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Why Amazon and Google Are Duking It Out

By Mac Greer - Dec 7, 2017 at 9:55PM

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Two of the biggest companies in the world are trading blows on their platforms, but one has at least a little more of an edge.

In today's episode of the Market Foolery podcast, Mac Greer talks with David Kretzmann from Motley Fool Rule Breakers and Supernova and Jim Mueller from Motley Fool Stock Advisor, Options, and Supernova about today's market news. (AMZN 3.15%) and Google are battling on the streaming side of their businesses, but it looks as if Amazon is going to take the brunt of the damage. Dave & Buster's (PLAY 2.84%) is up big on an earnings report that wasn't all good news. Coty's (COTY -3.00%) European legal battle draws to a close, with big ramifications for their European business that don't translate to the United States. And Toys R Us's new executive incentive package is outraging virtually everyone who hears about it. Find out more on Market Foolery.

A full transcript follows the video.

This video was recorded on Dec. 6, 2017.

Mac Greer: It's Wednesday, Dec. 6. Welcome to Market Foolery. I'm Mac Greer. Joining me in studio, we have David Kretzmann from Motley Fool Rule Breakers and Supernova and Jim Mueller from Motley Fool Stock Advisor, Options, and Supernova as well. Guys, welcome!

David Kretzmann: Hey, Mac!

Jim Mueller: Hey, Mac! How are you?

Greer: Guys, I'm good. We're going to talk some European luxury, some Dave & Buster's, and a surprising holiday bonus-type story. We're talking about you, Toys R Us. We're coming after you!

Kretzmann: Oh, that's a show!

Greer: That's a show! But let's begin with a battle of the tech titans. Google is pulling YouTube from some Amazon devices in retaliation for Amazon refusing to sell some Google products. Google also saying that it plans to block YouTube on Amazon's Fire TV beginning Jan. 1. Jim, sounds like someone woke up on the wrong side of the bed.

Mueller: It's not faiiir. I mean, seriously, it sounds like two children fighting on the playground. But there's a lot of money at stake in what these guys are fighting over. Like you said, Amazon doesn't sell various Google things. I tried looking for a Chromecast the other day, and they don't have it. Google Home's smart speaker as well. And Amazon has bluntly told Google, "We're not going to sell these things for you." Also, Amazon Prime video is not available on the Chromecast, and Amazon also stopped selling stuff from Nest, which is one of Alphabet's (GOOG -0.27%) (GOOGL -0.21%) other sections.

In response, Google is now saying, because you're not doing what we want to do, we're going to block YouTube on your devices. I believe we're talking the streaming app over Amazon's Echo Show and Fire TV devices. Amazon is sending people to the website. But Google also says "That's not part of the deal, guys," so they're saying, "We're going to block you if you're going to block us."

Greer: So how does this shake out? Because YouTube, that's some pretty powerful leverage. People love them some YouTube. David, how do you think this shakes out?

Kretzmann: I think this hurts Amazon more than it hurts Google, although Amazon does have a bit of clout when you're talking about the streaming devices. They are at the No. 2 player behind Roku. Sixteen percent of households with Wi-Fi have a Roku. Fourteen percent have a Fire TV, 8% Chromecast, 6% Apple TV. So Amazon does have some sway there. But how many people are only going to have a Fire TV now that they can't access YouTube anymore? I think people would rather spend the $30 for a Chromecast or buy a Roku so they can access YouTube and all their other favorite apps, rather than just sticking with the Fire TV.

So I think this move will probably hurt Amazon a little bit more, will get under their skin. They'll probably have to, I would imagine they'll try to negotiate to get YouTube back, because that's just such a dominant video platform, certainly in the top three when you're talking about these streaming platforms out there.

It's also interesting to take a step back and look at the different strategies that we're seeing here. For a long time, Google and Amazon had horizontal strategies. They want to be as many places as possible. But you're seeing both companies try to become a little bit more vertical with their strategy and keep consumers locked into their own ecosystems, following Apple's strategy for a long time. I think that's going to be a tough position to balance, because obviously, with Google search, you want its search to be on as many devices as possible. And up until now, you wanted YouTube to be as accessible to people as possible. So, pulling that back, Google could end up shooting themselves in their own foot if they limit YouTube on many other devices.

So I would expect that Google won't go down this route very often, but my guess would be, this is just more of a short-term jab at Amazon, saying, "Be careful, because we can play, too."

Mueller: The frustrating thing about this is, the two are also some of each other's biggest customers as well. Amazon advertises a lot on Google, and Google uses Amazon Web Services for a lot of its own storage needs. So there's an interesting dynamic. Parts of them are fighting with each other, while parts of them are doing business very well with each other.

Greer: We should come up with the word for if you're friends but also enemies.

Kretzmann: Co-opetition.

Mueller: Co-opetition.

Greer: Frenemies! Come on, work with me!

Kretzmann: Sorry, Mac.

Greer: It's early.

Kretzmann: We're warming up.

Greer: As we wrap this up, I want to ask about that frenemy question. When you look at the big tech companies, and let's confine this question to Apple, Amazon, Facebook, Google/Alphabet. Who do you think is on the most direct collision course, and who do you think has the biggest moat when you look at those four? Because there is this frenemy dynamic. They work together on some things; they compete on other things.

Kretzmann: I would say Google and Amazon are probably the ones that are going head-to-head the most. You're seeing Amazon flexing its muscles bit by bit more with advertising, which is obviously Google's bread and butter, because Amazon has so many people going straight to the site when they're searching for a product, and that opens the door for advertising dollars, rather than people going to Google to search for a product and then going to the ad that Amazon bought on Google.

As far as the moat there, I don't know, I think Amazon certainly has a strong position, because they have such -- they don't disclose the number of Prime subscribers, but having that subscription base of people who are, for the most part, locked into that Prime ecosystem with Amazon, and seems like they rely on Amazon a little bit more for shopping and all these other wide array of apps and services that Amazon is throwing into that ecosystem, I think that's a tough thing to top.

Mueller: I would have said Google and Facebook, because they're both trying to keep customers on their sites as much as possible, Facebook with all of the pages and talk to each other, Google with things like YouTube and things like that, so that they can serve up advertisements to those people. In that case, I think Google has the better moat, because, as you say, it's the search engine. "Google" is now a verb in English use, which really implies that's the company for search.

Greer: Let's go overseas to Europe. A big win for luxury brands in Europe. On Wednesday, the European Court of Justice ruled that luxury cosmetics company Coty had not broken E.U. rules when Coty blocked its German distributor from using Amazon and other online retailers. Coty's brands include Calvin Klein and Cover Girl. Jim, this seems like a big deal when you can basically say, hey, not so fast to your distributors who want to put your wares on Amazon.

Mueller: This raises an interesting question about dynamics. The luxury brand, one of their biggest selling points is, we're luxury, we're exclusive, we're special; we don't want to be paired with, in the consumer's mind, knock-off or cheap products. So Coty was arguing that Parfumerie Akzente, that's the German distributor, even though it sounds French in name, they were selling products that they bought from Coty on Amazon. And Coty said, that's ruining our deal, and our cachet, our specialness. Other luxury brands are hailing this and saying this is a big thing.

But on the other hand, consumers might not be as benefited because they don't see the comparison of these handbags or this perfume or this makeup looks the same. They act the same. How come I'm paying extra for the luxury brand just because it's Calvin Klein rather than Joe Schmo? Well, of course, I don't think any woman would wear Joe Schmo makeup.

Greer: Well...

Mueller: Maybe.

Kretzmann: Probably safe we don't go there.

Mueller: Yeah, we're guys here. Let's leave that alone. But it also plays into how much consumers are willing to pay. And are they willing to pay up for the luxury and for the ability to walk down the street with a really expensive handbag, like those $60,000 Birkin bags? So there's an interesting dynamic there.

The other dynamic that's in play here is, Europe is not the U.S. Coty is a U.S. company, and in the U.S., there's this first-sale doctrine, where once you sell something, you have no control over what is done with it. It could be rented out, which is what Netflix did with their DVDs and movies, or it could be sold on, which is what distributors do with the product, and how that happens, whether it's through stores or online. So in the U.S., there's this very different dynamic.

And that also plays out with investors. If you're invested in a U.S. company that's going overseas, or a company that's International in scope, be aware of the different cultures. Many companies have tried to go into China because there's a billion people. It's a huge market. But American brands don't play well over there, unless your name is Starbucks or KFC or something like that. And Amazon isn't down in South America very much. That's MercadoLibre's turf. So be careful in realizing that there's risk for going overseas.

Kretzmann: Yeah, I would say for Europe in particular, European regulators are much more trigger-happy, I think, than regulators in the U.S. We saw this summer, Google got levied with a $2.7 billion fine for some supposedly antitrust behavior, some monopolistic behavior. And really, when you look at the details of that case, Google was promoting some products through their own shopping app rather than directing people to other shopping comparison websites. Really? That's why you're going to fine Google $3 billion for?

It just shows, especially if you're these big tech giants where you don't necessarily have a lot of up-front capital to invest and expand into these markets, and you can expand very quickly and have a very wide reach, Europe, they want to protect their own turf, and they've shown this year, I think this move just reiterates that they're willing to flex that regulatory muscle more than we've seen in the U.S.

Greer: Guys, let's talk about an American company, Dave & Buster's having a very good day, hitting a three-month high on better-than-expected earnings. David, the entertainment company here, also, announcing plans to open some smaller locations.

Kretzmann: Yeah. Taking step back to last quarter, the company had raised guidance for revenue and earnings growth for the rest of the year, but they had also lowered their same-store-sales guidance. So they're essentially saying "Our growth is going to come from opening new stores."

And the numbers this quarter were decent. Revenue was up a little over 9%; earnings up 13%. But same-store sales actually dropped 1.3%, so less people going into the stores. The amusements or the games part of the stores continue to really drive the growth. Same-store sales for those amusements were up 1.1%. But food and beverage was down 4.2%.

So on one hand, you can get discouraged to buy that, but I think that's actually one of the nice things about this Dave & Buster's model, that they do have a diversified revenue stream. They generate more sales from alcohol compared to most restaurants on average. They do have that food and sports bar component that I think helps bring people into the stores if they want to watch the game. Then they have the amusements, which is a very high-margin way to engage people of all ages in a very addictive and high-margin way.

They also did lower guidance for the rest of the year just a bit, but I think the reason the stock is up today is probably excitement over management being optimistic about ongoing store expansion. Right now, they're a little over 100 stores; they're planning to open 200 or more in North America. Going with a smaller format store, which will be between 15,000-20,000 square feet compared to 25,000-45,000 square feet for their stores to this point, that'll help them enter into some smaller towns and cities potentially, so maybe allow them to open more stores than investors had initially anticipated.

I do like that it's a diversified concept, and it's really focused on experiences. I think, when you're getting people into brick-and-mortar stores, it really needs to be based on some sort of experience. And I think Dave & Buster's plays into that more than most restaurants. 

The main thing that I worry about as an investor, the valuation is still reasonable. I think the P/E multiple is 21 or 22 now that the stock has recovered over the past couple of months. The main thing I worry about, the company went public a few years ago with a substantial amount of debt. They are generating positive free cash flow now, but if we were to enter a downturn, which will happen at some point, we'll enter another recession, I'm not sure how the company will fare when cash production goes down and they have these interest payments they have to cover. So that'll be the main thing I watch.

Mueller: And that ties into something you were saying earlier, David. How do they differentiate themselves so they can survive? I like the game concept. A sports bar is a sports bar. This is what has been troubling Buffalo Wild Wings recently. How do you differentiate yourself? With the games, that's one way. There's several different ways. But being just a sports bar is not the key to success.

Greer: OK, guys, our final story, I'm calling this "Have you no shame, Toys R Us?" On Tuesday, a judge approved a Toys R Us plan to spur holiday shopping. So far, so good, right? Well, the plan will pay Toys R Us executives up to $21 million in bonuses. David, the argument that seemed to have won the day was, those bonuses will incentivize executives to boost sales during the holiday season. Now, call me crazy, but it seems like the fact that Toys R Us is in bankruptcy should be incentive enough. What's going on here?

Kretzmann: Yeah, you would think not going out of business is enough reason to get out of bed in the morning. You don't need $21 million to incentivize you.

Mueller: Well, you're not these executives.

Kretzmann: You're right. I don't have these cushy executive jobs.

Greer: These impoverished executives.

Kretzmann: This is just unbelievable, the more I read into this. The deal with this bonus is, you have 17 eligible executives who would split $21 million in bonus if EBITDA -- that's earnings before interest, taxes, depreciation, amortization -- reaches $641 million for this fiscal year, which ends at the end of January. So, through the holiday season.

Mueller: And if they don't make that, they have a fallback plan: $14 million if EBITDA is $550 million.

Kretzmann: Right. The thing here is, their target, which you would think is a stretch goal, is $641 million. But in the four quarters ending July 29, 2017, so, ending this summer, EBITDA was $696 million. So, $50 million above their stretch goal for this fiscal year.

Mueller: So it's doable.

Kretzmann: It's doable. But the thing is, their lawyer says this target will be incredibly hard to achieve. And I'm like, how full of it are you to consider this a stretch goal? And another thing with EBITDA: You're excluding the interest expense, which is the reason that Toys R Us is going bankrupt. So as a financial metric or a performance metric to be shooting for, excluding interest expense, which is the reason the company is in trouble -- interest expense over the past four quarters was $461 million, almost half a billion dollars -- there's just so much wrong with this. The fact that it isn't actually a stretch goal, and this is probably going to be easily attainable, because 40% of Toys R Us revenue is generated in the holiday quarters --

Greer: And if you're working at Toys R Us, you're on the front lines there, working for minimum wage. Jim, how are you feeling about this?

Mueller: I'd quit, frankly. A company that's in bankruptcy with a yearlong turnaround plan that's going to have to be approved by a judge and all the creditors and all that -- I would seriously think about leaving, especially after the story hit the company news grapevine. OK, incentivize people to do something that benefits the company. That's exactly what companies should be doing. Except this one, as David pointed out, is so wrong on so many levels. These guys are well paid already. The U.S. Trustee in its arguments against this pointed out that five of those potential 17 recipients split $8.2 million in bonuses the week before the company went bankrupt, or declared bankruptcy. And the CEO, David Brandon, has other perks like aircraft use and limousine use. Meanwhile, the minimum-wage employees are getting there on a bus, or they're certainly not driving around on limousines.

Greer: And no aircraft.

Kretzmann: Probably not, yeah.

Mueller: So if the money is there, and apparently it is, if the money is there, use that to motivate the employees to drive sales. One example, give a $1,000 bonus to each employee who meets a sales target, or give a $1,000 bonus to the two highest-performing employees in each store, along with the manager for meeting certain targets. Those minimum-wage clerks are on the front lines interacting with customers, and they are the ones doing the sales, not the CEO, not the CFO, not the COO and all those other senior executives. They're back in the headquarters sitting in their leather chairs.

Greer: And when I read about incentives, I'm so naturally skeptical, because it seems like more often than not, we end up measuring the wrong thing, we end up incentivizing the wrong thing. As an investor, what type of incentives work, and what type of incentives don't work? When you're looking at a company, what do you want to see, and what do you not want to see?

Mueller: What I want to see is an incentive that's long-term, say, three years, either in discrete periods or a rolling three-year term, so you don't earn it until three years have gone by and you're looking at three years' worth of data, and over something that the executive actually has control over as part of their job, rather than something like EPS, earnings per share, or the share price. "If the share price reaches this target, you'll keep an extra $5 million." Well, that way we used to Enron.

Greer: Which is bad.

Mueller: Well I thought the word "Enron" by itself was sufficient. 

Kretzmann: [laughs] Yeah, you would hope. I agree with Jim. I think, for executives, the longer-term the incentives, if you're rewarding them with restricted stock that vests over a period of three to five years, rather than giving stock options out as a blanket compensation tool. But if you have it on a restricted basis that vests over a long-term period, I think that's effective. If it's tied to financial metrics like free cash flow, which actually help drive the underlying long-term value of the business rather than something like earnings per share, which can be --

Mueller: Or, even worse, adjusted earnings per share.

Kretzmann: Right, numbers that can be juiced in different ways, either by stock buybacks or making acquisitions and bumping up some of these numbers artificially in the short term, which might not actually be all that healthy for the business over the long term. So I think longer-term incentives, focus on the underlying value of the business, that's what we like to see.

Mueller: I also like to see companies that are incentivizing people further down the ranks, not just the C-suite and not just the senior management, all the executive vice presidents and all that, but down to the middle-level managers and down into the people who actually do the work that the company is selling.

Greer: David, Jim, thanks for joining me. 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 Mac Greer. Thanks for listening. We'll see you tomorrow.

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
$2,174.75 (-0.21%) $-4.51, Inc. Stock Quote, Inc.
$109.56 (3.15%) $3.35
Coty Inc. Stock Quote
Coty Inc.
$7.77 (-3.00%) $0.24
Alphabet Inc. Stock Quote
Alphabet Inc.
$2,181.62 (-0.27%) $-5.83
Dave & Buster's Entertainment, Inc. Stock Quote
Dave & Buster's Entertainment, Inc.
$33.71 (2.84%) $0.93

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