The great investor Benjamin Graham famously said: "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." We could also say that the market is a soothsayer, an oracle: Values are set based on what we think is going happen, and what companies tell us they think is going to happen. But if Wall Street lives on predictions, it endures plenty of wrong ones. For example, the leaders of the rising co-working powerhouse The We Company last month offered an array of upbeat forecasts in their IPO filings, and predicted an ambitious range for the offering price. But since then, everything has gone sideways, and on Tuesday, it said it was putting the going-public process on hold.
Another example: When Berkshire Hathaway and 3G Capital joined forces to swing the merger of Kraft and Heinz a few years ago, the common view forecast success, because with a team-up like that backing the deal, a win was in the bag. But that's not how it has played out, and Tuesday, investors were unhappy to hear that 3G had recently sold 25 million shares of Kraft Heinz (NASDAQ:KHC). Last example: A pair of consultancies just forecast similar good things about the upcoming holiday shopping season. But one added a serious hedge to its prediction.
In this episode of MarketFoolery, host Chris Hill and Motley Fool Asset Management's Bill Barker discuss these news stories and more.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Sept. 17, 2019.
Chris Hill: It's Tuesday, September 17th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, from MFAM Funds, Bill Barker. Thanks for being here!
Bill Barker: Thanks for having me!
Hill: We've got a holiday retail forecast. We've got some consumer goods news. But we're going to start with the end of We Company. Not the end, I suppose, for the parent company of WeWork, but certainly the end of its attempt to be a public company. It is officially over. WeWork has shelved its plans to go public. I'll just say something that I've said before, which is, I have never seen anything like this before. I've never seen anything this negative, this fast. To go from, in less than a month, basically, "We're going public, here's our valuation. Oh, you don't like that? We're going to cut it in half. Oh, you don't like that?! Can we lower it even further?" And now, I don't know what happens to this company.
Barker: They've postponed the IPO until at least October. You've said this is the end, but I think is just the end of the beginning, the end of the first attempt to go public. Let's paint a good picture here for them for a moment, which is that they come out with another quarter of results; the results are better than expectations. Expectations are to lose billions of dollars, and they probably will pull that off, but maybe in a smaller amount than the worst fears. Revamp the atrocious executive compensation and, ownership structure that they've got, and bring this out at something approaching a reasonable valuation. Then, maybe, you see this come out again, which may be necessary, because they're going to need the money. They have adopted a business plan which appears to be, "We can burn through lots of money because we're going to be able to get money out of an IPO when we need it." I think they're still pretty much wedded to that business plan.
Hill: That may be, but keep in mind, the most recent public filing we got from WeWork was a revamping of, maybe not all of the moves they could have made in terms of executive compensation, but they certainly ratcheted down the power that the CEO has; they improved the corporate governance. It seemed at the time, and it still seems, like rearranging deck chairs on the Titanic. If they really need to go public, then yeah, you're right, I suppose there's a pathway in which they beat expectations on how much money they lose; they still need to radically overhaul what they're doing on the compensation side. And, I would argue, even the corporate governance side. I feel like they're just scratching the surface of that, if they really need to unlock public market value.
Barker: I agree, and I think that that is probably what is ahead, at least probably rearranging some of the names of some of the higher up executives.
Hill: Do you think they need a change in leadership? In the same way that Uber got to the point, when it was still a private company, that Travis Kalanick was no longer tenable as the leader of that company? It seemed very much the case that, certainly, behind closed doors, there were people telling Kalanick that, and other people who have that company, "Look, if you want to go public and have any decent shot of overhauling your image, that guy has to go."
Barker: Yes. I think that's what they need to do. Whether that is what is done will remain to be seen. But if they were to do that, and get some very credible leadership to come in there, that's their best opportunity, I think, for a valuation along the lines that they want. It's a long way from here to there, given the ownership structure. But that's a better path, I think, than any other one. If you're talking about what, from the outside, seems to be a small change -- just get a different person who has the skill set and credibility. There are those kinds of people out there.
Now, that said, Uber did that, and it's not like they've been a great IPO. They went public, and one can always take the perspective that if you go public and achieve more money than the stock is worth later on in time, then you've done a good job in terms of getting money into the company, and not selling all of your company at the wrong valuation in terms of fundraising. But, in terms of what investors want, and what investors are looking at, given the somewhat broken IPOs of Uber, Lyft, Slack, yeah, this does not appear to be the time to bring out a, "we're growing really fast, we're losing lots of money, trust us" IPO.
Hill: Last thing before we move on. How confident are you that they go public before the end of 2019?
Barker: I'll take the under.
Hill: Does that mean yes?
Barker: Less than all of them go public. [laughs] I think it's not going to happen in 2019. They've announced this is postponed until at least October. They're going to bring it in, retool, talk to people, see where the sentiment is. I think that the things they're going to hear are, "You need to do more than you think you need to do." And that's going to take longer. It's easy from the outside, "Why don't you just get a different CEO together?" That's not going to sit well with the current CEO and founder. You have to wade through that. Everybody has their price, though. If his interests are, "Look, I just want to have a whole lot of money from this," then he may be convinced that that is the way to get the biggest pile of money.
Hill: Shares of Kraft Heinz down 4% today. That's because 3G Capital disclosed it's sold 25 million shares of Kraft Heinz. I will add parenthetically, this is on top of the 20 million shares that 3G sold in August of 2018. In some ways, this seems like the opposite of WeWork, in the sense that WeWork gets ready to go public, and pretty much everyone who looks at it says, "Oh, God, I want no part of that company at a valuation of $47 billion, or, for that matter, $25 billion." You think back to 3G Capital getting together with Berkshire Hathaway on the Kraft Heinz deal, and at the time, was anyone negative on this deal? This deal that has just continued to go south quarter after quarter, year after year? At the time, it was like, "Oh, it's the brilliance of Buffett. 3G Capital has this reputation as great operators. They're going to make this work."
Barker: Yeah, I don't recall anybody being skeptical about the long-term prospects here. But, times change. I think that 3G has brought the cost-cutting mentality, and has improved significantly operating margins at the entity. But, they have in part done that by cutting back on brand building and advertising, so the top line is not growing at all. Where they find themselves is in a world where Kraft and Heinz -- to shine a spotlight on the brands that you know through their name, and there are many other brands under the umbrella here, but Kraft cheese, Heinz ketchup. You've got two brands that are stuck in the middle, and this is where they are. They have brands, everybody knows the names. But, there's increased competition by private label, which can compete in terms of quality against them. And then, there's lots of other things coming into the market that are more organic, more healthy, certainly advertising themselves as more healthy than the highly packaged goods that we associate with these names, more expensive. So, if people are going to spend a little bit more than the private label, maybe they're going to spend a little bit more than that to get the organic stuff, the healthier stuff. And Kraft Heinz has the middle part of that market, which is not growing.
Hill: Let me move away from the business and talk for a moment about palace intrigue, for lack of a better phrase. Back in June, Warren Buffett was asked about tensions between Berkshire Hathaway and 3G Capital over this deal. Berkshire Hathaway has had to write down the Kraft Heinz acquisition. At the time, he was like, "No, no. Everything's great." How many more times can 3G Capital sell tens of millions of shares before Berkshire Hathaway starts to think, "You know, maybe we're going to dump some of this, too"?
Barker: Well, in part, it depends on how accurate the possibility is that a lot of what the sale was about was a capital raise. 3G has windows where it needs to return capital to shareholders who want some of their money back. This being one of their largest holdings, this is one of the places that they have to go to get that. There was a separate filing that the head of 3G, for himself, his personal holdings, increased by $100 million of Kraft Heinz. That's the narrative that Buffett presumably has to figure out. If the head is buying more, showing confidence in the company, at least at this price, and there's nothing that they can do about the money that they have to return to shareholders other than to liquidate things they otherwise wouldn't want to liquidate -- including but not limited to Kraft Heinz -- then maybe everything is good. If that turns out to be a story that he can't trust, for some reason, then things are not as good. The palace intrigue ends in murder, I suppose. Presumably death.
Hill: [laughs] Presumably. 3G sold 20 million shares last summer, summer of 2018, at around $60 a share. They just sold these -- right now, the stock's around $28. It's close to an all-time low. Does this look at all attractive to you on a valuation basis? Do you think there's any chance Buffett goes out and buys more of this? Or, do you think this is just one he lets sit there for a while because of the pain it has caused at this point?
Barker: I'm not sure if he has a philosophy on throwing good money after bad.
Hill: I'm pretty sure he's against that.
Barker: Yeah, I mean, when you phrase it that way. Or, averaging down, if you want to look at it a bit more positively. It's trading about 9X earnings, I think. There's certainly a place where you get interested in the valuation here. Presumably, it's been in that place for a while, actually. I think it is possible. But, he doesn't need to go further down this path.
Hill: Holiday retail sales are projected to increase 4.5% to 5% this year. This is according to an annual survey by Deloitte looking at holiday retail spending somewhere in the neighborhood of $1.1 trillion. Although, as you like to say, the great thing in life is to have an easy act to follow. Holiday retail sales in 2019, a little bit of an easy act to follow, or easier act to follow, because retail sales last holiday season were a little bit lower due to a number of things, not the least of which was, you may recall, last December, the stock market went basically straight to zero. Not straight to zero, but it went down a lot.
Barker: [laughs] About 20%, a little over 20%, depending on what average you're following from its high to the low, which was right before Christmas. That was pretty tough. The real economy is growing 2%, 2.5%; inflation, 1%, 1.5%. So, 4%. So, throw another percent, maybe, in terms of holiday cheer, on top of just real growth plus inflation. It's not really that much of an estimate. You don't need a lot of data sources beyond your head to come up with that one.
Hill: Wow! That's quite a shot you just took at Deloitte.
Barker: I mean, it's just not some huge mystery, I think.
Hill: I should add parenthetically, for those who are thinking about looking at the landscape of retail stocks you could buy, e-commerce sales expected to grow in the range of 14% to 18%. Maybe not a surprise that e-commerce sales, looking to run ahead of traditional bricks and mortar retail as well.
Deloitte came out with their annual survey. There was another forecast that came out today as well. Maybe timed specifically to come out with a Deloitte one. From global consulting firm called AlixPartners. Basically came out with, not an identical forecast, but very close. Slightly lower range. 4.4% to 5.3%. It's basically the same, although AlixPartners in their forecast warned of, and I'm quoting here, "unprecedented uncertainty this holiday season for retailers." What do you think they know at AlixPartners that nobody else does? You're throwing a word like "unprecedented" around? Really?
Barker: There were four Christmases that came to mind as possibly being even more uncertain. 1941 comes to mind. And then, of course, the year Rudolph came into Christmas. Very uncertain going in there.
Hill: Yeah, there were headlines warning that Christmas might be cancelled outright.
Barker: Exactly. The year the Grinch actually did steal Christmas, there was a lot of uncertainty. "How's this going to play out?" Happy ending, as it turned out, despite the theft. And, of course, the year without Santa Claus.
Hill: Right. By the way, all those things you just mentioned, they all happened. So, there are the precedents right there. I don't know what the folks at AlixPartners are imagining is going to happen this holiday season.
Barker: Lack of research, I say. The precedent is there. Each one of those four Christmases, way crazier. It's just a little trade war. There's some tariffs. Maybe you're going to have to pay 15% more for your plastic toy, vs. a literal Grinch --
Hill: Breaking into your home.
Barker: What even is a Grinch? People had no idea. This year, you're like, eh, 15% more for a toy. And no one's stealing it overnight. Probably.
Hill: I think we need AlixPartners to step up, give us some potential bullet points here. What does this look like? Game out a couple of scenarios for me. What kind of unprecedented uncertainty are you talking about? Otherwise, you're just throwing words around.
Barker: Yeah. We'll revisit this. Those that have been around know that Rudolph, at least, is evaluated every year in this space.
Hill: Always. You can read more from Bill Barker and his colleagues. Go to mfamfunds.com. Thanks for being here!
Barker: Thank you!
Hill: As always, people on the program may have interest 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 MarketFoolery! This show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!