In this episode of MarketFoolery, host Chris Hill talks with Motley Fool analyst and video game industry whiz Aaron Bush about some market news. Data analytics company Datadog (NASDAQ:DDOG) went public, and despite an increasingly bearish IPO market, investors seem pretty excited about this one. Apple (NASDAQ:AAPL) Arcade launched today, and Apple gave the service its own tab. Aaron explains why he thinks this could be Apple's biggest service going forward. Also, in light of Microsoft's (NASDAQ:MSFT) dividend/ buyback announcement, Aaron explains some context around the trillion-dollar company -- namely, why that money isn't going toward, say, new games; and what the next few years look like for Microsoft. Tune in to find out more!
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This video was recorded on Sept. 19, 2019.
Chris Hill: It's Thursday, Sept. 19. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio this week, he's the Iron Man, it's Aaron Bush. Thanks for being here!
Aaron Bush: I'm happy to be here!
Hill: Yesterday you were in the studio with David Gardner for Rule Breaker Investing. Check out that episode, if you haven't already. And, Aaron's going to be on Motley Fool Money this week. Can we start with some happy IPO news?
Bush: Let's do it!
Hill: It seems like all the IPO news we've talked about lately has been about WeWork, and that's just been sadder and sadder.
Bush: Not a good IPO poster child.
Hill: No, no. Here's a potential IPO poster child for 2020, and that's Airbnb, which announced this morning it is going public in 2020. I'm interested to see some more data as it comes out. The last private market valuation I saw for Airbnb, I think it was two years ago this month, and the valuation was somewhere around $31 billion. It has to be higher now. There's no way it's lower now.
Bush: Yeah, it'll be much higher. Wouldn't surprise me if it's double that when it IPOs. It's taken them so long to IPO. I'm glad they're finally putting it into the works here.
Hill: Is that something where the second the S-1 gets filed, you're going to get your hands on it? Or, is it one of those things where you're like, "Oh, I'm interested. I'm not necessarily that interested."
Bush: No, I'm definitely interested. What Airbnb is doing is a big deal. I'm sure me, along with most of the rest of the investing world, will be paying a close attention to this one when it comes out. I think what's going to be most interesting about it is, Airbnb is more than just people leasing their homes out short-term. They're trying to be an OTA and compete with the Expedias and Bookings of the world from a different angle. Seeing their success on that front, and what it means for the financials and growth, that'll be really interesting for me to see.
Hill: I think what's interesting about their business, and this is something that doesn't really show up on the balance sheet, but it could be something that they speak to in terms of qualitative metrics, in terms of what they know about their customer base, is Airbnb is one of those experiences that, if you try it, and it works out well for you, then you're hooked. At least, that was the case with me. A lot of my friends, same thing. It's like, "I'm going to try this once and see how it goes." And when it works, you're just like, "This is now the default for me when I'm on vacation travel as opposed to business travel."
Bush: Yeah. Definitely, a word of mouth marketing is a big component of that, too. My Airbnb experience has been hit and miss, so it's not my necessary go-to every single time. But I think it's still good to look at.
Hill: I'm assuming that if it was a miss the first time, you'd be like, "No."
Bush: Yeah. It was solid the first time. Got me coming back.
Hill: Alright, more immediately, we have an IPO today, and that's Datadog, which is a data analytics company. Great name. Kudos to whoever came up with that name. Datadog at this point -- it's just about 12:00 noon as we are recording this -- we don't have public data yet, which is a little unusual. Typically, when a company goes public, we see the stock open usually around 11:00 in the morning. So, the fact that Datadog went public at $27 a share, we still don't have an opening price --
Bush: Oh, it looks like we do, actually. As of right now, it's about $41.
Hill: OK, I was just about to say, the one report I've seen right before we started recording was someone from CNN Business saying that it indicated about $40. So, there you go. $41 a share.
Bush: Up about 50% from their price. It's not showing the market cap yet, but I think that's about a $12 billion market cap. Pretty absurd.
Hill: For the sake of context, it's worth pointing out that Cisco Systems made an offer to buy Datadog for a little more than $7 billion. Sorry, Cisco Systems! They're probably just pounding the table today, seeing what's playing out right now.
Bush: Yeah, good for Datadog. I will say, though, pricing IPOs much lower than they go public at is definitely criminal in some sense, because that means that --
Hill: [laughs] Wait, do you want to use the word "criminal"?
Bush: Criminal is probably a strong word. But the companies that are raising money, they're essentially just leaving tons of free money on the table when their stock goes up much higher than what it was priced for. Datadog is probably leaving hundreds of millions of dollars on the sideline by not pricing their IPO higher. But, it's also a testament to investors out there, they're into software right now, they're craving high growth, and Datadog is giving it right to them.
Hill: And it's the sort of business that has the tendency to be sticky if you do it right. If you have a good data analytics company that you're working with, and they're serving you well and constantly innovating, you don't want to switch there.
Bush: Yeah, for sure. It might be worth backing up a little bit just to share what Datadog is and what they do. They provide monitoring and analytics for developers and IT teams. They sell access to a wide variety of features via software-as-a-service. The point of all of this is to break down silos between teams and integrate data from lots of different sources and turn what was once a chaotic mix of data from lots of different places into something digestible and actionable in one place. They're not the only ones who do this. Companies like New Relic, Splunk does some of this, too. They're not the only player in this space.
But what's impressive is, they've been able to quickly add more and more capabilities. They started with infrastructure monitoring maybe seven years ago. Since then, they've added tons of other features. Application performance management, log management. They just got into the world of user experience monitoring. If they were just focused on any of those one things individually, they probably wouldn't have a solid competitive advantage. But by being able to combine all of these things together, it makes them stand out. And that shows in the numbers. 40% of customers over the past year are using at least two of their products. Revenue grew 82% over the past year. Their dollar based net retention rate, which essentially shows whether existing customers are spending more money, is 146%, which is absurdly great. Maybe the highest net retention rate I've seen since Twilio a year or two back. The company has solid margins. They're producing positive operating cash flows. It doesn't surprise me that investors are interested and pricing it at a premium. But, it must be something like 40X sales right now. They have a lot to prove based on where they're being priced at right now.
Hill: As a general rule of thumb, when a company goes public, do you have a typical waiting period that you employ before you buy shares? Or is it just on a case by case basis? Typically, you want to see the first couple of quarters, not only how they do -- because we know every company, and I don't blame them for this, but every company, when they're filing to go public, they want those numbers to look as good as possible. We've seen, certainly this year, companies come out with that first report, and it is a big drop in quality. But you also want to see, how does management handle the calls?
Bush: Yeah. As a general rule of thumb, it is smart to wait. You get more information. You can see whether they are able to deliver and live up to the hype. But I think there are times where it can make sense. If you see something others don't, which often occurs in times where there isn't a mania around lots of stocks going public, you can find really solid businesses and not be too worried about whether they'll pop or drop at the next earnings.
Hill: This is expensive, but what we're seeing today with Datadog, this isn't Beyond Meat. This isn't day one of Beyond Meat.
Bush: [laughs] No. Beyond Meat is something else.
Hill: Let's move on to gaming. Apple Arcade launches today. Arcade is Apple's video game subscription service. You were telling me this morning you think this has the potential to be the next big service for Apple.
Bush: I think so. It wouldn't surprise me if it ends up the biggest, the most profitable. We've known about Apple Arcade for a while. What we learned recently is, you pay $5 a month for access to over 100 games at launch that are ad-free, micro-transaction-free. So you pay $5 get access to full games. No gimmicks or anything. The price is lower than what I expected and I think what most people expected. But I think it could make sense. What they lose in price, they can more than make up for in volume. And I say that because Apple has probably one of the most insane distribution advantages of any company out there. There's something like 700 million Apple users. And Apple is actually going to be changing one of their five tabs and the App Store to be Apple Arcade. That shows how much importance they're putting into what this service is going to be.
It was estimated that they spent about $500 million or so on the initial slate of games. That sounds like a lot of money. It is a lot of money. But the cost structure is actually so much better than what something like Apple Music is. With Music, Apple has to pay every single time a song is played, which makes it really difficult to scale over its cost. But with games, they just pay a flat amount. It's a fixed cost. The cost is the same whether Apple has one million or 100 million subscribers. What's different is that the outside can grow exponentially. And Apple's pretty smart. They wouldn't be changing how they sell access to games unless it was beneficial to them. So, I'm optimistic that this will be a very meaningful contributor to their services.
Hill: I want to go back to something you mentioned. I think it is one of those things that doesn't sound in theory like a big deal, but it actually is. It's the addition of Arcade as a separate tab. That's one of those things that Apple does not do lightly.
Bush: No, not at all. When you have hundreds of millions of people using that one app, it makes sense to optimize it. If they're saying, "This one service should be one of the five tabs," and that's including search and apps, it shows that they think that this could not only be a big deal, but be very profitable for the business because it can attract lots of people.
Hill: Real quick before we move on, do you expect Tim Cook, maybe not this next conference call, but at some point in the next year or so do, do you expect Apple to start breaking this out separately? Or does it just get lumped into, "Here's what we're making off of services?" My expectation is, at least initially, that's what it's going to be.
Bush: I think that makes sense. I don't think they'll break this out separately. In fact, I think the whole services narrative could get even more confusing going forward. If you just play out how Apple is thinking about services, it makes sense that everything about Apple could turn into a services company. Even how you pay for your iPhones becomes a service. iPhone-as-a-service. So, how they decide then at some point to determine how they calculate the services segment vs. other things, I think that's just going to get messy. In the same way that Alphabet doesn't break out YouTube, and that makes people upset... I have a feeling we might see similar feelings about Apple in the next few years.
Hill: Yeah, but, I don't know... I agree with what you're saying; I don't agree with the timeline. I think that services would need to get significantly bigger over the next few years. It wouldn't surprise me if Tim Cook had already thought about this, and in the back of his mind, he thought, "I'm not going to be CEO when that happens." Not that he's looking to step down anytime soon, but he may just be like, "That'll be the next person's problem."
Bush: I don't know, I mean, this is a trillion-dollar company, or so. Their services business is still larger than pretty much every company on the planet. Could make sense to break some things out.
Hill: Microsoft, the trillion-dollar company, announced it is raising its quarterly dividend 11%. Also announced a stock buyback plan to the tune of $40 billion. They've got the money. They can do all of this. If you're a shareholder, you've got to be happy about this. But I'll just say now what I told you this morning. When I saw this news, the very first thing I thought of was gaming. A lot of times, when I see, "Company X announces raising dividend, stock buyback plan," my first question is, "Is that the best use of their money?" I don't necessarily think in terms of specifics within a given business. But in the case of Microsoft, I thought, "Wait a minute, should they be investing more money in gaming?"
Bush: Yeah, I think that's a good question. That's a question you can ask about gaming, about their cloud services, about pretty much any part of their business. But yeah, gaming in particular. I actually do think they are thinking intelligently about strategy and about investing right now. They're ramping up for their next console launch, which will be around the holidays next year. Associated with that, they're investing lots of money into figuring out what xCloud is going to be, which will probably be a leader in cloud gaming. They've been acquiring many studios to bring them in-house so that they can create more exclusive games. That's a strategy that's been really successful for PlayStation and Nintendo in some ways. It makes sense that Xbox invests more there. They recently struck a deal with Ninja, one of the largest gaming content creators, to stream exclusively on Mixer, which is Microsoft's Twitch competitor that I think most people don't even know that they have.
Hill: I didn't know.
Bush: So now Ninja streams exclusively there. And it wouldn't surprise me if, once the next console comes out, their next big Halo game comes out, if they invest more money to get other content creators exclusively on Mixer, and they can make Mixer a solid Twitch competitor, and maybe make the playing field look more like it is with China, where companies spend a lot more money for content rights and that type of thing and personalities than here, where Twitch reigns supreme. So, there's a lot of things that they are doing. There's lots of things that they could be doing more of within these realms. But I think in general, they're making the right moves in gaming right now.
Hill: Is there anything in the gaming industry, whether it's with Microsoft or Arcade, or even just the publishers themselves, Electronic Arts, Take-Two Interactive, Activision Blizzard, etc., anything going into the holiday season we should be watching for?
Bush: I don't think there is too much that is unique to be looking for this holiday season. I think it's going to be more of the same. More games being published, more people buying games. What's going to be most interesting is the next holiday season, when the next PlayStation console comes out, when the next Xbox console comes out. We'll start seeing early signs of what the next era of the gaming titans will look like. This is the end of an era right now. Maybe not the most important. It's ramping up to the next phase.
Hill: I like you're already looking ahead to 2020.
Bush: I am. But, I will say with Microsoft, it's important to put a lot of these big numbers in perspective because they just have so much freakin' money, Chris. They're raising their dividend 11%. They're going to spend another $40 billion on share repurchases. They produced about $40 billion in free cash flow just this past year. That grew about 20%. So, when you think about increasing their dividend 11%, there's a chance that they might actually be spending a lower percentage of their cash flow next year on dividends than this year. $40 billion is less than 4% of their market cap, and is equivalent to their free cash flow, roughly. So there's a chance they might not even dive into their $130 billion or so cash pool, which is mind blowing. So, yeah, there's a ton they could do. It wouldn't surprise me if they make more acquisitions. I liked Microsoft's acquisition of GitHub, for example, a year ago. It wouldn't surprise me if they do more things working with developers, more data analytics, maybe acquiring an Alteryx or Elastic, more software related companies. They certainly are massive and have tons of options that they can pursue.
Hill: I'm not saying it's not a challenge for the people at Microsoft, but it's got to be kind of fun to be in those conversations. It's basically, "Alright. Thank you all for coming to this conference room. What are we going to do with all this money?"
Bush: Yeah, there aren't many rooms in the world that are like, "Alright, everyone, we have $100 billion to figure out what to do with. What do we feel like buying now?" [laughs]
Hill: [laughs] "Jen, get up to the whiteboard. Let's start brainstorming here."
Three quick things before we wrap up. Next Monday and Tuesday, a bunch of us are going to be in Washington D.C. for a Fool member event. We're still going to be bringing you episodes of MarketFoolery. We've already recorded one of those, ready to go.
Second, this afternoon, Andy Cross, Jason Moser, and I are going to be doing a live Q&A on YouTube. The subject -- speaking of Microsoft -- is dividends, dividend payers. Check that out. It's free to subscribe to The Motley Fool's YouTube channel. Check that out!
And last but not least, shout out to Anthony, one of the dozens of listeners, visiting from Andorra. Across the Atlantic. Thank you to Anthony for stopping by!
If you want to learn more about gaming and you're on Twitter and you're just looking for a good follow, follow Aaron Bush, for crying out loud. @AaronBush100 is the handle. Thanks for being here!
Bush: Thanks for having me, Chris!
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'll do it for this edition of MarketFoolery! The show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Monday!