In this MarketFoolery podcast, host Chris Hill is joined by Motley Fool contributor Matt Argersinger from Million Dollar Portfolio to discuss one macro event, one relative microbrew, and one odd IPO. Gary Cohn, Trump's knowledgeable chief economic advisor, quit this week after being unable to ease the president away from his plan to impose tariffs on steel and aluminum. As Fools, we're not usually too concerned with personnel shifts like this one, but in this case, it does make a difference for individual investors.
In corporate news, Coca-Cola (NYSE:KO) makes its debut -- at last into alcohol with fizzy adult beverage. Only in Japan, sadly.
Lastly, the guys answer a question several listeners have had about the pending spinoff of Baidu's (NASDAQ:BIDU) streaming video unit, iQiyi: How will this work for Baidu shareholders?
A full transcript follows the video.
This video was recorded on March 7, 2018.
Chris Hill: It's Wednesday, March 7th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today, from Million Dollar Portfolio, Matt Argersinger. Thanks for being here!
Matt Argersinger: Hey! Great to be here!
Hill: It's going to be a fun day. We have a Facebook Live going, which we do from time to time. We haven't done this for a while. If you're out there listening and you're on the Facebook, every once in a while, we turn on the cameras here in the studio and we take questions live once we're done taping this podcast. We're going to dip into the Fool mailbag. We're going to be talking about the next Netflix (NASDAQ:NFLX), which is coming soon to the public markets. I suppose we should start with Steve Cohn, who's the Chief Economic Advisor to the President of United States --
Argersinger: And by Steve, I think you meant Gary Cohn.
Hill: Did I say Steve?
Argersinger: You did say Steve.
Hill: I meant Gary.
Argersinger: That's fine. There's a lot of Cohns out there.
Hill: This goes to your point from right before we started taping. You said, "Do you think the average person out there had ever heard of this guy before today?" And I said, no, but plenty of people on Wall Street know who he is. Successful career at Goldman Sachs, Chief Economic Advisor to the President, and apparently he just couldn't take it anymore in terms of the tariffs on steel and aluminum that are coming. He's a free-trade guy, and he just thought, "You know what? I can't do this, and I'm walking away."
Argersinger: Yeah. I think, from the market perspective, Gary Cohn was someone who was a little bit of a stabilizing factor. The market hates uncertainty, and Gary Cohn being in the White House offered a little bit of more certainty, especially around financial, economic things that people care about, mostly on Wall Street, but elsewhere, too. Him leaving adds a little bit of instability, a little uncertainty.
Hill: Right. And at The Motley Fool, we are bottom-up investors. We focus on the businesses themselves. So, who is the president at any given time, who is the chief economic advisor at any given time, doesn't really have a direct effect on what decisions Mark Zuckerberg is making at Facebook, or Jeff Bezos at Amazon, any of these companies that we talk about all the time.
Yet, I do think, regardless of who the president is, one thing that has been common in my adult lifetime is, and you mentioned stability, and I think that's the right word, because whether it's the treasury secretary, the chief economic advisor, or who's going to chair the Federal Reserve, the one thing those three positions have in common is, they're almost always filled by people who project some level of stability to Wall Street. Again, everyday investors like us, it doesn't really matter. But to the institutional investors, it kind of does.
Argersinger: That's right. And, I think, as individual investors, this probably causes some short-term turbulence, angst. But long-term, the fortunes of the stock market, your fortunes as an investor, are much more determined on people, like you said, like Jeff Bezos or Mark Zuckerberg, not who's chairing the Economic Council or things like that at the White House.
Hill: Short-term angst. Also, depending on how you look at it and what your cash situation is, short-term opportunity.
Argersinger: Absolutely, always.
Hill: The news broke late yesterday, and I looked and I thought, oh, boy, Wednesday morning, the market is going to open, the Dow will drop 2%, that sort of thing. Right now, it's down about 0.6%. It's not that big. And yet, we do see these short-term effects. I think there's almost never been a better time for individual investors to have a watch list of stocks, and if you have the means, a little bit of cash on the sidelines.
Argersinger: So right. And we haven't had a lot of volatility in the market in the last 18 months until recently. So, if you've been patient and you've been building up cash and adding to a watch list, it's probably a time you've been looking forward to.
Hill: Alright, let's get to some actual businesses. We'll start with Coca-Cola. I'm no longer a shareholder of Coca-Cola, but this absolutely put a smile on my face, and it's the news that Coca-Cola is going to be launching its first alcoholic beverage in Japan. Do I have that right?
Argersinger: That's right. Limited market.
Hill: Limited market. It's essentially a fizzy alcoholic drink. Probably appropriate that Coca-Cola's first foray into alcoholic beverages is not liquor or wine, it's something with bubbles. I like this move for them.
Argersinger: I like it. I like fizzy alcohol beverages, I'm sure a lot of people do. My first reaction was, what took them so long? I feel like, the last couple of years, we've seen things like hard root beer, or hard sodas. I know Boston Beer, a company we're familiar with, Sam Adams, they came out with a hard seltzer last year that I think has gotten a little popular. There are fizzy alcoholic drinks out there that are available that have hit the market, and it's surprising that Coca-Cola, of course, the king of fizzy drinks, with all the distribution power, all the marketing, has been kind of late to get into this. So, now they are, and I'm sure it'll be successful. We'll see if it rolls out beyond Japan.
Hill: Like you, that was one of my thoughts. What took them so long? I'm always interested in the behind-the-scenes story on how corporate decisions get made. I would love to be the proverbial fly on the wall, because I'm sure at various points in Coca-Cola's history, some executive or another has come up with this type of idea and has probably gotten voted down.
But, I like this move. I like that it's a test outside of the United States. I like that, not only is it not wine or liquor, it's not beer. This is one of those moves where I thought, this makes sense, I like this. If they had come out and said, we're launching, not even a Coca-Cola branded wine, but just, our own type of wine, I don't know, I would be more skeptical of that. You mentioned the distribution. For companies like Coca-Cola, it's all about distribution, and that's why I think this could be a small bet that pays off for them.
Argersinger: Yeah. As you were talking, I thought about, maybe this is a situation where they thought about doing this, but, you think about Coca-Cola, the relationships they have with universities, for example, around the United States. Maybe this was a situation where, "We can't go full bore launching a whole line of alcoholic beverages, just because maybe that doesn't represent well with a lot of our key strategic partners here in the U.S." So, it has to be a limited rollout, see if it works. Do companies who buy a lot of soda from us, if they also know that we offer alcoholic beverages, maybe that was kind of a stumbling point to that. But, I feel like, they were late to the market, they're getting into it, they're probably going to be successful. We'll see.
Hill: What do you think is the next thing that investors should look for to get a sense of how this is going for Coca-Cola? Off the top of my head, I don't expect this to come up in conference calls, that sort of thing. But I'm wondering if the next move here, if this is successful, do you think the next likely move out of Coca-Cola is a similar test in another country? Is it, we're going right to the United States, we're coming out with something U.S.-based?
Argersinger: No. I think it'll be a nascent market for them. The thing they're rolling out in Japan, it's actually kind of a cultural element that's really specific to Japan. So, it would take them going into other places like Brazil or France and figuring out what's going to work in particular in those markets. I don't know if this test in Japan is going to be a litmus test of what can work in the U.S., because I think, what works in Japan, might not work in the U.S. So, I feel like it's going to be a small snowball that's going to roll, and maybe it gets bigger, and maybe in a year or two down the road they launch something bigger that's more specific to the U.S. So, you have to wait and be patient with that, I think.
Hill: Our email address is firstname.lastname@example.org. We've gotten a couple of emails over the last couple of days regarding something you had mentioned on Motley Fool Money last week, and that is in relation to iQiyi. For those who are unfamiliar, iQiyi is the video streaming service that is part of Baidu, which is the search engine giant in China. Baidu is spinning off iQiyi into an IPO, we think in April. The timing is always a little bit fuzzy, but we're expecting sometime this spring. This will be in the U.S. They filed the necessary paperwork with the SEC. They have their ticker symbol, which is going to be IQ.
Devin Smith, Justin Lonchard, just a couple of people who have emailed asking basically the same question, which is, "How is this going to work for Baidu shareholders?" If you're a Baidu shareholder -- and I'm not, but if you are, good for you, because that's been a tremendous performer over the last decade -- but ,if you're a Baidu shareholder, are you automatically going to get shares when this gets spun out into an IPO? Or is that not the case?
Argersinger: Good question, and it's actually part of a bunch of questions that I've actually sent Baidu's investor relations department to get more clarity. But, from what I know now, and I've gone through the prospectus, I've gone through Baidu's last conference call, a few other things, I'm 95% sure that, as a Baidu shareholder, you're not going to get shares automatically in iQiyi. This looks to be a cash transaction for Baidu. In other words, they're going to sell off part of their investment in iQiyi for cash. And depending on the size of the offering, that could be a few billion dollars. We'll have to see as the offering approaches.
As a Baidu shareholder, though, I think there's a lot of reasons to be excited about this. iQiyi has always been kind of a subsidiary investment for Baidu. Now that they're spinning off a part of it, Baidu is going to continue to be a majority shareholder, they're still going to be the controlling shareholder, they're going to own all the class B shares, which are the super voting shares, for iQiyi.
At the same time, by deconsolidating iQiyi, they take out all the losses. iQiyi, as a fast-growing subscription Netflix-like service, incurring a lot of losses, investing a lot in content. Baidu takes those losses off of its income statement. It also removes itself from having to invest billions in content, that iQiyi is going to have to do over the next several years if they want to compete. So, you're left, in Baidu, as owning the core search advertising artificial intelligence business, which is very profitable and, in my view, undervalued. And, by the way, you have this optionality, I guess, in this iQiyi investment. So, that's Baidu.
For iQiyi, now, I think there's a lot of reasons to be excited. If you want to maintain the 80% ownership stake you had as a Baidu shareholder, you can simply buy iQiyi after it goes public to build that stake up. But, now you have a purely focused video streaming company in China which is the leading company based on several metrics. I talked about it on the radio show, but 120 million daily active users watching almost two hours of content on iQiyi, 50 million subscribers, up from 10 million just a few years ago. I think, if you missed out on Netflix, a lot of us did, this probably looks like a good chance to maybe get another Netflix-type investment in your portfolio.
Hill: It's interesting to hear you talk about Baidu and what this is going to do for shareholders in terms of transparency. It reminds me a little bit of when Google redid its corporate structure as Alphabet, and part of the impetus there was, we want to take the moonshot part of the business and essentially put it off to the side so that people understand, these are the economics for that, and they're essentially going to be off the books of the day-to-day Google budgeting. In terms of iQiyi, it's amazing to think of it as, essentially, a combination of what we think of in terms of Netflix and YouTube. That they have the subscription service, but they also have the free ad-supported model, as well.
Argersinger: Yeah, it's a great hybrid. If you like internet video and the business of internet video, from an advertising perspective and a membership perspective, this is pretty much the best of both worlds right here in iQiyi. Of course, it's also operating in the world's most populous country, and a country that's growing really rapidly in terms of internet adoption and video adoption and things like that. So, you have this great advertising business that still makes up about 40% of the revenue, but then you have this membership business, which is growing by leaps and bounds, that's also now getting closer to that 40%. So, it's going to be, in about a year, an even-even split between advertising revenue and membership revenue. The membership is probably what you really want to be excited about because I think that's what builds in that sort of flywheel of recurring revenue. Members come in, they pay for the content, that enables iQiyi to invest in more content, attract more members. It's just this virtuous cycle that Netflix has had now going on for a bunch of years.
Another thing for iQiyi that's fascinating for me, and this is stuff I'm pulling right from the prospectus, 42 out of the top 50 most popular drama series, variety shows and film titles in China are on iQiyi. 42 of the top 50 most popular shows. In terms of iQiyi's original content, they have six of the top 10 drama series in China in 2017. Six of the top 10 are on iQiyi. As I mentioned, users are spending about two hours daily watching videos. If you think about Netflix, what's made Netflix so successful is the breadth and quality of the content library that they've built out over the last several years. That's exactly the strategy that iQiyi is pursuing. What the IPO is going to enable them to do is get $1.5-2 billion in additional capital that they can invest back into the content library.
Hill: And that's one more thing to like about this move. Whether you're going to be a shareholder of these companies or not, I always like to see this level of transparency. In the case of Baidu, it's being very upfront about, this is what it's going to do, it's going to provide greater transparency to our overall business. In terms of iQiyi, they're very upfront about the fact, this is why we're going public, we're going to take this money and invest it in content. Good for them.
Argersinger: Yeah. Now, there's always caveats to this. It sounds like an amazing story. But you have to keep in mind, this is a company, like Netflix in the early years, burning a lot of cash. They lost $600 million last year alone, and those losses have kept increasing. And that's because they're just plowing so much back into content, which I think they have to do.
The other thing, too, and this is mostly from the advertising perspective, but the daily active users in 2017 were 126 million. That's only slightly more than the 125 million that they had in 2016. So, the growth there has really stalled out, whereas the membership business really soared. Now, I think an optimist would say, that's just a strategic choice that iQiyi is making, emphasizing the membership model much more. But, you do look at those numbers on the daily active users side and say, yeah, the growth is really flattening out. Is that because they're getting competition from Tencent, for example? Or Alibaba, which also owns a popular video platform? You could probably make an argument there.
If the market decides and investors decide to focus on those daily active users number, they might be less excited about iQiyi going forward, because that growth is going to slow down quite a bit. But, if you look at the subscriber numbers, which I think is the right metric to look at, and the amount of activity on the platform, which just keeps going up, and the minutes per day that are being watched, it's very, very exciting.
Hill: Thank you for mentioning both Alibaba and Tencent, because I did want to get around to the fact that they're not in a vacuum. They're not the only show in town. They have great numbers, what they have compiled to this point is very impressive, but they absolutely have competition in terms of two companies with very deep pockets.
Argersinger: Yeah. And it's a double-edged sword in a way. You have these two other very clearly defined competitors. But, at the same time, the overall market now, in terms of internet video, you really have three competitors, which is interesting. It doesn't face the same sort of fragmented entertainment market that we have here in the U.S. with more competitors. You don't really have a cable business. Cable is not really that big in China, so it's not like I have big alternatives. If I want to watch video on my phone or on my PC, I really have three big options. And iQiyi, right now, is in pole position.
Hill: Wow. It's like America in the 1970s. We have three broadcast networks.
Argersinger: That's right. There's three dials, that's it.
Hill: Alright. Matt Argersinger. This is going to be one to watch.
Hill: Thanks for being here!
Argersinger: Thank you!
Hill: 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 tomorrow!