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What Hyperfragmentation Means for Retail

By Chris Hill – May 23, 2018 at 6:01PM

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Companies like Amazon are consolidating like crazy while niche players fragment to an unprecedented degree.

As technology progresses, more and more ultraniche businesses are able to pop up and succeed in the private business world. In today's episode of MarketFoolery, host Chris Hill talks with investor at large Tim Hanson about the hyperfragmentation of retail, which tech companies are helping this trend flourish the most, and what this means in combination with the ultraconsolidation trend that's coming from Amazon (AMZN -3.01%).

Also, the two dive into the ongoing soap opera that is CBS (PARA -3.35%) (NYSE: CBS-A) and Viacom (NASDAQ: VIA) (VIAB). Shari Redstone and the CBS board continue to duke it out, and an upcoming court hearing will tip the scales for their most recent battle for control.

A full transcript follows the video.

This video was recorded on May 22, 2018. 

Chris Hill: It's Tuesday, May 22nd. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, investor at large, Tim Hanson. Thanks for being here!

Tim Hanson: You've had me on a lot recently. 

Hill: We're on a hot streak.

Hanson: This has been fun.

Hill: I hope listeners don't get used to this.

Hanson: [laughs] Are you going to blackball me for another eight months after this?

Hill: No. The people who are blackballed, they know who they are. [laughs] No, I'm kidding. I'm kidding!

Hanson: [laughs] Is that why I'm on so much now? You've blackballed most of the company?

Hill: No! No, no. As I mentioned yesterday, we're taping this early because our multimedia team is in a training. If there's breaking news on Tuesday --

Hanson: Do we know what type of training they're in?

Hill: Yeah.

Hanson: Is it technical training? Sensitivity training?

Hill: [laughs] No, it's technical training. Yes. It's video training, all kinds of stuff. I wanted to talk to you about something. This came up last week. You and I were Slacking back and forth about this, and then I had a meeting with Greg Strassell, who's an executive from Hubbard Radio, one of the better-run, if not the best-run, radio company in America. And he was asking me, he was like, "Have you talked about that?" And I said, "No, we haven't talked about the story yet, but I think we need to figure out a way to." It's the drama that's going on at CBS. 

Hanson: It could be on their own network.

Hill: Well, here's the thing. For those unfamiliar with what's happening -- we'll unpack this -- not only could this be a fictional drama on CBS or any other network, if this were a reality show playing out, there are parts of it that you'd be like, "Oh, come on! That wouldn't really happen, would it?" You've looked at this more closely than I have. Essentially, what's happening at CBS is a massive battle in the boardroom for nothing less than control of the company, where you have Shari Redstone, who's the daughter of Sumner Redstone, who has a massive amount of voting control.

Hanson: Almost 80%.

Hill: She's looking to force a merger between CBS and Viacom.

Hanson: And has been for a couple of years now, yeah.

Hill: And on the other side, you have just about everyone else on the board.

Hanson: At CBS, right?

Hill: At CBS. And, Les Moonves, who runs CBS --

Hanson: Powerful guy.

Hill: Very powerful.

Hanson: And well-respected in his industry.

Hill: Yes. And if you look at the programming track record of Les Moonves, you understand why he's so well-respected.

Hanson: I think they've been No. 1 15 years in a row, something like that.

Hill: Yeah. And when he took over, I'm pretty sure they were dead last.

Hanson: Well, interestingly, the reason Viacom and CBS got split up in the first place was because Sumner Redstone thought CBS was holding Viacom back.

Hill: Well, then. [laughs] 

Hanson: And now, here we are. [laughs] How about those predictions?

Hill: [laughs] Predictions are funny things when you see how they play out. So, we had this drama where the board attempted to essentially dilute the voting ability of Shari Redstone.

Hanson: Yeah. National Amusements, which is a theater company, they own about 10% of the stock of CBS but 79% of the voting control. They want this merger to happen, and they want it to be done at a price that's not very good for CBS shareholders, but pretty good for Viacom shareholders. It's not clear to me why Ms. Redstone is so passionate about recombining these companies. She could just be throwing her weight around, or she wants to dilute the power of Moonves, or something along those orders. But, who knows what the origin story is here.

But, the board has a fiduciary duty to all shareholders, so they obviously don't want this merger to go through, because they don't think it's a good merger or a good price. So, yeah, they wanted to issue a voting stock dividend to everybody else that would dilute her voting control.

Hill: Down to, like, 20%.

Hanson: Yeah, something of that order. But, before they were able to do that, she managed to successfully amend the bylaws of the company, which she's allowed to do because she's still the controlling shareholder, to say that no dividends can be issued without 90% board approval at two separate meetings 20 days apart. Which basically prevents them from doing anything.

Hill: That's a strong move.

Hanson: Now, they went ahead and did it anyway. [laughs] Pending -- maybe some more will happen by the time this runs -- a ruling in Delaware Chancery Court as to whether or not what they did or what she did is legal. So, there are almost two parallel CBSes that exist right now, one that doesn't have a controlling shareholder and one that does.

Hill: I'm glad you mentioned the time difference, because we're typing this on Friday afternoon. By the time this runs on Tuesday, several more chapters of this drama could have played out.

Hanson: It's wild, though. I think the reason it's relevant to everybody listening is, I bet everybody listening owns a stock that has a super-voting shareholder or a super-voting class. They've become so prevalent these days in very common stocks. FacebookSnap.

Hill: Doesn't Alphabet (GOOGL -1.40%) (GOOG -1.39%) have that?

Hanson: Alphabet. So on and so forth. And people say, "Well, Mark Zuckerberg is a benevolent visionary. Why would I not want to trust him to control the company?" Well, what happens if Mark Zuckerberg's diluted children take over the company and have super-voting control, and they want to force through some self-interested measure? This is one thing where, I think, from a corporate governance standpoint, it's fine until you stress test it, and then all of the sudden, you're like, this is a debacle.

Hill: And that's the thing. We have seen, in other cases, that trust earned and rewarded. Where, it's like, I trust this person or these people who have voting control, they have a supermajority and it's worked out fine. That's great. This is the bad version. [laughs] This is what the debacle version of supermajority looks like.

Hanson: Yeah. At the end of the day, there are laws and regulations that surround being a controlling shareholder, and the Delaware Court said, for example, that it could intervene if she does something that's outside of those responsibilities. But, at the end of the day, the controlling shareholder controls the board, but the board is supposed to represent everybody. How does that all fit together? It doesn't. It's one of those inconsistencies that only gets shown in cases like this. So, rare, but important.

Hill: Nell Minow is going to be on Motley Fool Money next week, and I'm definitely going to ask her about this. In a way, I can see both sides of this, in this regard: the board is living up to its responsibilities.

Hanson: Trying to.

Hill: Trying to live up to its responsibilities. And the way it's written right now, Shari Redstone, in theory, she is not superseding her power. She is exercising every bit of power that she has.

Hanson: Yeah. It's all legal at this point.

Hill: Stepping away from CBS and this whole drama, in your own investing, to what extent, if any, do you look at this type of situation or avoid it? At any point, when you're going through your checklist of, I'm going to buy shares of this company, where is, essentially, board strength and majority control? Does that ever factor into it? Or does it just go on a small list to the side, where you say, "Well, I don't love the way this is constructed in terms of who has voting control, but I like the business more"?

Hanson: I'd like to say it's the former, but in reality, it's probably more the latter. At the end of the day, I'd prefer independent boards with non-staggered elections, so on and so forth. When I worked in money management, we voted our proxies, we always voted in favor of those things. But a strong business is a strong business. Now, I don't delude myself into thinking that in a company like Alphabet, owning the voting shares is really going to matter at the end of the day. If you're going to buy Alphabet now, buy the non-voting shares. They're a little bit cheaper, and there's no value to being able to vote. If push came to shove, your voice doesn't count.

Hill: If you're us.

Hanson: Yeah, if you're just a retail investor [...] as they say. So, does that prevent me from owning Alphabet? No, I'm a shareholder. Do I like it? Not really. But I don't like a lot of things that I resign myself to.

Hill: [laughs] That's part of being an adult!

Hanson: Yeah! [laughs] 

Hill: That's not just part of being an investor, that's part of being an adult. Alright, we'll get to something that you are interested in in just a second.

Hanson: That's so sad. It's so sad.

Hill: It's not so sad. Let's talk about something besides the popcorn spectacle that is CBS. What are you looking at these days? It can be a company, it can be a trend, it can be an industry. What has your attention these days?

Hanson: I read a really interesting article about a week ago on something that the author called the hyperfragmentation of retail, which I think is an emerging and important trend in business. You see it online, you see it in your community. Whether it's, in the D.C. area, we have 20, 25 craft breweries now popping up. D.C. Brau, Port City, Aslin, so on and so forth. Then, online, you have all these niche brands that are filling interesting spaces in the market, whether it's Everlane and the transparent pricing, or, Warby Parker was one of the original ones to come in there and be like, I'm just going to do eyeglasses, or Bombas Socks. They're not luxury brands, but they are strong consumption brands. You're showing off a little bit when you wear your Bombas socks or your Warby Parker glasses, so on and so forth.

What I think is interesting about this, obviously, on one side, you have Amazon. That's just consolidating, consolidating, consolidating. But then, on the other side, thanks to technology, you have all this proliferation of all these smaller and smaller brands. And what's happening is, obviously, it's eating away at all those not-as-big-as-Amazon but appealing or as small --

Hill: Not as specialized.

Hanson: Yeah, exactly. This is where the General Millses and the Posts of the world are getting hurt. This is a very long-winded way of coming around to the fact that I think Square (SQ 0.61%) had a really nice quarter. Companies like Square and Shopify are the ones powering this hyperfragmentation. And, obviously, the ones that are benefiting are the Instagrams and the Twitters and the Facebooks, where they're doing a lot of their advertising and finding their customers. 

But, Square, I thought, had a great quarter. They're doing some really, really interesting things to acquire customers and grow their footprint, including, they acquired Weebly, which puts them in the website development space to really directly compete against Shopify. But they already have so many customers on their payments platform. That's a really nice ecosystem. Then, more and more to help small and medium-sized businesses, for an additional 1% take on any charge that goes through Square, they'll instantly deposit the cash in your account, so you can manage your working capital better, instead of having to wait two to five days to get that cash. 

So, if the world is going there, I think there are some really interesting winners in the public market space, even though the Aslin Breweries of the world are likely to stay private. And man, do they have delicious beer.

Hill: [laughs] Do they?

Hanson: It's out in Herndon. It's expensive, but it's good.

Hill: Worth the drive from here to Herndon?

Hanson: Well, or if you can get our colleague Eric Bleeker to bring it in for you when he commutes. [laughs] Eric told me, he went to buy some beer for me there, and he was like, "My wife saw the credit card bill and wondered what I could do buying $400 worth of beer." And he was like, "It wasn't all for me! It wasn't all for me!" [laughs] 

Hill: Two thoughts on what you just said. This was going to be the second one, but since we're already talking about beer -- this reminds me a little bit of something that you had told me years ago when we were in this studio talking about the beer industry. One of the examples that you used to illustrate the challenges that the big brewers have was Whole Foods. 

I remember you talked about, if you go to a Giant or a Safeway or a Harris Teeter, whoever, a big grocery store, there's a lot more shelf space. And if you're Budweiser, you can pay for that space, and that space is more important. If you go to a smaller grocer, if you go to a Trader Joe's or a Whole Foods, there's much less space. So, the small, independent brewers, just to pick the Whole Foods right down the block from us here at HQ, Port City, local brewer here in Alexandria, basically has as much shelf space at this Whole Foods as some of the biggest brewers in the country do. And it seems like, what was playing out in the Whole Foods beer section is now playing out in retail writ large.

Hanson: It's interesting you should bring up Whole Foods. There was a Harvard Business review article about this recently, the changes that have been happening at Whole Foods since they got acquired by Amazon. Whole Foods now is clearly trying to act more and more like, this is a bad term, but you know what I mean, a big boy grocery store. They've been pushed, they've centralized a lot of decision-making, they've centralized a lot of the inventory management, where it used to be radically decentralized. Like, the beer guy at the Whole Foods down the street could put whatever he wanted, wherever he wanted. Now, I think, that stuff is coming down from headquarters, for lack of a better word, and the SKUs are being reduced. I don't know if you noticed how many out of stock positions they've had at that Whole Foods. I think the range of choices has shrunk. Clearly, that's Amazon trying to make Whole Foods more profitable, and some of this started before they made the acquisition. 

But, I think it's hurt the Whole Foods experience. I've heard more than a few loyal customers complain about that. I think Whole Foods is actually one of those companies now that's stuck in the middle. Amazon is trying to make them more like Amazon, but they're going to lose that business, I think, that made that business special five or ten years ago.

Hill: The other thing I was going to mention when you talked about Square, the thing I always think about with Square is the ease of use. Talking years ago with a couple of people who just had side businesses, like, they would pop them up at a farmer's market, and talking about, not only how easy Square was to use, but how much easier it was than all other options they had.

Hanson: Yeah, it's really elegant. It's a really elegant design. I recently actually purchased shares of the company. I'm normally loathe to buy a stock with a valuation that looks kind of crazy, but I think they have a lot of things going right for them. Another megatrend, cashless world. I mean, you can say PayPal, Venmo. I think Square is easier to use than any of those, frankly.

Hill: Venmo is super easy to use.

Hanson: It is.

Hill: You may already know that, but certainly, when your kids are older and they're like, "Hey, can you just use this?"

Hanson: For our old man soccer team, we're all Venmo-ing each other for the entry fees to the league and things of that nature.

Hill: [laughs] Thanks for being here!

Hanson: It's my pleasure!

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!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Chris Hill owns shares of Amazon and PYPL. Tim Hanson owns shares of Alphabet (A shares), Alphabet (C shares), Amazon, FB, PYPL, and Square. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, FB, PYPL, SHOP, Square, and TWTR. The Motley Fool owns shares of POST. The Motley Fool has a disclosure policy.

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