In this podcast, Motley Fool analyst Jim Gillies discusses:
- Howard Schultz suspending Starbucks' (SBUX 0.18%) stock-buyback plan on his first day as interim CEO.
- The likelihood of Schultz remaining CEO beyond his "interim" period.
- Elon Musk taking a 9% "passive stake" in Twitter (TWTR).
- The subtle, yet important difference between a 13D filing and a 13G filing.
- Whether Tesla (TSLA 0.49%) shareholders are bothered by Musk paying attention to another company.
Motley Fool analyst Asit Sharma and Motley Fool contributor Brian Stoffel examine cloud infrastructure company DigitalOcean (DOCN 1.44%) through the lens of competitors like Amazon's (AMZN 0.37%) Amazon Web Services and Microsoft's (MSFT 0.88%)Azure.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on April 4, 2022.
Chris Hill: OneCloud business is ready for its close up and two CEOs are in the spotlight. It's a busy Monday, so let's get to work, Motley Fool Money starts now. [MUSIC] I'm Chris Hill. Joining me today from Motley Fool Canada, it's Jim Gillies. Good to see you.
Jim Gillies: Good to be seen, Chris.
Chris Hill: Here at The Motley Fool, we focus on businesses, but we also pay attention to the people who are leading the businesses that we are shareholders of, and we have two longtime business leaders that we need to talk about today. We're going to start with Howard Schultz because today is his first day on the job as interim CEO of Starbucks. If he's scoring at home, this is the third time in the corner office, and he is not waiting. Unlike most interim CEOs, his first active business is to suspend the share buyback plan that Starbucks had announced, I believe it was last year, to the tune of $20 billion that they had allocated, and Schultz and the executive team saying, we're going to suspend this buyback plan. This frees up money to invest in future growth of the business. You and I were chatting earlier today. I get the sense, do you think this is a good move?
Jim Gillies: I do. I'm going to commend you on being able to say interim CEO of Starbucks with a straight face. I am someone who remembers the last time Howard came back as interim CEO of Starbucks and lasted for nearly a decade, I believe. I thought as interim CEO, his job is to find the next leader of the business. I suspect he finds that leader of the business every time he looks in the mirror. Just putting it out there. I think Howard's around for a while but I also happen to think that's a good thing. If he is, and I hope he's around for a while because Howard Schultz has demonstrated in two tenures of multiyear, if not decade, 10-years, with Starbucks, that this man knows how to grow this business. If Howard Schultz says, we are going to cut. I'm going to point out that that $20 billion buyback on the table is about 20 percent of Starbucks [laughs] market cap, so it was a potentially seriously large buyback. Now, I note that if you have been on, and I know, Chris you are a shareholder as am I. I know you were a shareholder three-years ago as am I or as was I, I suppose. I know that all we have made from our Starbucks over these past three years is basically the two percent dividend yield. This is in spite of Starbucks spending about eight billion dollars in share buybacks over that time. I understand we had the pandemic through that but they've not done a lot of buybacks. They've only done about eight billion over the past three years, roughly, so since the end of June 2019. So almost three years. That's maybe money that was wasted a little bit but I've to quote a couple of our colleagues, because it was purchased at higher valuations.
I am a fan of Starbucks investing in themselves, investing in their stores, not necessarily new store growth, but in systems and their existing stores as well. Updating and improving their stores, improving benefits for their service providers, their members, the team members, the staff, the people who work there. I've always thought of Starbucks as a fairly good employer. I'd like to see better for the employees there because then it leads to happier members, happier customers, happier shareholders eventually. While I'm giving Howard a bit of a hard time, like he cares what I think. While I give Howard a bit of a hard time, I don't think buybacks here were large enough amount to really worry about. They've spent just slightly more on buybacks than they have on dividends and we know they like to raise their dividend every year. I suspect they're going to keep on doing that. That's a return. I also note that over the past three years, the buybacks have taken at about 4.5 percent of the stock count, which is a meaningful buyback, and that's a good thing. We talk about companies as cannibals that eat themselves over time so Apple's one, Home Depot's another one, eBay is another one. Companies that buyback meaningful and shrink their share counts. So if you still hold the shares, you are comparatively larger percentage owner. I think Starbucks will eventually come back to buybacks but for now, if Howard thinks this is the best course of action, I feel like I'm just a Howard homer here. If Howard thinks this is the best course of action, and to me that suggests more that he is going to be sticking around for a while to guide his baby. I am fine with taking my dividends, seeing what he does, because they're making lots of cash. That's not the issue. The issue is, let's get this thing rated and we'll come back to buybacks in a few years.
Chris Hill: I appreciate you pointing out, because it's true there are companies that do a very effective job of buybacks, that it is a meaningful way to reward shareholders and I say this as someone who has owned shares of Starbucks for more than 20 years. This is my least favorite way. The company allocates [laughs] money historically. I wouldn't bet against them doing it effectively in the future but I saw this news this morning. By the way, the stock is down five percent on this news. I'm not entirely sure that move is warranted. In a few minutes, we'll get to another stock moving in the opposite direction that I also wonder if it's really warranted. But when you look at the stock down five percent, I know it's not a huge drop, but I looked at that and I thought, boy, for people who wanted to get shares of Starbucks at a five percent discount, congratulations, today's your day.
Jim Gillies: Yes. It's funny, you say that about buybacks, you impugn buybacks in that fashion.
Chris Hill: Did I impugn? Wait a minute.
Jim Gillies: You impugned.
Chris Hill: Wait a minute. I don't think I impugned it.
Jim Gillies: You chastised.
Chris Hill: I impugned Starbucks track record with this every other way with the exception of the investments they've made in food over the year. Every other way Starbucks has spent money has been better spent money than the money on buybacks.
Jim Gillies: The food they never get right.
Chris Hill: Exactly.
Jim Gillies: Look, I quite like buybacks. They are in some aspects a more tax efficient means of returning capital to shareholders, presuming the share count goes down. I'll give you a long list of companies where they're blowing every penny of free cash flow, and the share count's going up, that's sub-optimal but I note that if you throw out the couple of months in like the March of 2020, really the end of February 2020 to say going into May 2020. There was something happened in the world at that point, the depths of the COVID, initial pandemic panic. You're buying Starbucks at its lowest valuation on an enterprise value to EBITDA in the past decade. It was about 13 times EBITDA heading into today, as you say, it's down five percent already. That's the low over the past decade, aside from that chunk of time when the pandemic was spooling up and no one knew what was going on. The other aspect, of course, as I said, I believe the dividends they have a history or track record of raising them annually. They're currently paying $0.49 a quarter. They paid three quarters of $0.49 so they'll probably pay one more. Then I would not be surprised by a hike. I think they brought out the dividend in 2010 and have pretty much raised every year since. I still think investors will get their take. Like you, I think today's valuation is interesting. It's been a while since I've added to my Starbucks holdings, but I'm onboard with this one.
Chris Hill: An SEC filing shows that Tesla CEO Elon Musk has taken a nine percent passive stake in Twitter. This news has sent shares of Twitter up more than 25 percent today. Before we dig into this, because you did this for me earlier today, can you, for the dozens of listeners, the difference between an SEC filing a passive stake versus an active stake.
Jim Gillies: It's funny because I actually recommended a company last week in the service that I run, Hidden Gems Canada, where I had to literally go through this exact differential. I'm going to pretty much read from what I wrote. There are two primary types of form 13s that we will see filed with the SEC. Both denote that the filing party has accumulated at least a five percent stake in the underlying company. That is a level of ownership that is deemed significant enough that it must be disclosed to the public. However, the suffix, the letter suffix is what differentiates. A 13G as in gold, a 13G, don't impugn it, just coming in with gold there. 13G is one that denotes a passive stance. The filing entity has simply bought and is holding shares that amount to five percent of the total outstanding but has no designs on control of the company. I'm going to apologize for my dog making noise. When you say like an ETF kingpin type company like Vanguard or BlackRock, practically every February they file a 13G or 13G/A, which is an amendment to a 13G, on practically every large company in America. When you see that it's because they run trillions of dollars in index funds, passive index. The index says, thou shall hold three percent of Starbucks so they buy a three percent of Starbucks. That's what a passive listing is. So they have no designs on controlling the company. A 13D also signals a five plus percent position, but comes with added requirements of disclosure, primarily concerning the purpose of the transaction. When you see a 13D, as in dog, it's generally an active or some other interested party looking to force some change, influence the business itself. Musk filed a 13G.
Chris Hill: Musk files this document. He says, I've got nine percent of Twitter, but it's a passive stake. Why are all of these other people piling into shares of Twitter? Because I could see it. If they thought he's going to ride the ship, he's going to push for a subscription business model. This is going to change the business of Twitter but if it's a passive stake, why is everyone reading into this seemingly that he is going to change the business?
Jim Gillies: Isn't that the question?
Chris Hill: Yes.
Jim Gillies: The problem with that is that I did Musk file the wrong filing. Is this a stunt? Long time Fools know I'm not the biggest Elon Musk fan, so I'm going to try to not let that trip over here. But I think he's going to have to be very careful, because if he is seeing, he has to be very careful if you believe the SEC will have any teeth to it, which might be another topic. But if he is seen to be engaging in practices that are perceived to be looking to exert control over the business over the course of the company, then he's filed an incorrect filing and you're going to get slapped with that. He should have put into 13D. I'm a little shocked that his lawyers didn't tell him to put in a 13D anyway but then that would send a whole other message that here's Elon Musk who is regardless of my personal feelings about the man, I think he is an absolute master user of Twitter. He is an absolute master of seizing and controlling, creating a narrative. I note with some sarcasm, some sardonic viewpoint. I note that this past weekend, Tesla, Elon Musk's primary vehicle, no pun intended to talk with the public on. Tesla released their car deliveries for the first, quarter. They release those numbers. They were mildly disappointing. As well as they change the definition of what they call it, a delivery. Are these delivery numbers directly comparable to a year ago or the prior-quarter? We don't know. They changed the verbiage of what defines delivery. I noticed that both of those new stories, which I thought were reasonably things we should be talking about or that people should be looking at. They're both gone because all people can talk about is Musk buys 9.2 percent of Twitter. About a couple of weeks ago, he was publicly speculating on whether Twitter was a force for good in terms of free speech. He publicly speculated on Twitter about starting his own competing offering, which sure, whatever. As I said, I think Musk is an absolute master at seizing the narrative and defining where the narrative is going to go and this would be a good example of that.
Chris Hill: Last thing and then I'll let you go. With this move with shares of Twitter up 27 percent today. That means that in the past 12 months, shares of Twitter are now down only 22 percent [laughs] but I want to go back to Tesla. We can end here. That was another one of my thoughts this morning that if you're Twitter shareholder, great, you are having a wonderful day. I'm not a Tesla shareholder. Do you think the average Tesla shareholder is happy about this? Wouldn't they rather he'd be spending more time on Tesla? [laughs]
Jim Gillies: Yes. The concept of score-carding, that stock price is the only thing that matters, I think is probably what's driving the average Tesla shareholder right now, because the stock price over the past few years is up substantially. It's not really gone anywhere for much of the last year, but I think it's an eight or 10 bagger over the past three or four. As I am someone who has been both long and short, Tesla in the past, I am currently longer today via index funds and look-through exposure to Tesla than I've ever been. I suppose I have a vested interest in saying, hey, Tesla go. I think the average Tesla shareholder looks at share price and says, go get them Elon. I don't think the nuance between a 13G and 13D filing is entering anybody's thought process aside from poor folks like us who do this for a living. I think it'll be interesting to see what, if Tesla's share price were to drop 50 percent. I just pull a number of thin air. If Tesla's share price were to drop 50 percent over the next quarter, I think that's when you'd see people complaining, oh it's distracted by Twitter. Until then, I don't think it matters. We know that he got sanctioned in 2018 for the 420 funding secured thing, which some folks would consider to be securities fraud. We know we paid a fine, $20 million fine for both himself and on behalf of Twitter. On behalf of Tesla, he is supposed to have a so-called Twitter sitter to oversee his tweets, which I don't think that's the most lenient Twitter sitter in history. We know right now he is currently engaged with the SEC on that prior settlement. I know he's trying to maybe loosen some of the strings there. With the scrutiny that he has attracted to himself, I think it's in his best interest to be real careful about his filings and about real careful what he does. Hopefully, he says nothing about his stake in Twitter, just he has it. It's there. He says nothing and we hear nothing. Then at that point, he's got the money, and how about it man? There's nothing to say. They had to both start with a T. I hope for the sake of Tesla shareholders that he does that, that he does in good faith, keep it passive because there's nothing that says you can't do this, and Twitter just goes on its merry way. Hopefully Twitter then under the new CEO, starts to make some real progress on monetizing the business because [MUSIC] as you say Chris, until today, you're basically buying Twitter at the IPO price on Friday, and since the IPO was in 2013, I believe that's not a compliment.
Chris Hill: Jim Gillies, always great talking to you. Thanks for being here.
Jim Gillies: Thank you. [MUSIC]
Chris Hill: One question investors have had for years about Twitter, Tesla, and Starbucks, has to do with just how big their market opportunities are. Social media, electric vehicles, and coffee, are about as different a set of businesses as you can find but the underlying question is both common and important. To Cloud Storage for example, it's a huge market opportunities, but it can be difficult to figure out how competing businesses are unique from one another. Today, Asit Sharma and Brian Stoffel take a closer look at Cloud infrastructure company, DigitalOcean, through the lens of its competition and how DigitalOcean is serving its customers differently than Amazon Web Services and Microsoft Azure.
Asit Sharma: Brian, investors have been hearing for years, how competitive the Cloud computing and storage market is. But outside of very familiar Cloud titans, which seem to completely dominate this industry, like Amazon Web Services, Microsoft Azure, Google Cloud, IBM Cloud, Oracle Cloud infrastructure, you get the picture. Are there any other companies that can even compete in this space?
Brian Stoffel: Well, Asit, I think it depends on what we mean when we say can they compete in this space. Because there is this market that you don't hear about that often unless you're directly involved in this business. That is meeting the Cloud infrastructure needs for small and medium-sized businesses. That's why the company we're talking about today, DigitalOcean comes in. Now, it's hardly the only player in its field but what makes this company unique is that they are really geared toward your small companies that need some type of Cloud presence. But working with Amazon or Azure just doesn't make sense. I was a little bit surprised to find out myself. Now I'm a former teacher, so I've been a teacher and I've worked for the Motley Fool, you don't want me touching your Cloud anything. But when I researched it, what was interesting to me, was just how difficult it can be to use AWS in Azure and how it really requires a company to have a team of IT professionals to make it work. Now obviously, your big companies like Netflix uses these guys, they've got the people to do that, so that's not a concern. But if you have like a small start-up, say architecture firm, you can't hire five people just to handle your Cloud infrastructure because you might be a two or three person organization, and there's a lot more of these two or three-person organizations out there than we might think. Add all that together and that's what DigitalOcean is after.
Asit Sharma: Yeah Brian, what's really interesting to me is how DigitalOcean has positioned itself to this extremely crucial segment of Cloud purchasers. CEO Yancey Spruill of DigitalOcean was recently talking about the sheer numbers associated with this market in both a recent earnings call and an investors conference. He said that by the end of this decade, there are going to be some 100 million small and medium-sized businesses around the world, and there are in addition, 50 million individual software developers that are associated with these businesses that will be working on project by the end of this decade. When you take this big group together, what do you think the spend is? It's big. The estimates are, according to Yancey Spruill, that there will be a $100 billion spent annually over the next several years just for Cloud infrastructure that relates to small and medium-sized businesses. To me, this is almost a niche space, but it's really hard to gain traction, and the way that DigitalOcean has gone about this is to just cast a wide net. They've got some 600,000 customers, they got a very wide marketing funnel. You can start with free tutorials on the site and the company will follow you along for years, potentially before you maybe join a start-up firm and spend the first penny. But having this niche focus and concentration on small start-ups growing customers, is great because it's a space that Amazon Web Services and Microsoft, Azure work, etc. it's not really profitable for them to touch because it doesn't really move the needle for their huge operations. One last thing I'll say on this point is Yancey Spruill had a really nice case study example he's been citing. There was a company in Tel Aviv, a start-up, just the type we're talking about Brian, they had eight people. When the company started, they were spending 20 bucks a month, fast-forward eight years, they're spending a $170,000 a month. Now, not every customer is going to grow like this, but the idea is to scale with these customers, even if that spend goes from 10- 20 bucks a month to the 100s, give a nice business here.
Brian Stoffel: Yeah. You know, I like that story Asit. The one thing I just want to say with that is it reminds me of Shopify, and here's what I mean by that. I always argue that there's a lot of detractors, you said Shopify is two million merchants, like most of those are just garbage. The fact of the matter is that's probably true but the point is is they just need to catch the Black Swan. What I mean by that is, it's almost impossible to know what's the small start-up today that's going to be a big important company organization tomorrow. We might think that we can predict that looking back, but we can't, because if you could, you'd be a genius. So instead, I said, Shopify just needs to cast a wide net, get a whole bunch of potential customers, and then grow alongside them. In fact, there are three different companies. I know Oatly is one of them that started their business on Shopify and are now publicly traded companies. It's the same dynamics with DigitalOcean, and one of the things Asit I talked about is the company needs to make sure that as those customers get bigger and bigger, that they continue spending on DigitalOcean and don't leave wholesale for an Amazon Web Services or Microsoft Azure.
Asit Sharma: Very true. Brian, I wanted to ask you, we've talked about the whales in this industry. Some call them cloud titans, some call them HyperCloud providers but DigitalOcean, if it's swimming below those, does it have to worry about any small competitors? Does it have this space all to itself?
Brian Stoffel: No, it doesn't have the space all to itself, but it still has a unique position. For instance, there's one provider, Heroku that was bought out and is now a subsidiary of Salesforce, and they are more of a high-end service. When you look at the stats for DigitalOcean, they tell you about customer spending or you can just go on their webpage and look at their prices, and it's like five dollars for this product per month, $10, it truly is cheap and your average revenue per user is below a $100. We're talking about some very simple things that people are buying. Whereas for Roku, they started about $250 if you go on their website, so they are tailoring to get the different ones. The two that stick out to me one is Linode, which is a subsidiary of Akamai, and then there's another one, Vulture that's privately owned, that just released that it has about a 125 million in annual recurring revenue. To put that in perspective, that puts it at about a quarter the size of DigitalOcean. DigitalOcean is much bigger. Linode, we can't really get a beat on how big their business is because they are a subsidiary of a much larger company and doesn't need to be broken out like that. That being said, I still think that we can follow the numbers to see how it's doing, and this is not a one winner take all category. If it was, then Microsoft Azure and Google Cloud wouldn't exist because Amazon Web Services had a seven year head-start and they still understandably, not a knock against them, don't have a 100 percent of the market for those enterprise customers.
Asit Sharma: You mentioned numbers. Let's talk about a few numbers and then I've got a couple of big picture questions for both of us. These numbers look pretty decent to me. DigitalOcean is a company that's growing between 30 and 40 percent on annualized basis. In the last quarter that they reported this was in February, their fourth-quarter of 2021, their top line increased about 37 percent to roughly a 120 million bucks. They have, as you mentioned, what they call an annual run-rate revenue, it's pretty similar to annualized recurring revenue of almost $0.5 billion. They are running at a loss, but this company is getting closer and closer to break evens, negative operating margin of about eight percent. Turned cash flow positive this year, and in fact, gross profit has been growing in some quarters at a rate that's faster than the sales acceleration. So improving gross margin, profitability. I think this is a company that looks interesting simply because it's not a hyper-growth company that's loss-making. It's established its niche. It's got some pretty decent metrics when you compare them to other software-as-a-service or platform-as-a-service type companies. The leadership team I should mention, which is not only made up of Yancey Spruill, but Carly Brands who is chief marketing officer came from a company called SendGrid, which this team scaled up and sold to another public company, Twilio. A lot of elements here are of a successful company but given that Brian, I wanted to ask you, is this a company that you'd invest in, why or why not?
Brian Stoffel: Right now, I don't own shares. I don't plan on owning them anytime soon either, but it's not because there aren't a lot of compelling things going on here. Part of it just has to do with the fact that it's much harder for me to gauge how wide the motives around DigitalOcean's business, and that's because I'm not involved in Cloud infrastructure. Personally, I don't work on that. It's easier for me to understand the net dollar retention rate of some other tools because I can see why switching would be so hard but Asit, I don't think it's uncommon for us to hear about a large company switching from for instance, Azure to AWS, like that happens. So I don't know how big are these switching costs. Is it a real moat or is it not? I will say that their dollar-based net retention has gone up significantly. It used to hover at about a 100 percent, and a lot of people might think a 100 percent for a SaaS company, that's not very good but you need to look at this in the same way that we look at a HubSpot. By that what I mean is HubSpot focuses on companies that have between two and 200 or two and 2,000 employees, small companies. If you focus on those, most small companies are going to go out of business and that's OK. That's no fault of HubSpot, no-fault of DigitalOcean, so that keeps that dollar-based net retention much lower, but it's up over a 115 percent now, that is a really important increase. That's more impressive than what HubSpot has been able to do, and I'll just throw another number that you really want to watch is the average revenue per user. It's gone up from mid 40s to mid 60s over just the last year and that again is a really impressive increase. Those are some of the things that I think you need to watch but again, I'm sitting on the sidelines, not because I don't like the company, but because as an investor you got to be super picky. There's 4,000 stocks for you to pick from a portfolio of 20-30 is good. So it's one of those things where you shouldn't knock accompany for not being included, just focus on what is included.
Asit Sharma: Brian, you just sold me on investing in this company the last couple of minutes talking about their great customer retention metrics, despite the fact that they probably see a lot of churn in that base because of the nature of having small customers. Our investing styles are different in that your portfolio is much more concentrated than mine, I'm not really ashamed to say this, but I say I have like 65 different companies [laughs] that I invest in. So I could see myself taking a small position in DigitalOcean to follow it along, maybe invest some more as they keep growing, and the strength of that moat becomes more apparent. This is a company I can definitely consider putting some money behind. Maybe not bet the firm here but I love the fact that it has a solid financial profile. This has been so much fun as always to chat with you. I look forward to next time.
Brian Stoffel: Thanks Asit. [MUSIC]
Chris Hill: That's all for today. Will be coming up tomorrow conversation about kids and money. 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. I'm Chris Hill, thanks for listening. We'll see you tomorrow.