It's on Sarah's watch list.
Priestley: It's on my watch list. It's kind of pricey right now. I think it's $50 a share. It's been on a bit of a tear. My personal expectation for this next quarter is that the SG&A is going to track up slightly, and I'm wondering if that's going to have an effect on the share price. They report next week at the end of the week. I am going to buy shares, because I believe they have a lot of potential. I would love a low entry point, but we shall see what happens.
Lapera: Same question for you. Do you own Facebook?
Lewis: I do. Michael Douglass and I did an episode about two or three weeks ago talking about Facebook in depth, and after the necessary compliance period ended, I bought shares because I had convinced myself of buying shares. And I had to be very careful in planning this show and that show to make sure that I was in a window where I was in the clear. In the interest of painting a full picture here, there are some other concerns that I have in addition to some of the other demographic stuff with Facebook, and I think it's worth mentioning. As I talked about before, that 50% growth rate is super appealing for their top line. Management has guided that that is going to come down considerably in 2017. One of the main reasons for that is, ad load has more or less reached full saturation on the Facebook feed itself. So, that's one of the main drivers of that. So, I don't know exactly what that's going to look like, but don't expect the company to continue to be growing 50% year over year. It might drop down into the mid 30s, I'm not 100% sure. They're not a very guidance-oriented business, so it's a little tough to peg. But given some of the other opportunities, even if what goes on with Facebook itself is kind of relatively steady state, I like the story there.
Some of the other risks to consider with monetizing Messenger and monetizing WhatsApp, they're both messaging apps. And the way that user interact with the messaging app is fundamentally different than the way someone goes to Facebook or Instagram. Those are both feed-based content styles where people are naturally going to be scrolling down their phone, and in-line ads are a very natural part of the user experience. So, they've done a great job monetizing platforms in the past. A lot of people doubted that they were going to be able to make mobile work, and that's why they traded down in the 15s at one point. But the messaging apps are a slightly different animal, and it's going to provide a unique challenge to management in order for them to really monetize it. So, I think that's another risk to be mindful of.
Lapera: Fair enough. I think that we're running pretty long.
Lewis: Long episode.
Lapera: Long episode. I think it's time to wrap up. As I said, listeners, I'm going to go home and do some research on all the companies I've heard about this week, and I'll talk about what I've decided to buy eventually, once I can buy it.
Lewis: No rush. Do your research.
Lapera: No rush, exactly. It takes me a year to find the perfect pocket knife. I can't even imagine how long it's going to take me to decide on stocks that people have already done about 70% of the work for me on. [laughs] But, no, I do have one question which I've asked everyone on the show so far, which is, if you could give one piece of advice to a beginning investor, what would it be?
Priestley: Read earnings calls. I think it gives you a really good flavor of the management. There's no better way to thoroughly understand the business and how competent a lot of the people in senior leadership are.
Lapera: That's absolutely true. There's been a few times that I've read earnings transcripts, and I'm just like, "Man, that guy sounds sketchy," and then a few months later some scandal happens and I'm like, I knew, because I read their earnings transcript.
Priestley: When you're in tune like that, definitely read the earnings calls.
Lewis: Wow. Expert judge of character. Who knew? I think my advice, similar to Sarah's, in the idea of understanding what's going on with the business. But don't just look at the number and cite the number. Understand the forces that play into the number, and what might be causing it. So, you get a lot of that color from the commentary on the conference calls. But, early on, when people are learning to invest, you'll see them and be like, "Oh! This is the P/E, so it's undervalued!" And I think that, really, you want to understand all the mechanics at play, and what's driving the business, because you get a much better sense of what's going on that way.
Lapera: Got it. So it's not just understanding what the ratio means, although that's very important, it's understanding what's driving the ratio, and understanding the ratio in context.
Priestley: The context of the industry is probably the biggest thing I learned when I started.
Lapera: Well, thank you guys so much. This has been a very, very substantial conversation. [laughs]
Lewis: Are you wiped after doing five episodes this week?
Lapera: Super wiped. But I was really pumped when I came into the studio and discovered Munchkins, the little donuts.
Lewis: Gotta love Chris Hill/hate him.
Lapera: The blueberry ones are the best. I know it's a super-fake blueberry taste, and I'm really into that.
Lewis: Are there any left in the box?
Lapera: Oh my God, yeah!
Lewis: Gaby shakes the box. I think, at this point, we can wrap the show?
Lapera: Probably. Do you want to do it, or should I?
Lewis: I'll take us home. Well, listeners, that does it for this episode of Industry Focus. If you have any questions, or if just want to reach out and say hey, you can shoot us an email at [email protected], or you can always tweet us @MFIndustryFocus. If you're looking for more of our stuff, you can subscribe on iTunes, or check out The Fool's family of shows at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Gaby Lapera and Sarah Priestley, I'm Dylan Lewis, thanks for listening and Fool on!
