In this episode of Market Foolery, Chris Hill is joined by Motley Fool analysts Aaron Bush and David Kretzmann as they look into the perhaps irrational exuberance around the Snap (NYSE:SNAP) IPO and how leadership at the company may be its secret weapon going forward.
A full transcript follows the video.
This episode was recorded on March 2, 2017.
Chris Hill: What a day -- Snap has gone public. If you're an investor, this is like Christmas and your birthday and the 4th of July all wrapped into one.
David Kretzmann: This is it.
Hill: Let the mania begin. We're going to talk about that in a second. We're also going to talk about the latest earnings from Shake Shack and Monster Beverage. Let's start with Snap. Snap goes public at $17 per share. It opens for trading to regular investors like you and me at about $24.50. If you're scoring at home, that's a 46% increase right off the bat before regular investors can get in. At that point, Snap's market cap is $33 billion, which puts it in the top third of companies in the S&P 500. I don't know where to begin, David. This is, partly, madness. It's certainly exuberance, this is what exuberance looks like. This is also what it looks like when you haven't had a tech IPO in a couple of years.
Kretzmann: Yeah, I think people are excited. This is one of the bigger IPOs, certainly, in tech, that we've seen in a couple years. So Wall Street is clearly excited today. All rationality is going out the window for a day or two, most likely. It's interesting to take a look at how Snap today compares to Facebook before the IPO. Obviously, Snap is a younger company going public today than Facebook was at the time it went public in 2012, but there are some similarities here, where you can see the opportunity or potential for Snap. It's still more of a stretch, I think, for Snap to succeed from here and really reward investors. But just looking at something like average revenue per user. At the time Facebook went public, its average revenue per user was $1.21. For Snap, it's $1.05. So, pretty close there. The main difference for Snap, and the reason the company is losing a ton of money right now and its losses are increasing, its cost per user is above $2, while Facebook's cost per user was more like $1.25. So, Snap now has even higher expectations. Whether or not the company can become profitable is something that they themselves question in the S-1. They say, "We might not ever be able to reach profitability." So, there are certainly a lot of question marks with Snap. It's a riskier company, very high expectations, and still a very limited operating track record that investors can work with.
Hill: I suppose you have to give them bonus points, Aaron, for just coming out and saying, "You know what? We might never be profitable."
Kretzmann: At least they're admitting it.
Aaron Bush: I do think that cost per user number is something that's going to prove to be one of the most important metrics that investors need to be looking at. When I read through the S-1 prospectus, I was starting to piece together that what management thinks is their competitive advantage isn't really the network that they have built, it's not necessarily the uniqueness that Snapchat has created, but rather it's their ability to innovate rapidly and always be one step ahead of the competition. And that's a very different kind of story than you hear from other social media companies. Twitter is "we are live". Facebook wants to connect the world and that kind of thing. On one hand, this is good, because it's going to keep Snapchat out of the trap that Twitter fell into where product innovation stalled. If anything, with Snapchat, we've seen an acceleration in the number of new features and stuff that they have thrown out. So that will help them, definitely, stay relevant and improve engagement, and that engagement should lead to higher revenue per user and that kind of thing. But that does come at a cost. And that's just yet another hurdle to overcome. And when Snap says that they're a camera company ...
Kretzmann: I cringe.
Bush: That's their leading statement for everything, "Snap is a camera company." It's like, what?!
Hill: It's like, why are you saying that out loud?
Kretzmann: Wasn't Kodak a camera company? How did that turn out?!
Bush: So, I think that's an important thing to be thinking about, what exactly that means. I think for Snap, that means that the evolution of the camera is real, and Snap is driving that. It means that software is playing a bigger and bigger role in what camera technology is doing in connecting people, and having people engage with each other on a mobile basis, augmented reality filters, all that kind of stuff. But it also means that they're probably going to be stepping more into the hardware game. They've already done that with Spectacles. I still don't really know what I think about that.
Hill: The Spectacles are literally just glasses.
Kretzmann: Glasses you wear, they take the 10-second videos that automatically upload to your Snap account. They cost $130. So, it might draw some comparisons to Google Glass. But obviously much more affordable, has a much more direct use case. So far, I think you have seen broader adoption, even at this early stage, compared to Google Glass.
Bush: Yeah, and I think Evan Spiegel in general has constantly been an underrated CEO. He probably is a really brilliant product guy. So, for Spectacles, that obviously is a better thing than Google Glass was, and I think we will probably see the hardware portfolio expand, as well. I don't really know what that's going to look like. But I get the sense that things are going to be moving more in that direction as well.
Kretzmann: Yeah, design and innovation, that's the name of the game for Snapchat. And like Aaron mentioned, I think a lot of that starts with Evan Spiegel, who does have a very solid reputation of being a designer and an innovator, a product guy, in Silicon Valley. But I take a step back and I think, there was a reason that Facebook and Mark Zuckerberg were very interested. At first, they tried to compete with Snap. Zuckerberg actually flew down to Los Angeles in 2011 and met with Evan Spiegel, and he said, "Here's what I would do if I were Snap, and by the way, Facebook is going to try to do this." And then, a year or so later, Facebook offered $3 billion to acquire Snap. And Spiegel and Snap turned it down without thinking about it, and they got a good amount of heat from investors and the press for that. And here they are worth 10 times what Facebook offered for them a few years ago. So, there is something there, especially with Spiegel.
I think that leadership factor is a huge piece of the valuation today, and those high expectations for Snap. And Chris, you and I were just at the member event that we had an Arizona, and you talked to Brad Stone, whose new book The Upstarts looks at the early days of Airbnb and Uber. And there was a quote that I thought was very relevant to how to think about Snap. This was a quotes from Fred Wilson, who was an early Twitter backer who passed on Airbnb, and he said that his mistake -- this is his direct quote: "We made the classic mistake that all investors make -- we focused too much on what they were doing at the time, and not enough on what they could do, would do, and did do." I think with Snap, you really have to look at the bigger picture. This is expected to be the first year where digital advertising spend exceeds TV marketing. That's a pretty big milestone, if that does happen this year. And Snap is really trying to capture those dollars that are shifting from TV advertising to digital advertising, trying to reach that audience of 18 to 35 years old, which is really Snap's bread and butter. So I can see where the company is in a really interesting position. They have some tailwinds, potentially, behind their back. They have a very innovative CEO. But yeah, the costs are very high, they're expected to keep going higher. So the company probably won't make money for a long time.
Bush: Yeah, and to give some final perspectives, on a numbers basis, when Facebook IPO'd, it came out with pricing about 28 times sales. Twitter was priced at 56 times sales. Snap, right now, at $33 billion, is about 80 times sales. [laughs] That's a high number. I would also keep in mind that today, Twitter, just to keep the comparison going, has $2.5 billion in sales, which is about eight times what it had when it IPO'd. And the stock, today, is trading for significantly less than it was when it IPO'd. Where it is right now, about $11 billion, is one third where Snap is right now. So, Twitter made all that progress, but here Snap is in the same boat.
Hill: Would you rather have all of Twitter or one third of Snap?
Kretzmann: I'd actually probably go with one third of Snap right now. I would take that gamble on Spiegel. I just like the leadership and the vision of Snap a lot more than Twitter right now. It's obviously a riskier bet, but I think Snap, right now, with the leadership, is a bigger idea than Twitter.
Bush: I'd take Twitter, but getting creative, I think if I can take 100% of Twitter, you can have some more control, and then I could make a deal to figure out how to work things out with Snap.
Kretzmann: Aaron Bush, new CEO of Twitter.
Hill: There are worse ideas. Let me go back to Spiegel for a second, just because here at The Motley Fool, one of the things we focus on is leadership. There are a lot of people going into this IPO -- speaking of Facebook and Twitter -- using those two companies as comparison points. Like, this could be the next Facebook. It could also be the next Twitter. People are saying that not as a compliment, in terms of the IPO. As you said, Aaron, Twitter's value today is about one third less than it was on the day that it went public. But, if you think back to when Facebook went public, there were questions about Mark Zuckerberg. Completely fair questions about both his age and his experience. That's where I think the comparison to Spiegel is apt. As I said, these were fair questions. Here's this young person. What kind of public company CEO is he going to be? I think that's the thing we will only find out with time. With the case of Facebook and Zuckerberg, you could point to people like Sheryl Sandberg, or other people in the management team, also a bigger and more mature company at the time. But you could see other people and say, "OK, whatever kind of public company CEO Zuckerberg turns out to be, he has some other steady hands on board there." I don't know who else is on Evan Spiegel's management team. We will only find out in time what kind of public CEO he's going to be. But I think it's perfectly legitimate to say -- and I agree with you, Aaron, he's underrated. To this point, I think Evan Spiegel is not getting quite the credit he probably deserves. But now, it's a brand new ballgame because they're a public company, and they're going to get a report card in three month, and we'll see how they do.
Kretzmann: Really, the main thing that Snap has going for it right now certainly is not its financials. It's leadership and vision. I think the company didn't even start making any revenue until 2015, so just a couple years. That's a very limited operating history. And they have been scaling that revenue pretty quickly. But that's not a whole lot to go off of. I think it really does come down to the design, the innovation of Spiegel and that vision. And obviously, Wall Street bought into it on the roadshow. But that, right now, is really the main thing investors have to go off of. So that's one of the reasons it's a riskier bet today.
Hill: All right, let's move on to Shake Shack. Fourth quarter revenue grew more than 40%, and that's great, until you realize that a lot of that, Aaron, is from new locations opening up. Their same-store sales, just 1.5%. That's not going to get it done.
Bush: Yeah, that's pretty normal, it seems, these days. But when you realize that last year, it was 11%, that's a pretty substantial deceleration. I think, for the most part, this quarter it was pretty good. The top line was moving in the right direction. That is probably the number one thing investors would want to see. It's still profitable. They just launched a mobile ordering app, which is, I think, David and I were talking about, we wish some other companies would do that. So, they might be a little bit ahead of the game here, which is a good thing. My issue with the Shake Shack is how much optimism is based into the price.
Hill: There's a little less optimism today.
Bush: Yeah, a little less optimism. But still, even compared to a few months ago, it's still not that different.
Kretzmann: It's 70 times earnings, still.
Bush: Yeah. So, when I see same-store sales dramatically decelerate, labor costs go up and squeeze operating margins, franchising isn't moving the needle, and that's a big part of their strategy now internationally. Competition in the burger space is about as rough as it gets. And I think that as they expand, they'll have more issues standing out. But I think, perhaps, most importantly, there's a pretty wide discrepancy between what's priced into the stock and the economic reality. Just a few numbers, each store, on average, delivers $5 million in revenue. But the market is pricing each store at about $20 million. So, take that for what it's worth. That doesn't entirely include all of the licensing stores, but it's hard to do apples to apples on that. So, that's very aggressive. If you look at the entire system, management has guided investors to expect $1.12 in earnings per share by 2020, which is kind of specific. But right now, Shake Shack is trading at 32 times that, and that is expected to come in two or three years. That's aggressive, and it makes me a little hesitant.
Kretzmann: They did raise their sales guidance for this year by 0.03%, though. Let's not overlook that.
Bush: Wow. Give them some credit.
Hill: I'm going to give them just a tiny bit of credit for that, because when you look at restaurants in general, I'm going to grade them on the curve in that regard.
Kretzmann: At least they're guiding higher.
Hill: Yes, ever so slightly higher, but higher nonetheless.
Kretzmann: The opportunity here with the Shake Shack, right now, they just have 114 locations. Seems like a concept that could be quite a bit bigger than that. So I think that is part of the reason investors are comfortable paying a higher valuation. Some other things I really like with Shake Shack that a lot of other restaurants are in this position, especially smaller concepts like this, they're already free cash flow positive, they have almost $75 million in cash, and no debt. So, they're able to open these new stores through their own cash. They don't have to go into debt, they don't have to issue stock. That's an attractive position, that's a similar position to what Buffalo Wild Wings and Chipotle were in 10 years ago or so. But, certainly, the premium that Shake Shack is commanding today ... you need to see some stronger performance within those locations. But you do have to give the company somewhat of a break, because restaurants have had a very difficult past couple years. But still, 1.5% comps isn't going to get the job done.
Hill: We were talking about Domino's Pizza the other day, and the numbers that they've been putting up. I threw out the question, restaurants are struggling, is part of the reason that restaurants are struggling because companies like Domino's Pizza are making it really easy for people not to leave their homes?
Kretzmann: Everyone who's going to Domino's, yeah.
Hill: Right, that's the thing, they're getting Domino's to come to them.
Kretzmann: Yeah, because Domino's same-store sales in a quarter that has been brutal for most restaurants, even pretty solid concepts, Domino's same-store sales --
Hill: Over 12%.
Kretzmann: Yeah, incredible numbers. And that's an acceleration from the past couple years. So, restaurants need to take more notes from Domino's, because the streak that they're on is unbelievable.
Bush: That's domestic?
Kretzmann: That's domestic.
Bush: Oh, wow.
Hill: From food to beverage, shares of Monster Beverage up 14% this morning after strong sales in the fourth quarter. David, a lot of that is going to the bottom line, too. Just in terms of this latest quarter, their profits look good.
Kretzmann: Energy drinks are hot sellers, and I think Monster still holds the honor of being the top performing stock over the past 20 years. I looked it up, any guess over the last 20 years how much that stock is up?
Hill: Wait a minute, I'm sorry, it's the number one stock for 20 years?!
Kretzmann: I know this was true last year, and based on the numbers I pulled up, I don't think there's any other stock that's overtaken that mark.
Hill: I can't even begin to guess.
Kretzmann: 238,850% over the past 20 years.
Bush: What?! How? That's ridiculous!
Kretzmann: Right now, Monster is trading at about $48 a share. 20 years ago, it was trading at the equivalent of $0.02 per share, so just a couple of pennies could have but you a share. There have been numerous splits and stuff, but it's pretty incredible performance. Energy drinks have done wonders for the company and for investors who managed to hang on through that.
Bush: That's ridiculous. I don't follow this as close as David does, but I have to say, every time that I think that a company is decelerating for good, or that things are going to slow down, as soon as I think that, the next quarter they just reaccelerate all over again, and raise guidance. Coca-Cola (NYSE:KO).
Kretzmann: Yeah, that really is the story with Monster. A couple years ago Coca-Cola took a stake in Monster. Coca-Cola basically said, "We're done competing in the energy drink space. We're going to give Monster the few energy drink brands we have." And now, Coca-Cola owns about 17% of Monster. Over the past couple years, each quarter, Monster will transition over to Coca-Cola's bottlers and distributors. This quarter, they transitioned to Coke's distributors in Brazil, Costa Rica, Panama, so, increasing that Latin American presence. They launched in China, in a couple areas like Shanghai, Shenzhen, a few others. They're expecting to continue that expansion into China and India in 2017. So this is really a story of Monster getting their product in front of more people. Once they do that, whether is in Africa, the Middle East, Asia, Latin America, or even in the U.S., they manage to sell more. It's just a very attractive business model. Right now, they have $600 million in cash, no debt. They're producing well over $100 million in free cash flow each quarter. So it's just a very solid, high margin business. It's been incredibly well run by Rodney Sacks, who's been CEO since 1990. He's been a big piece for that incredible performance of the stock and the company. They also are trying to get into this super soda category. I hadn't realized that Mountain Dew commands a lot of presence and a lot of market share in that category.
Hill: What constitutes super soda? Highly caffeinated?
Kretzmann: It's highly caffeinated soda. It's not strictly an energy drink, it's not strictly a soft drink. It's somewhere in between there. It's just a little bit more radioactive, I guess. But Monster, late last year, they launched Monster Mutant, which really does look radioactive, it's this really food color-y green and red color. But apparently it's selling pretty well initially. Then, you also have lines like Java Monster, which is the coffee drink that competes more with the Starbucks prepared beverages.
Hill: For those of us who don't get enough caffeine in our coffee, we can just grab a Monster.
Kretzmann: And that's the thing. You would think that with health concerns and the headwinds against soda, you wouldn't expect energy drinks to be doing pretty well. But between 2011 and 2015, the energy drink category in the U.S. almost doubled. This is actually a category that continues to grow. You have those tailwinds behind Monster, they're trying to get more market share from Red Bull and become the dominant energy drink brand in the U.S. and the world. And now with that they have Coca-Cola's distribution model, that whole system, that should continue to play to their advantage. I think there are still a lot of reasons to like this company going forward.
Hill: And that's the thing. You think about Coca-Cola, which is, in some ways, the quintessential American brand. And yet, from a business standpoint, the overwhelming majority of sales of Coca-Cola products takes place outside of the United States. And when I look at Monster Beverage, and in this latest quarter, international sales make up just a little bit north of 25% of revenue. Even taking into account the gob-smacking stock performance over the last 20 years, I just look at that and go, "Wait a minute, is it unreasonable to think that they can double international sales?" No, I don't think it is.
Kretzmann: Yeah, at least. Looking over the next 10 years, I think you see those tailwinds behind Monster's back. Having Coca-Cola's whole distribution system, that should help accelerate that transition and that growth internationally for the company. And then, there's still room to gain market share domestically against Red Bull and some of the other brands that might be nipping at Monster's heels. So, yeah, I think there are still a lot of reasons to like where Monster can go over the next decade.
Bush: And one thing that stands out to me is, five years ago, their gross margin was in the low 50%. Now, it's in the mid 60s. I think a big part of that came when the Coca-Cola deal emerged, and all that distribution, leveraging all those costs, has really pushed up the gross margin. But because they're still in growth mode, not all of that yet has come through and shown in operating margins and free cash flow margins. Even if revenue growth tapers down, there is still going to be plenty of room for the earnings growth to pick back up and keep the stock moving forward, which is just fascinating to me.
Hill: Have you had it? I've never had one of their drinks, have you?
Bush: I have, yeah.
Bush: It's a lot of caffeine. [laughs]
Kretzmann: I don't drink the actual Monster drinks anymore, they're just a little too sweet and I'm like, this just can't be good for my body. But the Java Monsters aren't bad if you like iced coffee, it's pretty similar to a Starbucks frappuccino or something. So, I'll go with a Java Monster, maybe a couple a year, if that.
Bush: We have to try the super sodas, see if we change colors or something. [laughs]
Kretzmann: See if we survive, yeah. You could probably run 10 miles after that.
Hill: One of the things I love about companies like this who are performing like this is, it just makes me smile for all the times that I hear analysts talk about the growth in organics. "Look at the health trends, we're all getting healthier!" It's like, not all of us are getting healthier.
Kretzmann: Monster is there to fill that gap, yeah, and they've done a good job at it.
Hill: All right. Aaron Bush, David Kretzmann, thanks for being here!
Kretzmann: Thanks, Chris!
Bush: Thank you!
Kretzmann: Producers Dan Boyd is going to give everyone a little something to get ready for the weekend. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening! We'll see you on Monday.