Megamergers and Megaconflicts Move the Markets

In this Motley Fool Money podcast, host Chris Hill and senior Motley Fool analysts Jason Moser, Jeff Fischer, and Aaron Bush reflect on the biggest business events of the week, and without question, at top of the list is that a judge has ruled the AT&T (T -0.59%)/Time Warner merger can take place without hindrance from the Trump administration's antitrust regulators.

Elsewhere in M&A news, Comcast (CMCSA -1.53%) strongly outbid Disney (DIS -2.90%) for Fox's (FOX) (FOXA) media assets, and the Fools expect this tug-of-war will have another round, or several, before one walks away with the prize. In other news, we get three key takeaways from E3, the Electronic Entertainment Expo; we look at a pair of stocks the made big pops last week; and of course, we get the the stocks on the Fools' radar this week. 

A full transcript follows the video.

This video was recorded on June 15, 2018.

Chris Hill: It's the Motley Fool Money radio show! I'm Chris Hill. Joining me in the studio this week -- senior analysts Jason Moser, Jeff Fischer, and Aaron Bush. Good to see you as always, gentlemen! We've got the latest headlines from Wall Street; we're going to dig into the entertainment industry with our guest, Tim Byers; and as always, we'll give you an inside look at the stocks on our radar.

But we begin with the deal of the week. At long last, a federal judge has given the green light to AT&T's $85 billion bid to buy Time Warner. There are a lot of ripple effects to this. Jeff, you and I were working here at The Motley Fool back in 2000, when AOL bought Time Warner. You tell me, is this merger going to go better than that one did?

Jeff Fischer: [laughs] That's the big question. The odds are, it will go better than the AOL-Time Warner merger, which was far premature and just went down in flames, as we all know. What AT&T is obviously trying to do is, it has fiber and a mainly wireless and satellite network. It now wants to deliver its own content over that network to compete with the likes of Netflix (NFLX -2.47%) and with Disney's upcoming streaming service as well. 

Time Warner, same thing. Almost all of Time Warner's content -- which is HBO, Warner Brothers, and Turner, so, a lot of brands that we all know -- that's all delivered through affiliates. They don't control how and where it's delivered, in most cases. So, to compete in the age of streaming, you have to merge these two businesses together.

Will it work? I don't know. There are 12 board members on AT&T's board, and they have 746 years of experience among them, which is great. That's a lot of years. The average age is 62, though, so are they seeing where things are going correctly? I don't know. TV continues to suffer. TV viewing traffic is down an estimated 8% year over year right now in the past week. But much bigger than that, Chris, are children's cable networks, where for going on six, seven months in a row now, viewership is down 20%-29% year over year. Children are just not watching cable. So you need to solve that with streaming.

Aaron Bush: I'm a bit skeptical that, 20 years from now, we're looking back at this being some amazing deal that went through. But I do think it's important, because it marks the beginning, probably, of a series of megamergers that will reshape who owns the content that we watch and who owns the mechanisms through which we consume this content. 

If you're like me, I just wanted to get a grasp of, these are two giant companies, what does this even look like? It's essentially going to be four main business units. It's going to be the AT&T Communications, which is all the fiber, broadband, mobile, that type of thing; their media business, which will be new for them; their international business, which is going to be ramped up from this, so this was also a little bit of global play, a little bit, I think. And then, an enhanced advertising and analytics business. It'll be interesting to see how they think about this in terms of advertising, too, I think.

Fischer: You're right, Aaron, about megamergers. This could make it easier for T-Mobile US and Sprint to merge, and deals with CBS (PARA) and Viacom (NASDAQ: VIA) (VIAB). Of course, there's 21st Century Fox and Disney trying to get together, and Comcast bidding for Fox as well. Even Express Scripts (ESRX) and Aetna (AET) could be green-lighted now. But I agree with you. I don't think this is the deal that makes AT&T's future bright. 

Hill: It's interesting, Jason, because last week on the show, we talked about the letter from Warren Buffett and Jamie Dimon, and their urging public companies to scale back on the short-term outlook. Steve Case, who was the head of AOL and was the head of that merger back in 2000 with Time Warner, he was on TV this week, basically saying, "When I think back on what went wrong, one of the big problems was we were too focused on the short term." It seems like, if this does work out for AT&T, it's because they're going to have to be patient about it.

Jason Moser: I mean, there's no question. It's one thing to go in there and make deals like these because you have some grand aspirations. But deals like these come with a lot of baggage. You have to figure out how to sort through all this, and you have to have, really, a singular vision of what you want this to be, and make sure that you have a team on board that sees that vision with you. It really does all boil down to leadership. 

So when I think about something like this AT&T deal, I see a lot of reasons for it to go wrong. Jeff was talking about T-Mobile and Sprint. That's a deal where, I do think it's going to get approved. Furthermore, I think that's going to be a really successful outcome because of John Legere, and his success at T-Mobile, his consumer-centric nature. Really, he has laid out a vision, more or less, of what he wants this company to be. I think it would be a very hard case to prove that it wouldn't benefit consumers, consolidating those three and four players in the space and giving us one more competitive solution to the AT&T and Verizon duopoly that exists today.

Fischer: And here's an interesting dichotomy, I think, is, these new media giants that own the pipelines and the content, are so weighed down with debt. They're not very agile, and the target is moving, the target audience, which is mainly younger people, is moving and changing habits and whatnot. Will they meet them where they are? And will that debt become a burden to doing that? 

Netflix, for example, by contrast, has menial debt, not much debt yet. And yet they don't own the pipeline. So I would be worried. As bullish as The Motley Fool has been on Netflix for a long time now, we still have to worry about them not having control to the access line to the consumer, aside from streaming through someone else's pipes.

Hill: You mentioned the bid for 21st Century Fox's assets. Let's go to that, because there was news this week, Jason. This was something we were expecting. It's nice to see that it actually came to fruition. That is Comcast coming in with a bid of $65 billion in cash. This is about 20% higher than the $52 billion that Disney had offered in cash and stock. Where do you think this is going?

Moser: I mean, I think it's going to a bidding war, ultimately. At least the rumors are that Disney is working on a package to outbid Comcast there, and looking for a deal here. Really, the going sentiment for this acquisition is that it's all in the name of Netflix and competing with Netflix. I think that's it, to a degree. Certainly, Netflix is the company that has changed the space, so to speak, and taken us into this over-the-top and personalized and on-demand world. They're not the only ones that can do it. 

I think this deal becomes far more interesting now that net neutrality has been overturned. Why would Disney worry about even getting caught up in a bidding war with this? I think it's because their perspective is -- and they have some experience to go on here -- that the IP is worth more than the pipes. I think it's reasonable to assume that somewhere down the road, with a new administration, net neutrality goes back to where it was before. I could see that being re-implemented. If that is the case, those pipes become a little bit less valuable. But that IP is going to be very valuable for a very long period of time. 

So I could see Disney putting up another offer here. They have the balance sheet to do it. They have a better balance sheet than Comcast. Both companies are about the same size. I think they can go in there and use stock as a currency, if they want to. I suspect we'll see some more back and forth with this.

Bush: It's interesting to me, the different ways that Disney and Comcast would approach Fox. Disney, on one hand, it would be much more of a horizontal integration, in terms of, it's just buying more of what it already does -- more content, more channels, greater access to more people. Comcast is pursuing more of a vertical integration, more similar to the AT&T-Time Warner deal, which is very different, in terms of the type of value that you would take out of the business. 

Personally, I hope that Disney is the one that does get access to Fox. But I fear that this is also just Comcast pushing up the price so that Disney might have to pay even more for those assets, which makes it a lose for whoever buys it.

Moser: That's distinctly possible. You also have to at least consider -- money talks, at the end of the day. But you wonder, the Murdoch family, would they rather be a part of the Disney family or a part of the Comcast family, even if they have to concede a little bit on the dollar front? I mean, when we look at the feelings that these two companies elicit, they're on polar ends of the earth, right? I mean, Comcast brings out the worst in everybody, and Disney seems to bring out the best. There's the warm fuzzy of Disney, and then the Twitter trolls of Comcast. So I feel like they probably want to be a part of that Disney family. I don't know how much that weighs into it.

Hill: You know who doesn't have a warm, fuzzy feeling for Disney? Brian Roberts at Comcast. They tried to buy Disney back in 2004; that failed. A few years ago, they were trying to buy Time Warner Cable, and Disney was part of the group that helped to block that. They may be trying to drive up the price, or they may be saying, "No, no. We're going to win this time."

Bush: This just a grudge?

Hill: A grudge with a business purpose. E3, the Electronic Entertainment Expo -- which is hard to say, and which is probably why they call it E3 -- E3 wrapped up this week in Los Angeles. This is the premier trade event in the video-game industry. Video-game stocks as a group have done well for investors over the last few years, Aaron.

Bush: Very well.

Hill: You like this industry. What's your headline for this event?

Bush: It's always fun to see the games being showcased, all the publishers laying out their pipeline for what's to come. But what's actually most interesting to me is figuring out where the industry as a whole is going. Throughout all the different things that these companies say, you can start to piece together some common threads. Just three main highlights for me. 

The first one is mobile. This isn't anything new. Showcasing mobile at E3 is always awkward, because it's a very hardcore gamer environment. But the fact that they're doing it more and more means that they're trying to get access to more gamers, because people are playing more games in more ways. They're trying to extend the franchises that they already have. We're moving toward a trend of being able to play the same game wherever you are. That's game-changing.

That leads me to my second point, which is that the future is streaming. There was a little bit of chatter at E3 about the next wave of gaming consoles. But even then, there was a little bit of chatter about what comes after that. It's starting to seem more and more likely that the next gaming console might actually be the last wave of gaming consoles. The shift of people powering these games in their homes on these big machines to companies with servers powering these games and just streaming it to people on whatever device they have, that's game-changing. It also lends itself much more to a subscription strategy, which changes the economics of the entire industry. That's a big deal.

Lastly, I just would say, more than any other time before, there were many personalities, in terms of people, at E3. This is pro players, this is influencers, celebrities. What that signals to me is that gaming is turning more mainstream than ever before, and the implications of that, who else becomes attracted to games, what else these gaming brands can do in new mediums. I see this industry turning much more profitable and more mainstream, and I think that's really exciting.

Hill: The hardware aside, one of the things we've talked about in this industry is that, kind of like the movie industry, it is dependent on the hits. Did you see anything this week that changed that thesis? That, no, at the end of the day, however these games are delivered, they still have to be great games?

Bush: It's definitely both. You have to win people over at the beginning. Then there's an ongoing element of more content. If you look even beyond E3, just the top gaming companies, already, many of them, half of their revenues come from these recurring purchases or this additional add-on digital content. So we're already there, but we still have a long way to go.

Fischer: Aaron, this wasn't premeditated. I'll just put you on the spot here.

Bush: Sure.

Fischer: Coming away from E3, your favorite gaming company, which I think you have well in your mind already, and a company to watch, perhaps?

Bush: In terms of what we actually can invest in, I think, actually, Microsoft is almost a dark horse. I say that in the sense that they haven't been super strong in terms of this console generation, in terms of their own exclusive games and such, but they're definitely laying the seeds to win over the next generation. And, if this world turns much more streaming-heavy, Microsoft has Azure, so they already have the infrastructure in place to make that experience better than what other companies could do. 

Hill: Dropbox, the cloud storage company, went public back in March. On Thursday, shares of Dropbox rose 20% on very high trading volume. Jason, there was no news, of any kind. What is going on here?

Moser: That's correct. It doesn't appear, at least, there was any news regarding this. Trading volume through the roof on Thursday and Friday. It's very difficult to pinpoint exactly what the cause of this is. I think that's where investors need to take a step back here and think, "Do the business fundamentals beget this kind of move?" It's hard to say that they do. This seems to be something inexplicable, almost. That's where investors need to be very careful, because it can be very tempting to want to jump on the bandwagon when stocks start going through the roof like this. 

There's a lot of interest, obviously, in these new IPOs. Dropbox is a fairly new company in the public markets. I think it's a fascinating business from a number of perspectives. I think a lot of us know it as consumers, that free little Dropbox app that we've been able to use. To me, this is not a business that I'd have any interest in investing in yet, at least. I think, with the most recent quarter, they've showed they're doing some good things. Paying users a total of 11.5 million, versus 9.3 million a year ago, and that's a big metric for them. I think they have a big opportunity to grow that paying user base in the enterprise side. 

But we are in a market environment today -- I mean, we've been talking about this for three years now -- it just seems like the valuations are through the roof, and Dropbox is no exception. Perhaps you want to get it on your watchlist, but be very careful buying into companies that aren't making any profits yet.

Fischer: So many interesting IPOs recently. By recently, I mean the last three years. So many of them are in cloud and storage and cloud software, mainly. I'm more drawn to cloud software than I am to storage. In a sense, Dropbox will meld and be some of both. 

But I agree with you, Jason. You have to be careful. Try to choose the companies that have competitive advantages that can sustain. I don't know where storage is going to go, price-wise. I would think down. Over time, the cost of storage should go lower and lower. It's more or less a commodity. That said, what we could all be doing, perhaps, is underestimating the size of the storage market. It could be much larger than estimated.

Hill: Shares of Etsy (ETSY -3.05%) up 35% this week after the online retailer raised guidance for the fiscal year. Etsy plans to increase the transaction fee that it charges the sellers on its platform. Do they have that kind of pricing power?

Bush: It seems like it. They're raising the transaction fee from 3.5% to 5%, and they're also going to initiate a 5% fee on shipping costs. That might not sound like a lot, but let's say I have a $100 item with $5 shipping. Before, that would have cost $3.50 in fees. Now, that would cost $5.25. That's actually a 50% increase in the fees that it would cause the seller, and that's pretty substantial. So it is no surprise that the company is raising guidance, with their revenue growth being forecasted from mid-20% growth to mid-30% growth. It's a meaningful change. 

Some might view this as a risk, because it could infuriate sellers, and they might want to move elsewhere. But to me, this is a sign of pricing power, and that they have solidified a brand and a lead in this niche part of e-commerce, and they have a pretty dominant two-sided network effect there.

Lastly, I'll just say, this isn't the first controversial move the new CEO has made in this space. Last year, when he first came in, he laid off 15% of employees. This is another step in him reorienting Etsy to be more of a business-first culture. So far, in a short amount of time, he's unlocked a decent amount of value.

Fischer: It's interesting, because it's kind of the opposite approach of Amazon. Amazon will charge its Marketplace sellers more money, but you don't necessarily see it come through to the customer. In this case, I would think a lot of these Etsy sellers would push these price increases through, because they're significant.

Hill: Dine Brands Global is the parent company of Applebee's and the International House of Pancakes. Shares of Dine Brands Global up 15% this week after IHOP changed its name to IHOb, the b standing for burgers. Let's go to our man behind the glass, Steve Broido. Steve, is this going to get you into an IHOP?

Steve Broido: I don't think so.

Hill: [laughs] At first, I thought this was a joke. Now, this seems like they're kind of serious about this strategy.

Moser: Well, who here at the table really thought that "b" was breakfast? I mean, thought it was going to be breakfast.

Hill: Or bacon.

Moser: Or perhaps burritos. Let's just go really far out there. I mean, burgers ... there's no competitive advantage in burgers!

Hill: The stock's up 15%. We'll see how this plays out.

Fischer: It's only up 7% annualized the last 15 years, though. [laughs] 

Hill: All right, let's get to the stocks on our radar. Steve will hit you with a question. Jeff Fischer, what are you looking at this week?

Fischer: Speaking of cloud software, AppFolio (APPF -1.68%), ticker APPF, is another semi-recent IPO. Market value of only $2.2 billion. Annualized sales of about $160 million, so it's a small company. But it's profitable, and it's been profitable for a long time. That's in its DNA, which I like a lot. AppFolio provides cloud-based software to their real estate market and the legal market. Two very large markets that it's growing into. Then, it plans to offer more markets beyond that. So it has a good long-term outlook.

Hill: Steve, question about AppFolio?

Broido: When do you get to not call yourself a cloud-based company?

Fischer: You know, that's the funny thing. Almost every software company is going to be cloud-based in the end. So when will we drop that moniker? Maybe pretty soon.

Hill: Jason Moser, what are you looking at this week?

Moser: Chris, you know I like baskets. I'm going a little bit of a different direction here and talking about the healthcare and wealth-care basket. It's four companies in the healthcare space: UnitedHealth Group, ticker UNH, big-dog insurer; Masimo, ticker MASI, in pulse oximetry; Idexx Labs, IDXX, because hey, pets are people, too; and also Teladoc, you may have heard of it, Chris, ticker TDOC. 

This basket of stocks, in equal proportions, 25% each, since inception -- in San Francisco, I released that out Feb. 9 -- it's beating the market 37.2% to 5.5%. I think it's a great way for investors to get exposure to the healthcare market without putting all of their eggs in one basket.

Hill: Steve?

Broido: Which one do you buy first?

Moser: I think you have to go with Teladoc, man. They're making real waves in this virtual healthcare space.

Hill: Aaron Bush, what are you looking at this week?

Bush: I'm looking at Carbon Black, ticker CBLK. This is another recent IPO, an interesting cyber security company. The company has been around several years, but it's actually acquired its way into a competitive position in next-gen endpoint security, essentially, security around devices that connect to a network. They're also becoming a cloud company. They haven't always been. Revenue growth is around 35%, but their cloud growth is over 200% right now. As this becomes a larger percentage of revenue, it should accelerate the business.

Hill: Steve, question about Carbon Black?

Broido: Given that we tell people to wait on IPOs, how much longer should we be waiting?

Bush: I think it just depends on the company. I don't think you always have to wait on IPOs. I think a lot of times, some great market-beating companies are great buys at the very beginning.

Hill: Steve, do you have something you want to add to your watchlist?

Broido: I think I'm going with Teladoc.

Moser: Good man! Good man.

Hill: Alright. Jeff Fischer, Jason Moser, Aaron Bush, guys, thanks for being here!

Fischer: Thank you!

Moser: Thanks!

Hill: That's going to do it for this week's edition of Motley Fool Money. Our engineer is Steve Broido. Our producer is Mac Greer. I'm Chris Hill. Thanks for listening! We'll see you next week!