Is a Monster Merger Brewing?

Jay Powell gets nominated for another term as chairman of the Federal Reserve. Cerence (CRNC -3.63%) shares drop 20% on guidance. Motley Fool analyst Jason Moser analyzes those stories and reports that Monster Beverage (MNST -1.46%) and Constellation Brands (CRNC -3.63%) are engaged in merger talks.

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This video was recorded on Nov. 22, 2021.

Chris Hill: It's Monday, Nov. 22. Welcome to MarketFoolery. I'm Chris Hill, with me today, Jason Moser. Good to see you.

Jason Moser: Good to see you, and gobble, gobble, happy Thanksgiving week. I'm already so excited, I can smell the turkey, Chris.

Hill: Yes, I understand. But in the meantime, before we go to the turkey, we have a potential merger in the beverage industry. It looks like Jay Powell is going to be keeping his job, but we're going to start with the stock of the day. Cerence, the automotive AI company, wrapped up its fiscal year with fourth-quarter profits and revenue higher than expected. But the guidance for 2022 is sending shares of Cerence down 20% today. How bad is this guidance?

Moser: Well, I'm glad you brought that up, because that is the reason for the selling. It's not as bad I think as the market would have you believe, but yeah, the stock is down new guidance. If you look at the guide for the quarter of $91-96 million in revenue, the market was expecting something more in the neighborhood of $100 million, and it's also on the lower end for the full year. Not by much, but enough to where, listen, if you have a stock price based on a certain level of expectations, when those expectations change, the stock price is sure to follow, particularly with these growth stocks that aren't keying in necessarily on profitability as much in the near term as they build out the business. To me, this is not a company thing, this is not a business thing. If you look at the general headwinds in the automotive market, they're everywhere. 

Maybe companies that are in this line of work are feeling some pain right now. Look, IHS is forecasting auto production ultimately to be flat for the year, and that's something that ties directly to Cerence's business. When fewer cars are being made, that means fewer cars are getting their technology. But generally speaking, you look at the quarter, the metrics matter, the key performance indicators all are very encouraging. For the quarter itself, $98.1 million in revenue, that was up 7.5%. That exceeded their own guidance and adjusted EBITDA came in on the high end as well. Average contract duration continues to grow from 6.8 years a quarter ago to 7.9 years this quarter. Strong bookings, $590 million in fiscal 2021, and now their backlog stands at 2 billion dollars. When you take everything together, I think the business is performing very well, but it is suffering due to macroeconomic issues that are simply beyond their control.

Hill: Do you look at the 20% drop as a buying opportunity?

Moser: Honestly, I do. This is a business that I've recommended in both services that I run here at the Fool, I think it's got a lot of share still to capture. It is not just cars anymore, either. Cerence is essentially targeting that market opportunity in automobiles to bring its artificial intelligence into the connected vehicle. But it is also expanding its market opportunities well beyond the automobile. Talking from a global perspective, looking at two-wheel transportation. There are all sorts of opportunities that they're pursuing out there. This is the one I think it sounds so weird, yet when you think about it, it could be a really need opportunity as well, elevators, Chris. 

Cerence is making inroads in the elevator market to help buildings as they retrofit with their smart devices as buildings go smart. Cerence is focused on the connected elevator market. Listen, there are a lot of buildings in the world, and a lot of elevators that are in those buildings. I think it's neat that they're branching out, utilizing that technology for other modes of transportation beyond just the automobile. I will say one more thing, too, I'm sorry to interrupt, but I will say, too. The other encouraging thing, they're maintaining their revenue target for 2024. A couple of months ago, they ramped that up from $600 million to $700 million. They still see as market conditions start to turn around, they do see that 700 million in year-end revenue target as still very achievable for 2024. I think that's another very encouraging sign.

Hill: So we're going to have voice-activated elevators, that's going to be the norm, because pushing the button is such an arduous task?

Moser: Yes. I will say it does seem a little, really is it that hard to push a button? It's like when you go in your house, is it that difficult to flip on a light switch? Do you have to tell Alexa to turn on the lights? Having experimented with both, it's fun to tell Alexa what to do. But every once in a while when the connection fails and your lights don't come on, you think, oh, man come on, and you realize how easy it is to flip a switch. In regard to elevators though, it's worth keeping in mind everything that's going on these past 18 months. People are not necessarily as enthusiastic about touching things that other people touch. Cash, we've seen clearly. But elevators, I understand that. Some folks may think, hey, listen, I don't want to be putting my hands on some keypad in an elevator that who knows what other hands have been on there. Generally speaking, there is a little bit of an opportunity there I think, but more so it is just this move toward the connected building. Buildings are becoming smarter and technology is playing a bigger role. It's very possible, Chris, that yes, you will get in an elevator one day here in the near future, and you may just tell that elevator what floor you want to go to and it takes you there. Very likely, Cerence technology will be powering that elevator.

Hill: Later today, we're going to record the Thanksgiving special for Motley Fool Money. Longtime listeners know that one of the topics that we've added to the show over the last few years is a thing I like to call "Not at the table, please," which is the business or investing topic that we just don't want people to ask us about over the holidays. The reason I mention this is because earlier today, the news broke that President Biden is nominating Jay Powell to serve a second term as chairman of the Federal Reserve, and that was going to be my "not at the table" topic. Because, look, I know it's a very important job, and at my core as an investor, I don't care who's doing it. I don't really care who's running. I want whoever is running the Federal Reserve at any given time to be qualified and thoughtful and experienced and open to the changing landscape of the U.S. economy, but other than that, I don't really care. What I've learned over the last couple of months is, there are some people who really care about this a lot. Like in the same way that at the beginning of this year, you and I and a bunch of people we work with were getting texts and emails from friends who came out of the woodwork to ask us, "What do you think about GameStop?" People who aren't really interested in investing, but they were reaching out to us. Same as I've had people reach out and be like, "Who do you think it's going to be?" Who do you think? I'm like, "I've never bought shares of a company based on who is running the Federal Reserve." Not once. [laughs]

Moser: I'm right there with you. I've never made an investment decision based on who is running the Fed and that's not going to start now. I tend to agree with you. It feels like the discussion revolves around this more because of politics than anything else. I think honestly, it's a smart thing for President Biden to go with Mr. Powell. I think that you stick with what you know, particularly given the situation here that we're witnessing in regard to inflation and just recovering from pandemic impacts. I think it makes more sense to not really flip too many things on their head, so to speak. I guess it really did boil down to either Mr. Powell or Ms. Brainerd. I think that some of the concerns with Ms. Brainerd might be that she favors a bit more of the regulatory path, maybe that concerns some folks, but I think that the two of them together should be able to keep things working in the right direction, but I'm totally with you. I don't really care. Like you said, I want them to be capable, I want them to be thoughtful, and generally speaking, I want them to be in favor of the United States of America, you want to be capitalists. I know there's some conversations around who believes in what these days, and that's all fine, but generally speaking, no, I wouldn't make an investment decision based on who's running that show.

Hill: There are multiple reports this morning that Monster Beverage is in merger talks with Constellation Brands. If this happens, this really would be a merger of equals. Monster's market cap is around $48 billion, Constellation Brands is around $44 billion, and with Constellation Brands, you have a whole collection of beer, wine, and spirits brands, Corona, Modelo, Ruffino, Mondavi wines, vodka, and of course maybe investment that Constellation made in Canopy Growth, so it's got a foot squarely in the cannabis space. Monster is obviously, that's the dominant brand, is Monster for Monster Beverage. I'm not even sure where to start with this because I don't own shares of either. I can see the bull case for this working and I can see the bear case for this not working out. There is a complicating factor when you consider that Coca-Cola is a major investor in Monster Beverage, and part of that means Coca-Cola has an exclusive distribution deal. If these talks are happening and I have no reason to doubt the reporting from Bloomberg and Reuters, I'm assuming part of the conversation is dealing with that piece of it, but just on the surface, what do you think when you see this report?

Moser: The first thing that came to mind really it feels like Constellation needs this more than the other way around. It feels like Constellation would need Monster more than Monster needs Constellation. If you look at the business, generally speaking you're right, it would be a merger of equals in regard to market cap, but Monster has a far better balance sheet, Constellation is pretty levered up. While Constellation generates more on the top line, the market looks at Monster more favorably. Perhaps that's because of its focus, perhaps that's because of the fundamentals of the business, the balance sheet, maybe it's just really a combination of all of those things. I'm glad you brought up the Coca-Cola dynamic there because it is worth remembering. Coca-Cola owns almost 20% of Monster in that distribution. We've always talked about distribution being such a key competitive advantage for business like Coca-Cola. Just having that channel be able to push stuff out all over the world at will makes for [laughs] a very strong business, and that's why I think Coca-Cola remains so stable. It's not lighting the world on fire with torrid growth, but I think they are trying to resolve that by purchasing things like Bodyarmor. The recent purchase of Bodyarmor. Maybe this is something that spurs more interest for Monster on the part of Coca-Cola. Maybe they take a bigger stake, maybe they would actually throw their hat in the ring and wanting to bring Monster Beverage fully into the fold there as well. A lot of different ways it could go when it's certainly something Constellation doesn't have that energy drink dynamic in portfolio, it would be additive in that regard. Then thinking further what they could do with those types of brands when it comes to alcohol, cannabis. It just a lot of different ways you can look at it. I certainly see the opportunity if it's something that comes up. Honestly, I don't think Coke would let it happen, [laughs] but it will be one to follow. Certainly remember that's floating out there today.

Hill: Similar to you, I was thinking I get why Constellation is having these conversations, particularly when you look at the fact that the overwhelming majority of sales for them is here in the United States. The opportunity to leverage international distribution in a way that they just haven't been able to, I get that. We'll see where this goes. Neither stock is moving dramatically on these reports. Maybe that is investors collectively signaling, "We're interested enough in this." It's not like a few weeks back when the news broke that PayPal was in talks to buy Pinterest. Everybody on both sides was like, I don't like this at all. That's not what we're seeing here, but it may also be the confusion on some level by the part of investors, "I don't know about this, so I'm just going to hold tight with the shares I got." Feel free to disagree, but would you agree with me that if this merger of equals takes place, the obvious first choice for the new name is Monster Brands. I'm not saying that's what they end up with, but if I'm in the room and we're talking about what is the name of this company going to be? I'm leading with Monster Brands.

Moser: I do agree with you in that. I think Monster is a far more relatable brand. I think there's more brand equity. I think when you hear Constellation, you immediately wonder, is that a space company? Is it a software company? I don't even know that it really elicits any thought of a beverage company and maybe that's about as on, I don't know. But to me it feels like the Monster brand is an asset worth exploiting. If that's changing the company name, it would make sense to me, just as long as they're not pulling like a Truist. When you just SunTrust and BBT and they come together and you're like, where the hell did you come up with Truist? What does that even mean? Utilize that brand equity that you have, because that can be very powerful over time particularly with the younger audience that so many of these beverages cater to.

Hill: Jason Moser. Have a great one. Thanks again.

Moser: Thanks a lot, you, too.

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. 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's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening and see you tomorrow.