In this episode of MarketFoolery, Chris Hill chats with Motley Fool analyst Jim Gillies about the latest headlines from Wall Street. They've got news on an all-stock deal in tech space. They answer a listener's question on why those in their twenties should own PepsiCo (PEP 0.98%). Also, they discuss the iPhone 12 launch, Prime Day, and much more.
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This video was recorded on Oct. 12, 2020.
Chris Hill: It's Monday, Oct. 12th. Welcome to MarketFoolery. I'm Chris Hill. Joining me today from Canada, where today is Thanksgiving, it's Jim Gillies. Happy Thanksgiving, my friend!
Jim Gillies: And right back to you, I guess about a month and a half early. [laughs]
Hill: Yes, yes.
Gillies: We like to get our pick of the turkeys and get all the good turkeys and then you guys can have what's left over.
Hill: You know what, at this point, I'll take leftovers, absolutely. Among the questions we're going to tackle today -- why should someone in their twenties own shares of Pepsi; what should shareholders of Apple (AAPL +2.77%) and Amazon (AMZN +3.51%) expect on Tuesday? But we're going to start with the deal of the day, and that is Twilio (TWLO +4.00%), the cloud communications platform buying Segment, a private company, a provider of customer data platforms. It's a $3.2 billion deal, and it is an all-stock deal, Jim. And when you consider the fact that shares of Twilio are up about 180% over the past 12 months, putting aside the business of Segment, just from a financing standpoint, [laughs] Twilio appears to have been smart here.
Gillies: Yes. The last time I saw financing, like, at what Segment was valued at, in April of last year, April 2019, so about 18 months ago, they did a venture funding round that valued the company at about $1.5 billion. So, Twilio today is paying up just slightly more than double that valuation. Now, I'm going to try to hide the fact that I am a technical luddite, and I can't really speak to the business of cloud computing a lot, but I can look at the financing and the financial argument that's being played here.
Clearly, I've looked a little bit at Segment. Segment has got some pretty high profile both investors, so Alphabet, the parent of Google is an investor here. They've got some pretty high-profile clients: IBM, Atlassian, Intuit. So they make a product that people seem to want, and they've got some big backers. And now, Twilio is coming and going to be the biggest backer. But Twilio has been very successful from a stock price perspective. Twilio is the kind of company that scares me as an investor, because it is valued as if it -- basically, it is a pure growth story, revenue growth in the last five years has been about 60%. And by the way, high growth, high growth can get you out of a lot of trouble, you know, in terms of valuation issues or temporary operational issues. High growth is something that can bail you out of a lot of things over time. So, I'm not casting aspersions on Twilio, I'm just saying, they got high growth going for them and not a lot else in terms of the financial argument.
This is still a company that is not free cash flow positive. And so, they have been financing themselves and financing their growth with -- they had a convertible debt offering, I believe, in 2018. The share count has gone from about 87 million at the end of 2016, to before today's deal, which will add about, I think, 10.5 million shares. Share account was at about 143 million. They had that convertible debt that I mentioned earlier, that they offered strikes at about $70, converts at about $70, that's as good as equity, Chris, I don't care that it expires in 2023. With Twilio well north of $300 today, that's de facto equity. So, you might say, well, good, they don't have to pay back the debt. On the bad side, you are going to be diluted. And frankly, that convert, maybe they shouldn't have issued convertible debt, maybe they should have done something else at that time. But when you look at the share count exploding, typical tech companies use a lot of, what I will call, equity cookies to compensate their employees, so the share count is going to only explode over time.
And eventually, as this company matures into -- with Segment embedded in them -- as this company matures, at some point the revenue growth will slow down, at some point they're going to be expected to produce cash flow sufficient to finance themselves and to justify the present valuation, which is over 30X sales. I know, the 30X sales is the new 20X sales, apparently.
And so, this is a very rich company, that's been very successful, Twilio that is, making a, looks like, a not bad deal, frankly -- you know, they're probably paying a little bit premium for a company that is in demand and has some backers who want to get out. Always wonder about, you know, who the seller is; that's always a good plan. But as Twilio continues to mature and grow larger, you might have some growing pains. And when you have a 30X sales valuation that isn't producing free cash flow -- they're almost at free cash flow, so I'm a little hesitant there. Just recognize that if they have a bad quarter or a bad year, you could get an opportunity to buy this company cheaper.
And I also, the last thing I'll say about this company is, it's no accident they're paying with stock. They have about $1.9 billion, I think almost $2 billion in cash on their balance sheet, Twilio does. But as we saw, I'm old enough to remember the great tech bubble and subsequent great tech wreck from, we'll call that '96 through 2002, both sides of that equation, I'm old enough to have been investing during that. And what you saw on the way up was companies, acquisitions, you always make them with stock. If your stock is overvalued, you always use stock to make your acquisitions. And the problem, of course, is, you dilute your base even further. And then when you do get a recession, you do get a downdraft in your markets, things can get a little unpleasant, we'll say.
But so far, Twilio is a highflier. They look like they're making something that's very in demand, and the acquisition, that is. So, good on them, and yeah, carry on.
Hill: Well, and just the other thing in terms of the valuation of Segment. I guess I'm a little surprised that the last funding round they did was 18 months ago. And if, in fact -- you know, like, if they were valued at $1.5 billion in the Spring of 2019, you look at the business they're in, you look at the rise in general as a group of cloud stocks over the past 18 months, Twilio is paying a premium here. I can't imagine if Segment was a publicly traded company, it would have to be at least $2 billion. So, whatever premium Twilio is paying, my hunch is they're not paying more than double.
Gillies: Yeah. Actually, if you're going to put the stake in the ground at $2 billion, I'm going to take the "over" on what this company would be worth on the public markets. Because given the performance of cloud stocks, I presume looking at the revenue growth of other cloud stocks, I would assume that Segment has probably been doing similarly. And so, that type of valuation, $2 billion, when it was this value a year-and-a-half ago, $1.5 billion. Yeah, I think Twilio is probably making a pretty savvy deal here actually.
Hill: Our email address is [email protected]. We got a lengthy email from Steven Splat. I'm not going to read the entire thing; it was a great email. But basically, his question boils down to this. He's got two sons who are 21 and 23 years old. They've got portfolios that have been invested in for 10, 12 years and Steven's question is about Pepsi. He says, "I know Pepsi is a widows-and-orphan stock, buy it and forget it, but given how young my sons are, would it be better for them to take the money they have in Pepsi and put it in something like Salesforce.com, Square, The Trade Desk or any other number of successful and long-term tech plays that would still have a chance to be a multi-bagger for them in the future?"
What do you think, Jim, because his email, and part of his email was providing the other holdings that his sons have, it was a reminder to me that there are a few different ways for investors to look at their portfolios. And you can look at them in terms of risk; you can look at them just from the standpoint of, I want to allocate X% of my portfolio toward more growth stocks and I want to have maybe a smaller percentage on the dividend players, the blue chips, the Pepsi's, and IBM's of the world. You can look at it in terms of industry, where I want to allocate across 10 different industries. Given that these are young men, given his question about Pepsi, what do you think?
Gillies: Well, Steven, I'd like to apologize, because Chris brought the crusty value guy on to talk about this, [laughs] so you're going to get the crusty value guys' response. You know, asking putting in things like Salesforce, Square, Trade Desk, I would caution on these growthy names. I would caution you to don't be looking at how those companies have performed, because they've all performed spectacularly well, and their valuations reflect that. And future games are not necessarily going to look like past games. I have some trepidation about each of those names; even as I will say, I have trepidations about high value stocks anyway. As I say, I own Square personally, so clearly, it's not that big of a trepidation.
But I'm of the opinion that you need bedrock in your portfolio, so you can work with the higher growth stocks, because not everything works all the time; ask value investors of last decade, but the market does tend to -- what's not working today will work tomorrow. And what works tomorrow will not work, you know, the next time period beyond that. So, I think you need diversification. And I don't necessarily look at Pepsi as that big of a deal here, even though you're a young man, of course, who've got 60, 50, 40 years of investing ahead of them.
Now, that said, Pepsi has indeed been an underperformer vis-a-vis the S&P 500. What does the S&P 500 get you? It gets you diversification, it gets you a little bit of tech exposure. Of course, the largest components of the S&P 500 are the big FAANG companies -- or FANAMA, as Bill Mann likes to say. So, I look and say, well, if you're not going to hold Pepsi, I still think, because Pepsi has been serving as the bedrock portfolio, as I look at some of your other holdings, I would slot it into bedrock. I might suggest moving the Pepsi into something like an S&P 500 Index Fund, which by the way, Pepsi is in, so you'll still maintain a little bit of exposure to Pepsi.
But that's kind of how I invest, is I use -- I own a lot of index funds for things when -- you know, as a placeholder, and then I like to go into, I own some growthy names, I mentioned Square earlier, I certainly have a long term relationship with a couple of stocks we're going to mention in about two minutes. And, you know, I also do a lot of small cap value, like, you know, special situation stuff. And when I'm not invested in those things, I just use the S&P 500 as a placeholder, and I don't think there's anything wrong with that, I very much believe in the index plus approach to investing, where, you know, you still have the exposure to the equity market. But you pick your spots for those outside investments. And so, I would maybe encourage, rather than looking at Pepsi, I would maybe encourage looking at an S&P, as the style of bedrock that I would suggest.
Hill: Also, hats off to getting your sons invested as early as you did; I mean, that's just already -- you know, part of me looks at that and thinks, you know what, they can [laughs] just the law of compounding says they can probably take the next two decades off, [laughs] just let this stuff run, they'll be fine. But it's obviously better to keep on investing, so kudos, Steven, for that.
Today is Monday, tomorrow is Tuesday. A big day in terms of, certainly, two of the biggest tech companies out there, Apple and Amazon. Apple is going to have its event to unveil the iPhone 12 and updated versions of other devices. And tomorrow is the long-delayed start to Prime Day. Amazon typically has Prime Day in July, for all of the obvious reasons it got pushed off to, well, tomorrow and Wednesday as well.
Let me start with Apple, you're an Apple shareholder. How do you approach these events? Sort of, the big -- what we've come to expect from Apple in terms of the Fall event where they unveil the newest version of the iPhone. As an investor, as a shareholder, what is your mindset going into a day like tomorrow?
Gillies: Honestly, Chris, I forgot this was happening until you reminded me this morning. [laughs] My mindset is, I don't pay attention. I know they're going to come out with their latest and greatest, I'm not really expecting something earth shattering or mind-blowing ever from Apple. I think Apple's track record would suggest that, aside from the very occasional gamechanger -- introduction of the original iPhone in 2007 -- they are happy with incremental progress and making their devices incrementally more useful, more awesome, just more interesting to their vast userbase. But as someone who is looking at this from, what are the investing implications of this? I actually really don't think there is anything that's going to move the needle that you should really worry about. And maybe that sounds like I'm avoiding the question, it's really not. If you own Apple, I would suggest it's a long-term relationship, you are owning the premier cash generator of our generation, frankly. When the market gives you a super-premium valuation on the stock, which has happened a few times in the past few years, I add to my holdings. And most of the rest of the time, I just leave it alone and don't worry about it.
Hill: Then let's move to Amazon. I said on Friday when we were doing Motley Fool Money, and I say this as a longtime Amazon shareholder, I think for the first time since the first time they did Prime Day, I think Amazon has got something on the line tomorrow. Because of the shipping problems, the fulfillment problems they had earlier this year, I feel like they are under pressure to make sure tomorrow and Wednesday go as smoothly as possible. In a way, unlike, since the first Prime Day, which I think was 2012.
Gillies: First, let me say, I love the fact they've made up a holiday. Here a holiday to buy stuff, Prime Day. As a long-term shareholder, as yourself, my answer is not that dissimilar from my answer to Apple. While I agree with you that, yeah, you know, they need to get all the logistics right, but, I mean, Amazon at its core is a logistics company ...
Hill: How's that been going the last few months? [laughs]
Gillies: But here's the thing, right, as someone who's probably ordering multiple things per week from Amazon, because I'll get my marching orders, we need this, we need that. I've not had a problem with anything fulfillment. So, I'm very much sample-of-one going, I personally have not noticed anything. But again, it's a sample of one, but I've had zero problems. And you know, we're happy Prime members. And I just order what I need, it shows up the next day. And some obscure stuff too, you know.
But, yes, they need to make sure they can handle the presumed glut of orders they're going to have. But that said, if they don't -- let's say, they have some problems, they'll have some upset customers, how many people are they going to lose? I'm still willing to bet you that the number of Prime customers a year from now will be more than they have today. And the No. 1 internet order -- the default thing that you will think of, oh! I need to order something online you're still going to go to Amazon first-and-foremost and go, OK, well, how much does this new bike rack I need for the wall of my garage, which I'm doing today? Oh, that's, you know, $12 on Amazon; boom, done, shows up.
Again, maybe it's the embedded long-term investor mentality in me, but I just like, uh! Prime Day, uh! That's nice, and then kind of go back to whatever I'm doing.
Hill: I don't think they're necessarily going to lose Prime members. And I agree with you that the number of people who are a [laughs] member of the Prime service is greater a year from now than it is today. But if I am Walmart, if I'm Target, I am watching what happens in the next 72 hours very closely, because this holiday season, when we get into late in November and early in December, given everything people in the United States have gone through with the pandemic, I think that the marketing message that is going to resonate with people this holiday season is some version of, we're going to get you what you need, we're going to take care of you. And if Amazon stumbles with Prime Day this year, if there is some tipping point where there are enough people who have fulfillment problems, shipping problems, whatever it is, I think that becomes part of the narrative. And I think if I'm heading up advertising for Target and Walmart, to say nothing of, you know, Etsy, eBay, Chewy, you know, anything out there, that's going to be, without mentioning Amazon's name, that's going to be a big part of our marketing this holiday season is, we're going to take care of you and your family, we're going to make sure you and your family have the things you're looking for, unlike wink-wink Amazon.
Gillies: Unlike that other big-name company we won't mention. Look, they should, they should absolutely look to exploit a weakness, but then, of course, you know what's the line, you come at the king, best not miss. You know, they had best be able to then operate their own fulfillment. Because, again, speaking as a Canadian here, Target in Canada is not a brand that we think very highly of, I'll leave it at that.
Hill: Oh, yeah, because Brian Cornell took over at Target, and one of the first things he did is say, I think we're going to leave Canada.
Gillies: Well, but to be honest with you, I don't think any Canadian was surprised when he said that, because they botched the rollout and the operations and the inventory management here so poorly, or rather, I guess, they botched it really well, we were a little shocked that it took as long as they did to leave, but I mean, the fact that they can be so successful in the U.S. and yet just handled their Canadian operations so abysmally was shocking to me, frankly. And remains shocking to this day, [laughs] five years later after their exit.
But yeah, Amazon is not unaware of the pressures they're under, I'm willing to bet, and I'm willing to bet that they are going to make every effort to delight their customers this happy Prime Day, as well as the greater holiday season in a couple of months.
Hill: It's not every business show where the guest analyst quotes Omar Little from The Wire. Jim Gillies, always good talking to you, thanks for being here.
Gillies: 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. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening, and we'll see you tomorrow.
