Do You Own Enough Cyber?

In this episode of MarketFoolery, Chris Hill chats with Motley Fool analyst John Rotonti about the latest headlines and earnings reports from Wall Street. They discuss a recent digital attack on FireEye and suggest ways for investors to approach the computer security space in general. They've got the latest results from a pet supplies retailer and put into perspective the phenomenal growth experienced by e-commerce in 2020. They've got a red-hot IPO to talk about and much more.

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This video was recorded on December 9, 2020.

Chris Hill: It's Wednesday, December 9th. Welcome to MarketFoolery. I'm Chris Hill, with me today, our man in Colorado, it's John Rotonti. John, good to see you.

John Rotonti: Hi, Chris, great to be here.

Hill: We're going to have a hot IPO, a red-hot IPO to talk about. We've got some earnings, but we're going to start with the stock of the day, and that is FireEye (MNDT).

Because shares of FireEye are down 12% after the company said it was the victim of a cyberattack. And what is particularly problematic here is that FireEye is in the business of network security. I don't own this stock, John, from an optics standpoint, this looks pretty bad, but just from a business standpoint, how bad do you think this is?

Rotonti: It does look bad optically. Like you said, FireEye itself is a network security firm. I don't know, long-term, how bad it will be, Chris, because I think the market in general tends to have a pretty short-term memory. I'll say that FireEye is saying that it was a highly sophisticated attack from a nation state, they haven't said which nation state as far as I'm concerned. An outside investigator says that it was so precise and so sophisticated, it was like a sniper shot, like they just, you know, threaded the needle almost to get into FireEye's systems; that's what it sounds like.

The argument against investing in computer security stocks has always been, well, once one of them is penetrated, then no one will really want to invest in them anymore. I don't know if that's true or not, what I will say is that, I've always advocated, when it comes to security firms, to invest in a basket of cyber companies, so you can invest across the whole stack from vulnerability, to ransomware, to, you know, whatever it is. And so, I think FireEye is probably a good long-term hold in a cyber basket of five or six stocks, but it's going to be difficult for a while. And we don't know all the information yet.

Hill: FireEye has said they're working with the FBI, they've also said that none of their clients' information was compromised. So, you know, that's probably why the stock is only down 12%. And the fact that they're working with the FBI means we will get more details at some point. I mean, this came from a regulatory filing that FireEye submitted to the SEC. So, we're going to get more information at some point, but I think you raise a really important point, which is, you know, we've talked for years on the show about the basket approach, and I think that, to your point, cybersecurity is one of those where I've yet to hear the [laughs] bear case for network security, I have yet to see the analysts come out and say, I don't think this is going to be an important trend over the next 20 years. But to your point, I think that betting it all on a single company probably is not the way to go.

Rotonti: Yeah, Chris. I'm also interested in why FireEye, like, why were they the ones that were targeted, what data do they have, what governments are they, you know, providing protective cyber software for? So, I'm just curious on why FireEye was the company that was targeted? So, I guess all of this we'll find out about, hopefully.

Hill: More information to come, for sure. Let's move on to some earnings from Chewy (CHWY 1.18%). Chewy lost money in the third quarter, but the loss was smaller than expected. This is the pet supply retailer; the stock is basically flat. And I think part of the reason it's flat, John, is not just the, like, well, yeah, they lost money, it wasn't as bad as we thought, but Chewy appears to be doing a pretty good job of growing their topline revenue.

Rotonti: It's fantastic. I mean, it was over a 40%-something growth on the topline, which for a company of this size and this scale, is a lot. And Chris, I've been thinking a lot about Chewy this morning. I think that 2020 is the year of warp speed, things have probably moved or shifted faster than at any time in modern history. Of course, this can be seen with Operation Warp Speed, which was the vaccine, it typically takes seven to 10 years to bring a new drug to market, with the COVID vaccine, we're doing it in less than a year. And of course, this can be seen with the work-from-home, which was probably the fastest, most tectonic shift in the way people work, possibly in the history of modern man. An example is Zoom. Zoom went from 10 million daily active participants in December of 2019 to 300 million today. But it's also, we can see that in Chewy.

And Chewy participates in U.S. e-commerce sales. And if I have a stat for you that may knock you out of your chair, Chris, it's this one. So, U.S. e-commerce, online sales, as a percentage of total retail sales went from virtually 0% in 1999 to 11.8% in the first quarter of 2020. Then from the first quarter of 2020 to the second quarter of 2020, it went from 11.8% to 16% of total retail sales. So, it took 20 years to grow to 11.8% and then only three months to grow from 11.8% to 16%. This is truly warp speed. And of course, Chewy is participating in this e-commerce boom, because it's the largest pet e-commerce company. So, it was a primary beneficiary of this massive acceleration of e-commerce. Like so many things, the COVID pandemic and the subsequent lockdown and the new guidelines around social distancing, only accelerated a trend that was already in place.

And so, now what has happened is that many people, my parents for example, that never ordered online prior to COVID, were forced to shop in a new way. And I think enough time has gone by that the habit is sinking in. Now my parents are totally obsessed with the convenience and the choice and the cheapness that you can get from online shopping. I think Chewy is going to continue to be a fast-grower from here.

Hill: There are absolutely folks like your parents, who, you know, just started online shopping this year. And I think this is one of those things that helps businesses like Chewy. There are people like you and me who were very comfortable online shopping, but because of what happened so suddenly in March and April, in terms of supply chains, I know I've absolutely started using a lot more places to shop online than I did before. I mean, I was basically like, well, I'm going to get this from Amazon, because they've got [laughs] everything. And the troubles that Amazon had, you know, makes people like me say, all right, well, yeah, let me take a few minutes and set up an account with Target and set up an account with [laughs] Chewy.

And I think the fact that Chewy just focuses on that one space, pet supply, I think that's really been an advantage for them, and I think they're, -- you know, I mean, Jason Moser has talked about this before, where he's got pets in his house, he's been a steady Amazon shopper forever, and then earlier this year saying, yeah, you know what, I'm going to give Chewy a try. I wonder though if -- and this goes beyond Chewy, but we've seen this with a lot of other companies that are very much in growth mode, they're not profitable. And it's almost like, once a company gets out of growth mode and starts to turn a profit, they get judged differently. So, it's one of those things where, like, of course, Chewy is going to be profitable at some point, I wonder if, in a weird way, they get held to a higher standard. But right now, I mean, this is a stock that has performed incredibly well, it's more than doubled so far in 2020. And I'm sure there are probably some investors out there who are hoping that they were going to post a bigger loss, so that the stock could get knocked down a little bit, so they could buy it a little bit more cheaply, but you know, bad news, Chewy is staying right where it is.

Rotonti: Chris, and it's not just the growth which is fantastic for Chewy, but there's a large addressable market there. So, I think the pet market in the U.S. is somewhere around $100 billion, Chewy has a balance sheet with more cash than debt, so we call that net cash. There's high recurring revenue because, one, they're selling consumables, like dog food, right? Like, you got to keep buying dog food. But also, 70% of their sales are something called Autoship, which is like signing up for a subscription service and, you know, they just automatically ship you the dog food every month or whatever. So, there's that predictability factor. And then it's got improving gross margins. I think there's probably more room for gross margins to improve.

And then, you know, the higher the gross margins are, which is high up on the income statement, the more likely it will be able to invest heavily all the way down that income statement and still end up one day with pretty decent bottom-line profitability, so like, net income margin. So, I do think there's a potential for profitability here.

Hill: It's important that I timestamp this next story. So, DoorDash (DASH 0.55%) is going public today. And I say going public today, because we don't yet have a price, it's about quarter of noon as you and I are talking right now, quarter of noon here on the East Coast. DoorDash was priced at $102/share. In the last hour, the indication of where it's going to open when it finally gets opened for trading, has gone from $140 to $150 to $160, and just in the time that you and I have been talking, John. In one of my browsers, I've got CNBC streaming. And saw on the [...] that now DoorDash is indicating that [laughs] it's going to open at a range of $170 to $175/share. So, let's just [laughs] put aside the stock price for a second, is DoorDash a business that you are attracted to as an analyst and investor?

Rotonti: I don't think so, not yet. So, I recently received an education on the food delivery space from Abi Malin, one of our colleagues. And from what I learned, I sort of had an intuitive feeling that I wasn't going to love the space, but now I really don't think I do. And so, [laughs] one ...

Hill: [laughs] I'm sorry, I just love that. I went in thinking I wasn't going to like it, and now I really don't like it.

Rotonti: I really don't, not yet. No, I want to be fair. I haven't read the S-1 yet, and I probably will at some point, because I think DoorDash has somewhere around 50% market share of meal delivery in the U.S. So, you know, when a company has that much scale, I'll probably read about it, but I haven't rushed to read it.

A couple of things. So, the meal delivery companies don't have a lot of control over the quality of the food, right, how it's plated, how it's presented, the weather, the traffic, all of those things that they need to deal with and that will affect the eventual outcome and the customer experience. All of these companies take the same routes and roads, and so, although they're sort of logistics companies and they're like these applied math companies and the algorithms help them get there faster, I don't think that one company's algorithm is that much better at, like, navigating traffic and finding the fastest route to the customer. You know, that much faster that it's some sort of massive differentiator.

And so, then they compete on three main criteria. One, is on price, which is like a race to the bottom, really, so that's not good for the industry, if you just get a bunch of irrational pricing. The other one is, they try to compete on customer service, which is difficult. Because like I said, if the food doesn't taste good or, you know, it's the wrong food or something, DoorDash gets blamed, not necessarily the restaurant, because DoorDash is the last-mile, they're making the transfer of the product to the customer. So, that's like the last thing in the customer's mind is, oh, DoorDash must've messed up. At least I think that's what the perception is going to be. And then, so you can compete on price, you can try to compete on customer service.

And then the third thing is scale. And by scale, I'm referring to, like, signing up the most restaurants. But what happens is, all of these restaurants are using multiple of these service providers, multiple of these mail delivery companies. And so, I don't know if, like, achieving scale is a sustainable strategy either. And then, I don't know if the restaurants love this model, because they take a big take rate.

When you think about it from a multi-stakeholder perspective, are they treating all of their stakeholders well? Well, the restaurants are one of their key stakeholders, and I don't think they love the idea.

Hill: I think you're right. And an example of how much some restaurants don't love the idea is, you see this in places like New York City, I've even seen it in the Greater DC Area, where there are some restaurants that will offer you as a customer an incentive to come pick up the food yourself. [laughs] So, you know, to be fair to DoorDash, and you hit on I think one of the key parts of the bull case for DoorDash, which is, their market share, for all the talk of Uber and Uber Eats, DoorDash is the big player in this space. They've got somewhere in the low-50% range in terms of market share.

And I think, so part of the bull case is, look, food delivery isn't going away. If we think this is going to be a zero-sum game or that there's going to be one dominant player, right now the way to bet is on DoorDash.

Rotonti: Yup! And it looks like that's the way the market is betting, at least based on that $170 to $175 range. I know the stock hasn't started trading yet, but it's interesting.

So, another trend in restaurants that is definitely going to affect this industry is ghost kitchens, which is -- and actually Uber's Founder, Travis Kalanick, has started a ghost kitchen. And it's the idea that restaurants are expensive to operate these days, even before COVID, because leases, the real estate space, real estate rents are going up so much. And so, some restaurants are deciding to actually shut down dining and just open these ghost kitchens, which is shared kitchen space like a large warehouse where they make good food and then just deliver to the customer. I'm not sure how that -- my immediate gut reaction is, that's got to be great for someone like DoorDash, because that's more delivery business, people are going to be dining in less if there's more ghost kitchens, and so DoorDash will get some of that delivery business.

But another one of my colleagues, Bill Mann, was saying, if restaurants turn into ghost kitchens, a lot of the employees that were working the floors of the restaurants may want to become delivery people. And so, maybe the restaurants could some, sort of, create a shared delivery service. So, I'm not sure how it plays out, but it's definitely something to watch, this trend toward ghost kitchens.

Hill: And just in the time that we've been talking about DoorDash, the indicated price has moved up once again, it is now [laughs] trading in the range of $175 to $180. We'll see where this goes from here, but it's definitely a week for big IPOs. When you think about this one, we've got Airbnb coming tomorrow, C3.ai I think is public today as well. So, interesting times to say the least ...

Rotonti: ... big year for IPOs, for sure.

Hill: Big year, very big year. John, great talking to you; thanks for being here.

Rotonti: Chris, thank you so much.

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, we'll see you tomorrow.