In this episode of MarketFoolery, host Mac Greer talks with analysts Emily Flippen and Jason Moser about some recent market news. Microsoft (NASDAQ:MSFT) was awarded a $10 billion cloud computing contract with the Pentagon, which seemed to surprise just about everyone -- including Microsoft. Amazon (NASDAQ:AMZN) isn't happy about it, and may make its complaints heard in court. Tiffany (NYSE:TIF) is being courted for buyout by luxury brands specialist LVMH. Spotify (NYSE:SPOT) had a good day after reporting a strong quarter, and the company's long-term growth picture looks pretty good, too. Where do podcasts fit into the picture? Tune in to find out more, plus an overrated/underrated Halloween candy throwdown.
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This video was recorded on Oct. 28, 2019.
Mac Greer: It's Monday, October 28th. Welcome to MarketFoolery! I'm Mac Greer and I am joined in studio by Motley Fool analysts Emily Flippen and Jason Moser. Welcome! Happy Monday!
Emily Flippen: Happy Monday!
Jason Moser: Hey, hey!
Greer: How are we doing?
Moser: Doing great! You had a pretty good weekend, didn't you?
Greer: Yeah, if I'm a little horsey, it's because I was cheering on my Astros. I'm an Astros guy. I grew up in Houston.
Moser: You went to one game?
Greer: Two games.
Moser: Two, wow! Which ones?
Greer: I went to games four and five.
Moser: Saturday and Sunday.
Greer: Saturday and Sunday. But I was just saying before the taping that I have mixed emotions. I love for the Astros to win, but I don't like seeing the Nats get swept. I'm trying to go around the office and cheer people up. It's not working today.
Moser: Swept at home.
Greer: Swept at home. That's rough. But the Astros got swept at home also. Still some baseball to be played.
Now, on today's show, Tiffany has a suitor, and I'm not talking about the pop star. Jason, I'm talking about the retailer. And Spotify has a surprise for investors.
But let's begin with Microsoft. Shares opening at a new high on Monday after Microsoft was awarded a $10 billion Pentagon contract for its cloud computing services. Now, Jason, it may shock you to know that there may be a political layer to all this. Amazon's the market leader in cloud computing. They already provide cloud services for the CIA. They are considering challenging the awarding of the contract, citing President Trump's interference in the bidding process.
Now, we will let the politics sort itself out. But in terms of the business and vacations, what does it mean for investors?
Moser: Very good point there regarding the political nature of this. Who knows? We don't, obviously. But from a business perspective, I think it's important -- we talk a lot about cloud these days. AWS has always been the No. 1 --
Greer: Amazon Web Services.
Moser: Amazon Web Services, that's the No. 1 company in the space for a number of reasons there. But Microsoft clearly is doing very well in this space. It's very important, I think, to note that it's not just cloud business, and then that's it. There's nuance to each company's cloud business and what they do. What I mean by that, if we look at Amazon, for example, you look at Amazon's 10-K, and they refer to AWS, Amazon Web Services, as the segment which offers a broad set of global computer storage database and other service offerings. Now, in 2018, AWS recorded about $26 billion in sales. Now, if you look at Microsoft, Microsoft commercial cloud in 2018 actually recorded $38 billion in sales. $38 billion is more than $26 million, and yet Amazon's the cloud leader. How can this be, Mac?
If you look in Microsoft's 10-K, the way they define their commercial cloud is, commercial cloud revenue includes Microsoft Office 365 commercial, Microsoft Azure, however you prefer to pronounce it, the commercial portion of LinkedIn, Microsoft Dynamics 365, and other cloud properties. My point being is, when Microsoft talks about cloud, they're defining it a little bit more broadly. That's why you see Microsoft with that $38 billion vs. Amazon's $26 billion.
But what we're talking about is this infrastructure as a service. That's what Azure is. That's what Amazon is. It's the building blocks of the cloud there. So, while Amazon is the leader in that space with basically half market share, 50% of that market share, and it's actually more than the next four players combined, Microsoft is a strong No. 2 player in this space, and they're gaining market share.
So, political motives aside, there is a business case to be made for giving Microsoft this contract, is my ultimate point. So, we shouldn't be surprised by this.
Flippen: Yeah, Jason, to your point, this is rumored to be about a $10 billion contract. When you think about the size of these businesses, this is huge. With AWS, like you mentioned, having about 50% of the market share, and Azure being much further behind with 16%, according to Gartner, this contract moves a lot of needles for these companies. I think, Microsoft, even though this is great for them -- but they were very clearly surprised by this. Earlier this year, they were the ones beating the table saying that a $10 billion contract was way too big to give to just one company, and the DOJ should look into using multiple providers. So, I think it's clear that they definitely were surprised by this news as well, because even earlier this year, by making that comment, they felt behind AWS.
Moser: I think a lot of people were surprised, maybe, by this. I think most people think because of Amazon's experience in the space and the contracts they've locked up at this point, it's probably the most sensible fit. Again, it is a matter of what the services are needed for, and what you're ultimately trying to do with those services. Microsoft cloud services, they've placed a big emphasis on AI and analytics. It's not to say that Amazon doesn't have those capabilities, but Microsoft has been investing more in that. Perhaps this JEDI contract is something where they're going to benefit more from the AI and the analytics, and they felt like Microsoft was a better fit.
But at the end of the day, again, I think it makes sense from a customer's perspective. You look at Amazon and you think, they've got basically 50% market share. But you also don't want to be signing up and putting all of your eggs, essentially, in that one basket. You get into that single point of failure risk there, and if something happens to Amazon, your entire cloud infrastructure gets flushed down the toilet. So, you have to be very careful how you're picking this. So, seeing customers being very deliberate about how they choose their providers, and then also diversifying away from being a single provider, makes a lot of sense.
Greer: Emily, to your point, I assume that Microsoft will no longer be complaining about the size of the $10 billion contract.
Flippen: [laughs] I think that's a safe assumption!
Greer: OK, let's move onto Tiffany. Shares of the retailer up more than 30% on Monday on news that French luxury group LVMH has made a takeover offer that values Tiffany at around $14.5 billion. That's a whole lot of those little blue boxes, whatever comes in those. Isn't that the Tiffany thing?
Moser: It is.
Greer: You can tell I buy a lot of jewelry at Kay.
Moser: I got my wife a Tiffany bracelet --
Greer: Once again making me feel bad.
Moser: -- birthday gift to go with a necklace that I got her a while back.
Greer: Look at that! Well, LVMH is the world's largest luxury goods group. Fun fact: it is owned by Europe's richest man. I just learned that this morning. What does this potential deal mean for Tiffany? And if I'm looking at Tiffany's stock, should I think about buying it right now?
Flippen: It's interesting because Tiffany's actually had a really tough year leading up to this. This stock isn't necessarily a terrible performer, but the 22% increase in value this acquisition offer poses to them is definitely much appreciated by current shareholders, because Tiffany's has been struggling. It's interestingly in large part due to the trade war with China. They get a lot of their sales from Chinese consumers. They're among some of the largest purchasers of Tiffany's products. So, the trade war has actually caused declining sales for Tiffany's. Last quarter, sales fell 3% year over year, and management attributed it to what they called weak demand from foreign tourists. But I think that paints a perfectly clear picture of what Tiffany's is going through. Actually, last quarter, their sales were down in every single region in which they operate. Admittedly, that's compared to 2018, which was a good year for them. But the point is, is that it's an industry that isn't particularly high growth. And when you look at younger consumers, you look at how the market is starting to evolve, it does beg the question of, is Tiffany's really the value-add that it once was? Not only is there potentially weak demand for traditional diamonds among younger consumers -- people being much more concerned about how their diamonds are sourced, the ethical uses behind diamonds, as well as just current demand for diamonds vs. other things. At least, that's true in the Western markets. But the fact that their sales have been down across the board is definitely concerning.
I will say that Tiffany's is definitely not dead in the water, though. I would say that they need to either restrict supply or starting meeting the market where it is. When people look to shop, they're no longer going into that Tiffany store, at least not to the extent they were previously. They're looking online. So, Tiffany's either needs to restrict that demand -- their inventories were actually up year over year, which is not a good thing for Tiffany's -- or they need to start maybe going lower market. Maybe go a little bit easier, meeting the consumer halfway.
Moser: Do you see how they can now grow diamonds in a lab?
Greer: Is that true?
Moser: Yeah, that's technology that's here and now. It really makes you wonder, to your point about the sourcing behind these diamonds, the ethical arguments for and against, you may completely remove that some point if you just have these lab-grown diamonds. I've always looked at Tiffany's as kind of like investing in an oil company, honestly. They're so good about protecting their brand. They don't resort to fire sales. You're not going to see them participating in, what is it, Black Friday? I forget it, even. It's all just kind of the same now. Isn't every day just one big fire sale, Mac?
Greer: I like that!
Moser: It feels like it.
Greer: We could put that on a motivational poster. "Isn't every day one big fire sale?" [laughs]
Moser: They've done a very good job of protecting the brand, but the thing is, it ebbs and flows with how the consumer's doing. You can buy Tiffany when it's depressed, when the results are really bad. And when things start looking great, you probably want to sell it. It does seem kind of capped in where it can ultimately go with the market that it's serving. They're not going to be pursuing that mass market audience. If they do that, they lose that exclusive nature that the brand communicates. It's always been a difficult investment from that perspective to me, because you have to be so in touch with the valuation. But it's a very powerful brand. I can understand why a luxury house like this want to own it.
Greer: I'm impressed that you're buying from Tiffany. I would not trust myself to buy something from my wife from Tiffany. I'm like, "Here's an Amazon gift certificate. Costco, let's go to Costco."
Moser: I will say, I'm with you there. I'm horrible when it comes to jewelry. I'm blind. Now, one trick, and I discovered this a while back, if you get one piece of jewelry, then you can try to find the other pieces that complement that.
Greer: You've already lost me.
Flippen: Lost me, too.
Moser: When we had our second daughter, we gave my wife a gift saying, "Hey, thanks for doing all that hard work." And it was a Tiffany necklace with a little pearl on it. So, for her birthday this year, I found the bracelet that matched the necklace. And I knew that would be OK because she already had the necklace and she liked the necklace.
Flippen: Here's the problem with that. You're going to get one gift. They're going to say, "Oh, thank you so much!" They hate it. Right? It's horrible. And then, every year for the next 10 years, there's a new gift based off the original bad gift! [laughs]
Moser: That's the fear!
Flippen: You have to be good to start!
Moser: I'm working on 18 years here, essentially -- sorry, 13 years --
Greer: Emily Flippen, throwing cold water.
Flippen: [laughs] Oh, no!
Moser: [laughs] I'm working on 13 years of assuming that my wife has been honest with us and telling us that she does, in fact, like this necklace. But if she doesn't, you're right. My thesis is blown out of the water.
Flippen: Tiffany still appreciates it.
Greer: Let's close with a little Spotify, the streaming music giant. Some sweet music for Spotify investors on Monday. Shares up around 17% after Spotify reported a surprise. That surprise was a quarterly profit. Stronger than expected subscriber growth. Five million new paying subscribers for the quarter. Spotify ending the period with 113 million Premium subscribers. Emily, what do you think?
Flippen: Spotify is an interesting one. We were talking earlier about this. I'm not a big music listener myself, but it seems like for 113 million paid subscribers out there, Spotify is their go-to. I would just say, there's a lot of fear in the market when it comes to Spotify, just based off the idea of, can they acquire customers profitably? This past quarter, revenue rose 28%. Marketing and operating expenses rose respectively 11% and 22%. So, while there are increases in costs there, the increase in revenue did outweigh it. So, I think the market's really just appreciating a company that proves, "Look, we can acquire customers at a higher rate than historically, profitably." So, good day for Spotify today.
Moser: It was a nice surprise. So sweet, we have to bring in that the Widespread Panic surprise --
Greer: You're a big Widespread Panic guy, right?
Moser: Yeah. There's a listener out there or two who know what I'm saying. Emily keyed in on something I think that's really important. Revenue growth continues to outpace expense growth meaningfully. That's really important for this company over the long haul. Mac, I know you're a big fan of us leading with our strong statements. I'm going to lead with a strong statement. It's not mine, this is from Barry McCarthy. He's the outgoing CFO. He says that streaming was to Netflix as podcasting is to Spotify. Now, think about that for a second. He goes on to say, "We can see in video that streaming wins and linear dies." That's where they're making the investments. The Street will catch on eventually. I think there probably is something to that. I think that the more and more we go in the entertainment space, whether it's video or music, or podcasting, or whatever, it's on demand. It's listening to what you want, when you want, where you want. To my mind, we've seen some players like Amazon and Apple have done really well in building out music and podcast services, but Spotify, really being the pure play, has devoted all of their time and resources into building out this streaming platform that transcends music. It's podcasts and all other forms of entertainment that will come down the pike here. But the user growth is there. Total MAUs, monthly active users, were up 30% to 248 million monthly active users. Paid subscribers, you have 113 million Premium subscribers now. That was up 31%. That matters because Premium subs tend to churn less, and they are more profitable for the company. Ultimately, they're just trying to grow that Premium membership. And they do that through compelling offerings like the family membership, which we have in my house. Great value there. They have a student membership, and they're coupling up with other media properties out there like Hulu and others to try to bring more subscribers into that universe there. I think it's all working out. It's just tough to see a business like this spending so much on the content side. But that's what they have to do. We've seen other businesses do this, whether it's Netflix or Pandora. It's a difficult business in the near run. But in the long run, the trend is clearly toward digital and streaming. And that's what Spotify is focused on.
Greer: What about the stock?
Moser: It's been a really difficult year for the stock. Obviously a very good day today for it. I tend to believe that this is one that you're going to have to revisit maybe annually to make sure you're still happy owning it. But I think this story, it's going to be materially different five to 10 years down the road, because they're ultimately looking to completely disrupt the big recording houses, the big publishers, and offer artists another avenue to get their content out there and actually make more money doing it. It's this two-sided marketplace they continue to talk about. It's going to take some time, it's going to take some investment, but clearly, things are going in the right direction.
Greer: OK, let's wrap up with our desert island question. You're on a desert island. You don't have a lot going on so you might as well invest in a stock, and you might as well hold it for the next five years.
Moser: Why not?
Greer: So, here are your choices. Microsoft, Amazon, Tiffany, or Spotify? What do you think?
Flippen: For me, I hands-down would choose Microsoft. I think Microsoft is... I don't want to call it a comeback story, because that makes it sound like Microsoft was ever doomed. I don't think they were ever doomed. But they work they've done with Azure has been absolutely amazing. There's a lot of room for them to expand that business. The $10 billion contract is just one part of that. It's going to be a tough road. There's going to be lawsuits associated with that contract, undoubtedly. But I think the underlying business is solid. That's not anything against Amazon, by the way.
Greer: You think Azure skies ahead for Microsoft?
Flippen: Yeah, I do.
Greer: OK. Jason? What do you think?
Moser: The pragmatist in me should choose Microsoft. I like Emily's thinking there. But maybe I get bored on this island. Maybe I want to listen to some music and podcasts and whatnot. I feel like I'm going to go ahead and put my chips on Spotify here because I think that long-term story here holds. I think investors in Spotify will be very happy that they stayed patient and let this one play out.
Greer: OK. Something we're going to do all week because it is the Halloween season, it's in that spirit that we're going to close our podcast this week by talking about overrated and underrated candy. We're going to bring our very own Dan Boyd in on this one. Dan Boyd, I need to hear your overrated candy and your underrated candy.
Dan Boyd: OK, sure. I'll start with the overrated, and it's Milky Way, because Milky Way is a garbage candy that is just Snickers without peanuts. Why would you eat a Milky Way when you can eat a vastly superior Snickers? Now, I understand that some people are allergic to peanuts, and that's too bad. I understand that, in that case, a Milky Way would be superior.
Greer: That was a nice qualifier. I like that.
Boyd: If you're not allergic to peanuts, it seems to me like it's a worse move. It doesn't make any sense to me.
Greer: I like it. How about underrated?
Boyd: Underrated? I don't know. I think I'm going to go with Snickers once again here because Snickers are amazing and have all the elements of a fantastic candy, and are quite fantastic. You take all those ingredients, put them together, it's more than the sum of its parts, if you think about it.
Greer: Still underrated? I think a lot of people would say that Snickers trades at a pretty rich multiple. You're saying it's still underrated?
Boyd: I think I'm channeling value investor Ron Gross here today. I think Snickers is probably the most valuable candy on the roster.
Greer: You would say it's firing on all cylinders?
Moser: It's the one in plain sight. It's there but no one ever thinks about it because it's been around for so long.
Boyd: I'm very excited to hear what Emily has to say because she's been frowning and shaking her head at me the entire time.
Greer: What do you have, Emily?
Flippen: Dan, as usual, you're just wrong. There's no saving you at this point. Look, I'm going to go underrated Milky Way, because if you're eating a Milky Way plain, yeah, you might think to yourself, "Oh, I wish it could be a Snickers." Put it in the freezer, Dan. Put that Milky Way in the freezer. Don't freeze a Snickers. That will break your teeth. But if you freeze a Milky Way, that makes it a superior candy, underrated candy.
Boyd: So you have to do something extra to the Milky Way to make it good, is what you're saying?
Greer: Both fair points.
Flippen: Sometimes good things in life require a little work, Dan. You have to try a little bit for your candy. Earn it!
Greer: OK, hold Milky Way. I love it! How about overrated?
Flippen: Overrated? Oh, that's a good question! Any non-chocolate candy is overrated, in my opinion. You're not going wrong if you're eating chocolate. I would say probably Skittles. Skittles are just low-class M&Ms.
Boyd: Hard agree there.
Moser: What do you think about Jolly Ranchers? You like Jolly Ranchers?
Flippen: I hate Jolly Ranchers. That's not even a candy. I didn't even consider it because it's so not a candy.
Greer: Not a candy, oh, my gosh! We apologize to all the Jolly Rancher people! Jason, what do you have? Overrated, underrated?
Moser: I like a lot of peanut butter and chocolate together, but the one thing that I --
Greer: Don't you knock Reese's.
Moser: I'll go overrated here, I'm just not a big fan of the Mr. Goodbar. When I get a Mr. Goodbar, it's just too plain. I don't not like it, but I'm not going to the store to get one.
Greer: It's like a Hershey but it's not.
Flippen: We all thought you were going somewhere else with that.
Greer: I thought you were going to take a shot at Reese's.
Moser: No way, man!
Greer: I'd throw a punch at you.
Moser: I have a little bit of class. Give me a break here! I mean, I do think, underrated, every time I see these my eyes light up a little bit -- how good is a Nestle Crunch bar? I like the crispy.
Moser: I like the crispy and the chocolate. It's simple. It's got a little crunch. A little sweet. I like the Nestle Crunch.
Boyd: I don't get it, mainly because the Kit Kat is right there. It's crunchy and it's better.
Moser: OK, hear me out. What about the Whatchamacallit? The Whatchamacallit trumps all.
Boyd: I don't know about that, man. Sometimes you put too much in -- the Baby Ruth doesn't work.
Greer: It's interesting that you say that because I was toying with the Baby Ruth as my overrated, but I landed on Milk Duds. It just feels like it takes a lot of work and after the first one, I feel like a horse. I just don't want to do that much work.
Underrated, I am conflicted. I had Junior Mints, but I'm going to go with Twix.
Moser: The caramel or the peanut butter? Which one?
Greer: That's a tough call. I think I would go the caramel. But what I will say about a good candy, and Junior Mints and Twix, you don't need to freeze them. That's such a crutch. If you have to put something in the freezer --
Flippen: [gasps] Fighting words!
Greer: -- I don't know if anyone has thrown that idea out there yet, but I just have to say, that's a crutch.
Boyd: OK, I want to ask real quick, are people rating Milk Duds high? At all? Are people not rating Twix high?
Greer: Sorry, I'm a time traveler from the 1930s -- [laughs] You have to take your castor oil shortly after eating your Milk Duds.
OK, if you have thoughts on overrated, underrated candies, if you have thoughts on any of the topics we have talked about today, email@example.com is our email.
As always, people on the show 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. Emily, Jason, thanks for joining me!
Moser: Thank you!
Flippen: Thank you!
Greer: That's it for this edition of MarketFoolery! This show is mixed by Dan Boyd. I'm Mac Greer. Thanks for listening! And we will see you tomorrow!