WageWorks' Very Bad Day

In this episode of MarketFoolery, host Chris Hill and analyst David Kretzmann chat about the market's biggest stories. Apple (AAPL -1.77%) revealed its newest iPhones in an annual event that felt more like an obligation than an unveiling. WageWorks (WAGE) lost a whopping 15% in one day on even more bad news about internal investigations, suspect numbers, and departing management. Don't be tempted by the discount -- this one has a heck of a lot farther it can fall from here.

Finally, resident marijuana stock aficionado David shares some of his biggest takeaways from the last few weeks, which he spent talking to multiple different executives and touring companies all over the country. Tune in to learn more.

A full transcript follows the video.

This video was recorded on Sept. 13, 2018.

Chris Hill: It's Thursday, September 13th. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, David Kretzmann. I feel like it's been a while, for me and you!

David Kretzmann: Yeah, probably at least a month or so.

Hill: You've been in the studio here with Mac, but it's been a while since you and I have been in the studio together.

Kretzmann: Some quality Chris Hill time. I'm excited!

Hill: See, I think of it as quality Kretzmann time. 

Kretzmann: Perfect!

Hill: We'll talk about where you've been. I follow you on Twitter. You've been doing some traveling with business intention. We'll get to that. And we will get to the stock of the day. Unfortunately for shareholders of that stock, it's not the stock of the day for good reasons. Let's, real quick on Apple. We're going to talk about Apple on Motley Fool Money this weekend. Tim Byers is our guest and I'm going to be interviewing him later today. I'm just curious, real quick, any sort of gut reaction to the event that Apple had yesterday? Unveiling the new phones, the smartwatch? Anything strike you one way or the other?

Kretzmann: I think it was more of a ho-hum event this year. We talked yesterday several hours after the event, and I had totally forgot that the event even happened yesterday. I feel like a lot of people, that was basically the story there. There weren't any huge product reveals. They had the incremental upgrades of the iPhone, now they have the iPhone XS. A couple of new models. It's really just improving off what they already had. Some changes with the screen, battery life, but nothing dramatically different. Same thing with the Apple Watch. 

Really, I think you're seeing incremental progress for Apple. I'm personally still an Android user. I didn't see anything yesterday that would have made Apple devices at all more appealing for me. I don't know if it'll be more appealing for any other users who aren't yet in that Apple ecosystem. But for people who are already iPhone users, I think, yeah, if you're due for an upgrade, this will keep you hooked in, whether it's with the watch or the phone. 

I would think next year, in 2020, those will be really interesting years to watch. It's usually every two years where Apple will have more of a new device or a really big leap forward from a product innovation perspective. Obviously, they're rumored to be working on augmented reality glasses, which are rumored to come out 2019 or 2020. I think that's really what a lot of people are keeping an eye on. That'll probably be the newer big announcement in the next couple of years. But for now, this event was steady as it goes. Nothing too game changing that I saw. 

Hill: Yeah. It checked the box. That's sort of how I looked at it. Oh, OK, we got the upgrades that we were all expecting. There were no big surprises. As you mentioned, the XS or 10-S, whatever, I saw someone, I forget who, someone on Twitter, spelled it out phonetically, saying, "No, it's tennis, like the game tennis, as opposed to excess as in too much." But, yeah, it seemed like a check the box.

Let's move on to WageWorks, which is stock of the day because it is down more than 15%. I think it's important before we get to today's news to remind listeners that WageWorks is a company that is still in the process of reviewing its financial statements from 2017. That's why we saw a big drop earlier in the spring. And, the news today that WageWorks has set up a special committee to examine an earlier investigation into financial irregularities. This is the employee benefits administrator company, WageWorks. 

I don't think, in all the years of hosting this show, I've seen that before. I've seen special committees set up. I don't think I've ever seen, "We've set up a special committee to examine the earlier investigation, which presumably was its own special committee." I don't want to overreact, but I'm wondering if dropping 15% is an underreaction. 

Kretzmann: Yeah, this is a really ugly story. You have the announcement today, but you really go back to March, that's when they initially said, "We're going to delay filing the 10-K for this fiscal year, we're going to be looking at potentially restating previous results." This really is going back to 2016. I think the culprit is, they had a large government contract. It's just a matter of how they're recognizing sales and timing and things like that. It sounds like they overestimated the amount of sales they were bringing in, and maybe employees were afraid to be realistic with upper management and saying, "Hey, you know, that contract, I don't think it's going to be as big as we think." It sounds like there was something like that, where they just overstated what they brought in, as far as revenue and earnings. They're expecting to restate 2016 results. Earnings will probably be at least 20% less than what they reported that year. 

But then, also going back to March, they had a leadership shuffle. The longtime CEO, Joe Jackson, he stepped down as CEO, but he was going to remain executive chairman. Well, today's announcement, he's out the door.

Hill: He's gone.

Kretzmann: He's gone. And he didn't even have a quote in the press release. So you know that there's something going on with Mr. Jackson there, that the board and upper management just weren't jiving. It sounds like we're seeing today more symptoms of a lot of inner cultural turmoil, at least at the top of the company. 

Hill: I'm glad you mentioned that with the press release. Because there's a temptation to look at stocks when they are falling and ask the reasonable question, "This is down suddenly. Is this a buying opportunity?" And then, when you start to dig into it -- a lot of times, press releases are just perfunctory. Much like Apple's event, they check the box. I was struck by that, as well. Here's the longtime CEO, he steps down, he remains chairman of the board. Now he's out the door, and there's nothing from him in the press release. The press release, which concludes with this line -- early nominee for understatement of the month -- the final line of WageWorks' press conference: "WageWorks announced that the board is actively searching for an independent board member who will have the right skill set to complement the current board."

Kretzmann: [laughs] With everything that's gone on the past six months, that is not very reassuring, on any level. And on top of that, they're also now reviewing 2017 numbers. Those could be changed. And then, on top of that, they gave guidance for 2018 as a whole, and they're only guiding for 1-4% revenue growth. This is after making a pretty substantial acquisition a couple of years ago. Here, you have a slow-moving, slow-growing company that's reviewing the past couple of years of financials. You have a lot of leadership changes, and it sounds like disagreements on the board and executive level. A lot of yellow and probably red flags here. I agree with you. I think this could be a case where a 15% drop... I wouldn't be surprised if we see more red here in the days to come.

Hill: As I said, I follow you on Twitter. You've been doing some traveling. I think some of it's for fun, but clearly, you've been out interviewing people. To the extent that you can share some of the interviews that you've been doing -- you work with Motley Fool Canada. You've been focusing on the cannabis industry, where we are now not months away, we're just weeks away, aren't we? We're basically a month away from Canada fully legalizing -- I mean, it got passed, but it goes into effect October 17th.

Kretzmann: That's correct. Coming up. Last month, I went up to Toronto, where there's not one but two cannabis conferences, back to back. It was a busy week for cannabis in Toronto. The day that the first conference started, that happened to be the same day that the Constellation Brands (STZ -0.93%) and Canopy Growth (CGC -1.72%) deal came out. Constellation Brands came out and said, "We're going to invest an additional $5 billion Canadian into Canopy Growth," which at this point, by market cap, is still the largest cannabis company in Canada and the world. That was going to raise Constellation's stake into Canopy up to 38%. They'll now have four of the seven board seats, and they have options to basically take 50% or more control of the company down the road if they want to. This was a huge investment, by far the biggest investment we've seen in this space. There was a lot of buzz and excitement following that deal. 

Pretty much most people I talked to -- I talked to a lot of insiders, journalists, executives --they really see that deal reiterating the opportunity here. It legitimizes, yes, the legal cannabis opportunity is here. It's growing. To have a heavy hitter in an outside industry like Constellation Brands come in and just make such a huge commitment to the category, I think a lot of people see that as the first domino to fall. 

Diageo was another alcohol company that's been rumored to be meeting with Canadian producers. Anheuser-Busch, it's probably just a matter of time before they make an announcement. We've already seen Molson Coors Canada partner up with a Canadian producer. Then, you're probably going to see tobacco companies, pharmaceutical companies, consumer packaged goods companies, all start to take a closer look here, just recognizing that, yeah, more countries, more states here in the U.S., are legalizing cannabis. It's just a matter of time before, truly, a global legal cannabis industry is forming. 

The timing was great, to be able to talk to people right after that announcement. Spent a few days in Toronto meeting with executives and insiders. A lot of great conversations there. Then, I was in California, mainly for personal reasons. But while I was out there, I checked out a dispensary for myself, a MedMen Dispensary there. They're probably one of the bigger retail brand names out there. They have several cannabis dispensaries in high-profile locations in California, New York City. I was able to check out a dispensary for myself there. A lot of security and things there. 

Then I went to Chicago to visit a private cannabis company, Cresco Labs. They're the market share leader in Illinois, Pennsylvania. They're probably going to be a leader in Ohio, as well, which recently took some steps to legalize cannabis there, I think just on a medical level initially. But, while I was visiting Cresco Labs, was able to meet two of their co-founders at their headquarters there. Also, shout out to the (unclear 12:05) brothers, who are Motley Fool members, and they actually introduced me to Cresco Labs. They were able to invest privately in the company several years ago. They set up that conversation and introduced me to the company. 

We all met with management there, saw their headquarters. Then we drove out to Joliet, Illinois, where Cresco Labs has one of their bigger growing and processing facilities. You can see the plants being grown, you can see the processing, how they essentially convert the plants into oils and different product forms. Everything from seed to the final product. It was nice to be able to see everything that goes into this industry. It was a cannabis-dominating couple of weeks for me.

Hill: We've talked on this podcast before about, in the beverage industry, we've seen smaller beverage producers, whether it's small craft brewers or just a local company like Honest Tea, and they start and they're small. And, for a lot of them, the business goal, the ultimate business goal, is, "We'd like to be acquired by someone bigger." In the case of Honest Tea, they got bought by Coca-Cola. I'm curious to the extent that the Constellation investment in Canopy Growth maybe spurred any conversations that you had, whether it's with private companies or public companies. Do you get a sense of a common goal among the people in the industry? Is it, "Hey, from a business standpoint, we'd like to get to the point where we are publicly traded. We take this company public and we want to be one of the biggest players in this industry." Or, are there people looking at what happened with Constellation Brands and Canopy Growth and these other conversations going on, saying, "Yeah, we're going to try and grow this business as much as we can. But, ultimately, if someone's going to pay to buy us, that's a great conversation we'd love to have."

Kretzmann: I think a lot of people recognize and believe that we're still in the early stages of consolidation. The point where you'll see some of the bigger pure play cannabis companies acquire some of the smaller players in this space, you'll see some of the smaller and mid-level companies try to consolidate to better compete with the larger players. Then, outside of the industry, this Constellation deal is really spurring, what does it look like for outside established industries to make inroads into the cannabis space? I think across the board, with all those different categories, you're going to continue to see a lot of investments, partnerships, acquisitions. 

A lot of companies at this point are obsessed with gaining share locally where they can, in Canada, in a lot of cases. But you also have some U.S. operators who are trying to focus on certain states where it's legal, whether it's California, Ohio, Colorado, Pennsylvania, Florida. You have more and more states coming online. You're seeing a variety of different strategies, some companies focusing more on their local markets, some companies are obsessed with expanding globally as quickly as possible and taking some pretty extreme measures to do that. 

For me, it's just been fascinating to follow the category. As we've talked about the past few months, every company at this point is saying how great they're going to be. But their track record so far is pretty minimal, if not non-existent. You have all these companies outlining why they think their strategy is best. But, the nice thing about this October 17th date coming up, a milestone coming up, is, we'll finally get a sense for which companies are actually gaining traction, at least in Canada. Then, along the way, you'll see which companies are starting to gain more traction internationally, which of the U.S. operators are gaining traction. 

It's worth noting along the way that even though, in the U.S., cannabis is still federally illegal, it's recognized as a schedule one substance, right alongside heroin -- I mean, fun fact, cannabis is essentially rated as a higher-risk substance than cocaine in the U.S. right now. That gives you an idea, on a federal level, where the government is coming from.

Hill: We might want to revisit that. 

Kretzmann: Yeah. I think it's just a matter of time before that happens. In the meantime, with U.S. operators, they can't go public on the New York Stock Exchange or the NASDAQ because it's still a federally illegal substance. But what you are seeing is a lot of those companies going public on the Canadian Securities Exchange. These companies are going to Canada. Even in Canada, they can't list on the more reputable Toronto Stock Exchange for the same reason. The Toronto Stock Exchange says, "No, we won't let companies list that are selling a substance that's still federally prohibited in your country." For a variety of reasons, you're seeing Canada really become the hotbed both for the legal cannabis industry, but then also for any company that's looking to list publicly. They're going to Canada. 

A whole lot of things happening in this industry. It's just fascinating to follow such a fast-paced category right now. 

Hill: While you were up in Canada, when the news broke about Constellation Brands and Canopy Growth, on this podcast, one of the things we talked about when we talked about that topic was the price that they paid. I'm curious if anyone you talked to said anything along the lines of, "Hey, good for Canopy Growth. But holy cow did Constellation Brands pay a lot for that investment." That's what struck me. It wasn't that they did it. It was the price they paid.

Kretzmann: Yeah, it was a lofty price. I mean, about $4 billion U.S. dollars for 38% of the company, it's a lofty valuation. I don't think anyone in the industry will admit that. Everyone right now is so optimistic. They want their company to be invested at that same level. From Constellation's perspective, they really are treating this from a long-term view. They're saying, "We think cannabis globally will be a $200 billion market by 2030." Part of the reason that Constellation has been at the forefront of making investments into this category, they announced their first investment in Canopy Growth last October. By far, they've been the first mover. Now, the first mover with such a dramatically large deal. Part of the reason is that they're essentially still a family run company. You have, essentially, the Sands family. You have a founder-run company, they're not as beholden to thinking short-term about the risks, like, "Well, it's not legal in the U.S. yet. Will the federal government investigate us or somehow get in our way?" 

I think from that perspective, they see cannabis becoming an increasingly relevant cultural force. You're going to see more and more countries take the step to legalize cannabis. I also think, by making this statement now, if and when the U.S. does decriminalize cannabis on a federal level, all of a sudden, Canopy Growth has a war chest to go into the U.S. I think they're anticipating that within the next couple of years, we will see the U.S. on a federal level decriminalize cannabis. And if and when that happens, you're going to see Constellation and Canopy just go all out. 

Hill: Three quick things before we wrap up. First is that we are hiring here at The Motley Fool. We actually have a lot of jobs posted right now and more coming next week. You can see all of those listed on our job site, which is just careers.fool.com.

Also, secondly, the 25th anniversary sale continues in our podcast shop. You can just go to shop.fool.com. 25% off everything in the store. We've got some good stuff and it's not expensive. 

And last but not least, if you haven't been listening to our Industry Focus podcasts, we've got some new hosts. Nick Sciple, who's a new editor here at The Fool, is talking Energy and Industrials in the Thursday episodes. We have to get out of the studio so Nick can tape his episode. Next week, Shannon Jones takes over on the Wednesday Healthcare episode. Shannon has a bachelor's degree in neuroscience and a master's in finance, that's all Shannon has going on. [laughs]

Kretzmann: Incredibly smart!

Hill: And on top of that, starting next Monday, your new host of the banking Financial episodes of Industry Focus... Jason Moser!

Kretzmann: J-Mo!

Hill: Do you think the war on cash is going to come up on that on that episode of Industry Focus? 

Kretzmann: I think a new drinking game is in the works.

Hill: All of that, plus Vince Shen talking Consumer Goods and Dylan Lewis talking about Technology. Industry Focus. If you haven't checked out our Industry Focus podcast, now would be a good time to do so. David Kretzmann, good to be back in studio with you!

Kretzmann: Great to talk, Chris!

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 on Monday!