With 2017 coming to a close, Industry Focus is looking back to revisit the biggest investing stories from the year.
In this week's episode of Industry Focus: Consumer Goods, Vincent Shen and senior Fool.com contributor Asit Sharma discuss the busy M&A calendar, multiple bankruptcies, and other trends that defined the year.
A full transcript follows the video.
This video was recorded on Dec. 19, 2017.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, Dec. 19, and I'm your host, Vincent Shen. If you heard yesterday's episode, you'll know that we're in the middle of our Industry Focus Year in Review. Each day this week, we look back at major stories from 2017 in each of our sectors.
Today, joining me via Skype to discuss the biggest developments in consumer and retail this year is senior Fool.com contributor, Asit Sharma. Hey, Asit, happy holidays and welcome back to the show!
Asit Sharma: Hey, Vince! Happy holidays to you! And happy holidays, listeners! I'm glad, as always, to be back.
Shen: Are you going to be doing any traveling over the next few weeks?
Sharma: No, we're going to stay in town. We're going to chill, get some sleep, get some rest, and then get back to that house work I was telling you about, the never-ending renovation.
Shen: Oh, nice. You did the painting, what's up next?
Sharma: Doing trim, and then a lot of small things got lined up, like a screen door on the kitchen, which is hanging off one hinge. It's not quite that bad. But stuff like that. How about you? Are you traveling over the holidays?
Shen: Yeah, we're going to be up in Philadelphia again, same area we were for Thanksgiving, just to catch up with some family. We have some people flying in from Florida and elsewhere. It'll be nice to get everybody together.
Sharma: Awesome.
Shen: One reminder before we get started. The Industry Focus team has assembled a collection of our favorite Fool.com stories from 2017. If you'd like to see the list of what we consider the top articles from the year, shoot a note to [email protected].
Now, for the main event, Asit and I decided to take the shotgun approach this year and try to hit as many major stories as we can. Asit, I'm going to be using a timer to keep us in check and make sure we avoid running too long on any one topic. Going in chronological order, at least for the first handful of items, we start in January, when Luxottica and Essilor announced a $50 billion merger. Both were leaders in the eyewear industry, though they occupied separate but complementary corners of the market. Luxottica is best known for making frames, what feels like every major fashion brand out there, in addition to operating a network of retail storefronts -- think LensCrafters and Sunglass Hut. They also manage EyeMed, which is the vision benefits provider for something like 40 million people.
In the opposite corner, we have Essilor, which was a specialist in making lenses and optical equipment. This is intended to be a merger of equals, Luxottica is based in Italy, Essilor in France, with an evenly split board of directors and shared management. What's the latest on this deal?
Sharma: The latest is, the deal looks like it's going to go through. Listeners who were with us in January, I know you're thinking, wait a minute, isn't this deal done yet? We talked about this 12 months ago! But what's good for corporations isn't necessarily always good for consumers. And both the European Commission and the FTC have looked at this deal very carefully to make sure that consumers in their respective regions don't get hurt. The latest is that it looks to be approved by both trade organizations and March is when we'll probably see the European Commission, the slower of the two, finally give a thumbs up. In the meantime, this year, Essilor is up 20%, Luxottica up 13%. Listeners, the lesson here is, in these huge mergers, there's always some antitrust risk. So even buying stocks on a good idea, you're going to incur a little bit of that risk. This story looks like it's going to have a happy ending.
Shen: Yeah, we have regulatory approvals from markets like Canada, Australia, Russia, and Japan. The European commission, as you mentioned, Asit, should make a decision by next March. Both it and the U.S. are expected to okay the deal without any major concessions or conditions.
Then, looking ahead, to end on this segment, assuming the deal goes through, I think the integration process will be important for investors to follow. There is some uncertainty in terms of the top management for the combined entity. Current head honcho at Luxottica, Leonardo del Vecchio, and his counterpart at Essilor -- that beeping is our time -- Hubert Sagnières, they've both indicated at their ages, they're grooming the proper people to run the company in the future. But there's a little bit of murkiness in terms of the leadership there, and that's something that investors should follow.
Our next story, setting the timer, jumps to include February, March, and April. It's also for M&A. This time it's in the restaurant industry. Asit, can you give us a quick overview of some of the buyouts that happened during those several months?
Sharma: Sure. I'm actually going to focus on one of them, because this is surprising. It was the biggest M&A story this year in this space, and it was actually a buyout of a public company, Panera Bread, by private company JAB Holding Company. JAB Holding Company is a huge European conglomerate which owns a lot of coffee interests, and a lot of labels like Peet's Coffee, specialty coffee companies. It owns Dunkin' Donuts [Editor's note: though deal rumors have surfaced, Dunkin' Brands has not yet been acquired by JAB Holdings], and it's branching into other types of businesses like the Panera Bread business.
What's very interesting to me is, in restaurant M&A, we usually think in terms of a struggling competitor that's acquired by a stronger rival. But in this case, Panera Bread was doing just fine, had a great business. Its founder, Ron Shaich, had also started the Au Bon Pain company. A very successful businessman, he wanted to take this company private, because he felt that shareholders, especially institutional shareholders and the threat of activist shareholders, are forcing companies in this industry to make too many short-term decisions, and that's not creating value. In his mind, that's destroying value. Listeners, if you want to read up on this, he gives some very good pointers on this in the article that was in the Boston Globe this past Sunday, and it's called Five Things to Know About Ron Shaich. In this industry going forward, 2018, look for pressure on companies that are successful by these activist shareholders. We've covered a lot of them this year, but this is a double-sided coin. Sometimes, it can create a lot of long-term value, and sometimes it just ends up destroying it.
Shen: Alright, that's our time. I'm going to add a few notes. The other deals, the Panera Bread deal was by far the largest, but the others that happened in February and March included Restaurant Brands International, they already operate Burger King and Tim Hortons, they took over Popeyes for $1.8 billion. In March, Darden Restaurants scooped up Cheddar's Scratch Kitchen for about $780 million. So you know from previous episodes on the show, we've talked a lot about the ongoing weakness in the restaurant industry, and it's certainly made some of the smaller players attractive buyout candidates. But the JAB Holdings deal, if I can speak to it really quickly here, I think it's really interesting, because this Panera deal was just one more acquisition in a long string of them for JAB Holdings. They've already built up a portfolio of complementary businesses like Krispy Kreme, Peet's Coffee, Jacobs Douwe Egberts, Keurig Green Mountain. Something we didn't even cover in November was, JAB announced the acquisition of Au Bon Pain as well. With this huge coffee and dining portfolio, Starbucks founder Howard Schultz actually commented he believes JAB is trying to become the largest coffee company in the world.
Moving on to June, a busy month for us with two multi-billion dollar announcements in the grocery industry. The first being Amazon's $14 billion acquisition of Whole Foods Market. Asit, this deal made a ton of headlines and has been covered pretty extensively so far. Any big takeaways or things to watch for investors going forward?
Sharma: I think there are two, Vince. One, and this has, like you said, been covered extensively in many publications, including The Motley Fool, the impact on this in the grocery industry is going to be huge. But I believe, actually, it's going to be positive on the grocery industry in general and also for the new combined company. That's because this merger is forcing companies to figure out the new model of grocery delivery, which is online ordering, and often times delivery or drive-in pick up from the parking lot. Amazon is going to accelerate all of this and it will sharpen the instincts of companies like Wal-Mart, like Target, which we saw just buy Shipt.
The other thing which is prudent to investors that's not as well covered is the impact of Whole Foods on Amazon itself. Amazon, as everyone knows, has focused on revenue in favor of profits. For all its sales over the last couple of years, it's had $3 billion of operating income in 2015 and just over $4 billion in 2016. Now, Whole Foods has had operating income of $850 million for the last couple of years. We don't have exact numbers, though they released their annual report, and there were a lot of acquisition expenses in there that cut into that operating income. But you're talking about one-fifth of the profit that Amazon makes in a year, they got in this $14 billion acquisition. So there's something really positive on Amazon's income statement. Those of you who have enjoyed investing in Whole Foods and now maybe are owning Amazon, because you followed them there, it's actually a very sharp boost to the company's ability to take margin out of other places in its business, which I find, frankly, attractive.
Shen: Thanks, Asit! Our second bout of headlines from June and also in the grocery industry came from companies based overseas. Aldi announced that it would look to spend over $3 billion to open an additional 900 stores in the U.S. market. Management at Aldi wants to have about 2,500 stores in this market by 2022, which would make it the third largest supermarket chain. In that same month, its rival in Europe, Lidl, opened its first U.S. locations starting on the East Coast. Early targets are for 100 stores by 2018. That sounds like a lot more competition for Kroger, Wal-Mart, Costco, and also the dollar store chains, given that Aldi and Lidl are known for their low prices and focus on discount. What do you think?
Sharma: This has been surprising somewhat to me, Vince, because this was the year in which Lidl landed on the shores here in the U.S. Aldi is also going to spend another $1.6 billion just for remodeling, on top of the numbers that you gave. Many of us who follow the grocery industry thought there would be an immediate impact, like a doomsday scenario. But the expansion has been concentrated, so far, right where I and you are, in the mid-Atlantic states on the East Coast. That's given the big chains a chance to study how the prices are changing in local markets and how they're going to react. The impact has been muted so far.
In fact, in the trade publications I follow, it said that Lidl might actually slow its expansion just a bit, because they're finding that sales have not panned out to their projections. What we have in this very dense corridor is an expansion of chains like Wegmans, which many listeners in the Northeast know, expanding south, and Publix, for our listeners who are down in Florida and the East Coast, they know that chain very well. They're all converging on this central point in the mid-Atlantic. And that gives the incumbents like Whole Foods and Wal-Mart and Costco, Kroger, Target, it gives them all time to study this like a laboratory and figure out how they're going to react. So big news is, not much news yet. Longer-term it'll be more of a problem probably more from Aldi, because of the numbers that Vince laid out, it's a much bigger expansion planned by 2022. But it shows you how big the United States is as a market. It's a gargantuan market. On this side of the pond, we spend all of our time thinking about China, Japan, Europe, all these big markets, and you forget what a tremendous multi-billion dollar industry the food and grocery industry is here in the U.S. It takes more than just a few years and a few billion bucks to crack it.
Shen: Now for some more recent events that we've covered on the show already, but they're notable and I think worth mentioning for this year-in-review list, and we won't spend too much time on these. First, in November, the Department of Justice announced they would be suing to block AT&T's acquisition of Time Warner. That merger was originally announced in October of 2016, and was one of the bigger deals of the year at $85 billion. Of course, the companies plan to fight this decision. They believe this vertical integration, the content creator Time Warner combining with the content distributor AT&T, does not harm the competitive options for consumers. There is a direct precedent to this deal, it looks very similar to when Comcast took over NBCUniversal, which was approved with some minor concessions. That said, regulators did run into issues with Comcast keeping its various promises after the deal closed. So getting burnt that time could explain why the Justice Department is saying no to this deal entirely. We expect the legal battle to close by next spring.
To close out the year, just last week, we had the official announcement that Walt Disney would be acquiring a large portion of assets from 21st Century Fox, including major television networks, the film studio business, related intellectual property, and international assets in India and Europe. The all-stock deal is worth over $50 billion, and Disney CEO Bob Iger has delayed his retirement again from 2019 to 2021 so he can oversee a smooth integration of the two businesses. I was scanning headlines this morning, Asit, and lawmakers are already expressing some concern over this deal, wanting to hold hearings. I'm actually more skeptical that this deal will ultimately go through compared to the AT&T and Time Warner tie-up. What are your thoughts in terms of the final deal provisions? We've talked previously about this potential tie-up.
Sharma: I'm not as convinced that antitrust issues will come to the fore here as much as in the previous AT&T and Time Warner deal that we just discussed. Basically, Disney is getting access to a lot of content. It's aiming for streaming, and it's going to compete with companies, that if you look at it from an antitrust angle, already control the markets and are going to compete against the Google's, the Facebook's, Netflix, Amazon. So in some ways, from my perspective -- of course, I'm no lawyer, although I have played one on TV. [laughs] No, I haven't. Tried and failed to audition for a high school musical, and that was the last acting stunt I ever had.
However, this company, if anything, opens up the competitive field. I think this is good competition vs. monopolistic competition. Of course, Disney, the reason that, Vince, you're worried that this may have some eyebrows raised by antitrust regulators, Disney is just so large and dominant. Like your quick perspective -- again, I think this is good, I think it'll force more competitive content creation, which is only going to be good for viewers, people who love to watch and binge-watch. But what are your concerns in terms of this very large player coming in and scooping up Fox?
Shen: It's about perspective. We're out of time here, but I'll spend a couple of seconds. I think it's about perspective in that Disney presents this deal as their means of playing defense against the streaming alternatives that have been powered by tech. You think about companies like Netflix and Amazon and the competitive offers that they've been able to give consumers as how that's changing the entertainment consumption landscape. Disney presents this as their opportunity, in terms of Hulu, the streaming networks that they're going to have coming out soon. This is their own version of consolidating and circling the wagon so they can better compete. That concludes the more linear portion of our show. Up next, we're going to talk about some other highlights from the year in a more scattershot way.
Asit, we've been talking a lot about consolidation in consumer and retail. A lot of the big developments we covered were M&A deals. But obviously, not all deals talks ended up in agreement. What was a more notable one for you that was a missed connection from the past year?
Sharma: I think for me, Mattel rejecting Hasbro's offer to merge. Now, you and I just talked about this recently on the show. Our thought together was, this would be a great deal for both companies. Hasbro, the stronger player, which is really selling through the internet online channels very vigorously, and then Mattel is an older-school point-of-sale company which had gotten into trouble with this retail apocalypse that's been occurring over the last year. Interestingly enough, back to antitrust, the reason that Mattel has rejected this preliminary offer is, it's concerned that the FTC could say there's too much of a monopoly here. Although the combined company would still have a lot of competition from domestic and global players, they do occupy the two top spots in the U.S.
However, I was surprised. I think, to me, that Mattel needs Hasbro. I think Mattel is going to have a very hard holiday season. They're still managing inventory problems related to the Toys R Us bankruptcy, and I'm questioning if this is a good move. Investing takeaway, investors, year to date, Hasbro's stock is up 17%. Mattel's stock is down 45%. Be careful about jumping in as a value play in Mattel. What do you think?
Shen: I'm going to jump to two more deals because we're running out of time here. They're big ones that I want to mention. Kraft Heinz and Unilever, again, another one that we've mentioned briefly on a recent episode. In February, Warren Buffett, 3G Capital, behind Kraft Heinz, they unveiled their next big step for the company's growth, and that was with a $150 billion bid for Unilever. Unilever rejected that deal promptly, and Kraft Heinz actually withdrew its offer the next day, not intending to execute any type of hostile takeover. We provided a more in-depth update of Kraft Heinz on Industry Focus a few weeks ago, in terms of how the company is searching for its next growth avenue. You guys can jump to that episode.
Then, T-Mobile and Sprint had merger attempts fall through in 2014. Those companies were rumored to be discussing a deal again in 2017. But they officially announced an end to those talks in early November. The regulatory environment under Trump may have been more friendly to this deal, but the sticking point this time was control. SoftBank, which is the key shareholder at Sprint, did not want to relinquish too much control of the combined entity, considering T-Mobile's Legere was already slated to take over as CEO.
That's all the time we have for missed connections. Let's talk about some bankruptcies next. Brick-and-mortar retailers have closed thousands and thousands of stores this year as the squeeze from e-commerce and intense, increasing competition from traditional retailers has pushed some companies over the edge. Notable bankruptcy filings in 2017 in the consumer and retail space, we have about two minutes, which ones do you want to hit, Asit?
Sharma: I want to hit mall-based clothing retailers. This year, The Limited, Vanity, Gymboree, Wet Seal are just a few examples. And there's a theme here: fashion is fickle. Fashion is extremely hard. And these tended to grab the headlines, especially for Limited. If you start peeling the onion and looking in deeper, you'll note a pattern. Payless Shoes and HHGregg -- which, Payless Shoes is a clothing retail, it's a shoe retailer, and HHGregg is an appliance retailer -- what this is, companies which don't have a strong niche vs. price and/or are in fashion and based in malls got hit this year. But it wasn't the end of the world. The retail apocalypse wasn't really about Amazon destroying every retail company. It took out the weak in 2017. We talked recently on the show about Canada Goose, which has a clicks and bricks business model, as an example of how you survive in this future dominated by Amazon.com.
Shen: You mentioned Toys R Us during the segment when you were talking about the Hasbro and Mattel deal that has not quite happened yet. True Religion is another one, Gander Mountain another example. Among all these, those themes, declining foot traffic, especially for the mall-based stores, these various store closures, they're looking to create leaner operations. And some, like The Limited, have transitioned entirely to online only businesses. I would not be surprised to see that trend continue on in 2018.
Our last two topics for this 2017 year in review, it's been a while since we covered the gaming industry on the show. I'll be doing a deeper dive on the major casino operators early in the new year, but for now, we can point out some tailwinds for these companies. What are we seeing, Asit?
Sharma: We're seeing high rollers coming back into casinos. Macau is a great microcosm of the gaming industry. In October, it had gross revenue growth of 22%, a $3.3 billion monthly haul. What this says to me is, the high rollers are back. Especially in Asia, Chinese president Xi Jinping scared off a lot of gamblers with his reform, which started about two years ago. They're creeping back into the casinos. It also says that stock market valuations around the world are plumb. It's not just the U.S. Major stock markets in almost every geography except for a few developing regions, Latin America in particular, have been phenomenal lately, and that has a wealth effect on the psychology. You need these very wealthy people to get back into the casinos for the gaming industry to have a good year, and that's what we're seeing. It's not just tourism and small players like myself and Vince. It's the deep-pocketed, extremely wealthy people who feel great about where the markets are heading, and stable global GDP over the past few years.
Shen: Yeah. Macau has reported positive year-over-year gains in their gaming revenue for the first 11 months of 2017. This trend actually started back in August of 2016, and the market is picking up some serious momentum. They've seen 10 months of double-digit growth over the prior year. October, as you mentioned, saw about $3.3 billion, which is the highest level in three years. Keep in mind the Macau region is also facing some pretty easy comps right now, and we're still far from the peak revenue levels that casino operators enjoyed back in 2014 before that Chinese government crackdown on money laundering, outflow of money from China. Companies have already opened and continue to open luxurious billion-dollar resorts in the region to attract both mainstream tourists and higher-rolling VIPs.
Closing this out right on time, The Last Jedi premiered last week, so we have to look at this year's box office. The last time we covered this industry, theater operator stocks were underperforming, if not getting hammered by the market. It appears the fall release schedule is kind of bringing the total box office receipts for 2017 up to stronger levels. What are your thoughts, Asit?
Sharma: November seats for Thor and Coco, $1 billion. That's much better than, when we talked about the movie industry in the summer, we actually predicted that by the end of the year, strong season would bring the industry whole. And that's what it looks like has happened. It really drives home the point for investors, we talked about in June, who are interested in the cineplex companies, that invariably, American consumers go to the movies. You need a strong schedule, and they'll have a good year. And I wanted to give my non-spoiler review of The Last Jedi here. Vince, I've been talking about this for the last couple of days. On a sliding scale of 1 to 10, I started out in the theater 8 or 9. As the days have gone by, I'm slipping down to about a 6 or a 7. I want the whole series to take on more risk in the next installment. I'll leave it at that and flip it back to you, Vince. Everyone have a great holiday!
Shen: Thanks, Asit! I'm really excited to see it tonight, actually, I haven't yet seen it. Which is surprising, considering that when The Force Awakens came out, I had seen it three times in the first week. Bu, the movie has two more weekends to close out the year strong. And if it can top the current top-grossing movie of 2017, which is Beauty and the Beast, another Disney feature, then Star Wars films will be the highest grossing titles for three years running with The Force Awakens in 2015, Rogue One last year, and now the newest part of the trilogy.
One more thing in this industry that I want to mention, and that's MoviePass, and how that service made headlines by making its monthly subscription cost just $9.99 per month. That's about $10 to see one movie per day, every day of the month. If anything, I think it's changing how consumers view the movie going process. Similar offerings from the leaders in this industry -- we've already seen Cinemark, for example, roll out its Movie Club. I think that could help boost attendance, which has been going down for years now. Revenue for the industry goes up, the actual ticket sales numbers have been trending downward. These companies might lose money on ticket sales with services like this, but they generate the bulk of their profits from the concessions anyway, so I think it's an interesting opportunity and it'll be really fun to see how the companies balance offerings like this.
That's a wrap for our 2017 year in review. Thanks for tuning in! Asit, thanks for joining us!
Sharma: Thank you, Vince!
Shen: Austin Morgan is the producer of Industry Focus. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Happy holidays, Fools! Fool on!
