In this podcast, Motley Fool senior analyst Bill Mann discusses:

  • His belief that the Elon Musk/Twitter deal will get done.
  • Why guidance is the thing he'll be watching in the upcoming earnings season.
  • Why he believes stagflation is the biggest risk to the economy right now.

Motley Fool senior analyst Jim Gillies discusses a small-cap business that's been rewarding shareholders.

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 Oct. 05, 2022.

Chris Hill: Breaking news, world's richest guy decides he will buy that company he had second thoughts about. Motley Fool Money starts now. I'm Chris Hill. Joining me today, Motley Fool Senior Analyst, Bill Mann. Thanks for being here.

Bill Mann: Hey Chris, what's happening?

Chris Hill: Money never sleeps, so on we go. On Monday, shares of Twitter rose 22 percent after Elon Musk said, you know what, I think I actually will buy this company at the original price that I agreed to way back when. Today we are getting word that not all of the t's have been crossed and not all of the i's have been dotted. The agreement is not a done deal. I'm curious what you think as you are watching all of this play out.

Bill Mann: So the t's and the i's were he provided a letter to both the Chancery judge in Delaware who would be overseeing the case that would be coming up the trial that would be upcoming and basically saying everything is good, pending $13 billion in financing that I put into place before. Pending financing is actually a term that you would expect to see in any deal, but this is Elon Musk we're talking about who has tried to wiggle his way out of the deal. Immediately, people have gone to the place of what is pending mean. To me it's pretty straightforward, he's got to get the financing in place. I know being a world's richest guy, he doesn't have $13 billion or $44 billion in a checking account. He has to create and get that capital because the shareholders of Twitter expect to be paid in cash for their shares. Essentially what we're waiting on is a pro forma thing but given the fact that there has been all tomfoolery from Elon Musk from about two weeks after he agreed to the deal, I think that people are looking at it and just keeping interest to see what happens next.

Chris Hill: If you are in the financing business, if you're in such name of large Wall Street bank, are you calling him up and saying, hey, we'd be interested in talking about helping you finance this deal, or because of everything you just said about Elon Musk and everything we all have witnessed over the past six months, do you just say, you know what, we're going to sit this one out because we're just not sure.

Bill Mann: I'm trying to figure out how to answer that question without mocking you because Chris, I don't know if you've met investment bankers before, but some of them would sell their grandmothers in order to get to a couple of bucks, so absolutely not. They will be all over this, $13 billion in financing on a $644 billion deal? Oh no, they would hang up on anybody for this deal. I would not worry about that. The funny thing to me was, and thinking about the terms by which this might get scuppered would be, and Matt Levine from Bloomberg pointed this out. He said, well, we are contingent on the deal getting done. There is the possibility that what Elon Musk is doing is simply pushing the the case down the road by pretending to cooperate. But then there's also the potential that one of the banks themselves might say, well, we're not sure we can do this deal because of all the bots which would be unbelievable to have happened. But no, to me, this deal is getting done. It's getting done under these terms. It's getting done soon, regardless of those contingencies.

Chris Hill: Shares of Tesla are down 41 percent year-to-date. If you are a Tesla shareholder, are you hoping that this deal getting done means hopefully Musk can just turn the keys of Twitter over to someone else and get back to the business of Tesla? What are you hoping for if you're a Tesla shareholder at this point?

Bill Mann: I'm not sure that one has a whole lot to do with the other because Elon Musk has made it clear that the big problems that he wants to solve are throwing metal into space and changing how the world moves from point A to point B. Those are his big issues. I see Elon Musk now that the potential for legal action has decreased, turning this over to other people. He may have some more attention paid to the other parts of his empire by Musk from here on out. I'm not sure that the 41 percent down and Elon Musk being distracted by Twitter are necessarily a one-to-one relationship. I think it's pretty clear to say for someone whose net worth is in the nine digits, do I have that right? Yes. No, 12 digits.

Chris Hill: I think it's more digits.

Bill Mann: Twelve digits. That's a lot of digits. He's had a tough year.

Chris Hill: Well, let me get out my tiny violin. Let me get on my tiny violet for the wealthiest person on the planet.

Bill Mann: Exactly. Now I think that's absolutely true, but he has taken some pretty substantial hits, including the other day being told where he could stick it by the Foreign Minister of Ukraine after he came up with a plan that was basically like let's just think Kumbaya sorted all out. I think that he's probably looking forward to being in any way viewed as a saviour at Twitter at this point.

Chris Hill: Earning season starts in, let's call it 10 days and once that happens, we will start getting actual results and forward-looking commentary from the biggest, most important companies in the country. Until then, it feels like everyone on Wall Street is just grasping, untethered, looking for something to latch onto, to give them a sense of where the economy is going, where the market is going. Between now and earnings season, what are you watching to give you a sense of where the economy is going?

Bill Mann: Well, I think one of the biggest things that's happening right now, and this is not necessarily earnings driven and it's not necessarily being driven by the 13-week schedule. I do have some words to say about that. I think the biggest thing that's going on right now is at what point? Yesterday, the OPEC countries came out and said that they're going to essentially be slashing their quotas by about two million barrels of oil per day. We're already in an energy deficit and going into a much bigger one. The only solutions there are a reduction of energy consumption or an increase of supply. To me, the biggest risks that we have economically right now in the US is stagflation. Stagflation generally comes when you've got uncontrolled energy costs that are sucking up the oxygen for other parts of the economy. It's a big issue to me.

Now in terms of company earnings themselves, really what I'm looking for is companies coming out and saying, even if the news is bad, that they finally are having some form of visibility for what's going to happen over the next year. I think that people forget that in 2020, in 2021, because we were in the midst of a pandemic, companies and they're guessing all the time, but they had really almost no way of putting finger holds on what the next steps were going to be because the exogenous events were too big and too uncontrollable and too unpredictable. Now you have companies and by their hundreds that are sitting on, either still have supply chain issues or they have inventory issues because they've produced too much. I think you're going to see this quarter that for the first time companies, even if the news again is bad, having some semblance of an idea of what's coming up next. We're going to start learning about it, starting with the first earning earnings report here in a couple of days.

Chris Hill: Bill Mann. Always great talking to you. Thanks for being here.

Bill Mann: Thanks, Chris.

Chris Hill: Part of the attraction of SaaS companies is, their efficiency. If you're looking for an efficient business, how about a retailer that sells gently used goods? Jim Gillies has a look at a small-cap franchisor that's been quietly rewarding shareholders with more, here's Ricky Mulvey.

Ricky Mulvey: I think we've got to talk about one of the most underrated companies in the full universe. It's got a 94 percent gross margin. It's got a market cap of about $11 million per employee. Those metrics beat Salesforce, Meta, HubSpot, Atlassian, Adobe, and Zoom, and it sells gently used goods. We're talking about Winmark with Jim Gillies, a Winmark's superfan. Thanks for talking about the franchisor with me today.

Jim Gillies: I will say, Ricky, you've given me something new to think about. I've never thought of comparing the gross margin from Winmark to Salesforce, Adobe, and all of the other tech titans. Thank you for that.

Ricky Mulvey: Happy to look at different stocks and numbers and try to make comparisons that don't exist. This is a company that owns Play It Again Sports, Plato's Closet, Once Upon A Child, among other brands, it's got about 1,250 locations and a $750 million market cap. This is a smaller company. I would say a lot of people sleep on it. But Jim Gillies wise, Winmark and interesting company to you?

Jim Gillies: Boy, that's a wide-open question. Number 1, I do like franchise companies and you've mentioned they are the franchisor of five gently used. I'm not sure if I stole that from Winmark years ago or if I coined it. Gently used goods you mentioned, Play It Again Sports. They also have Plato's Closet, Once Upon A Child, Music Go Round, Style Encore. Play It Again Sports, of course, is selling gently used or even new sporting goods. Plato's Closet, is a team clothing, predominantly female-focused. Once Upon A Child, obviously children's gear, children grow to things quickly and they need a lot of stuff. Music Go Round is the smallest concept of musical instruments, you can get rid of that piano, that saxophone you never played. Style Encore is more women's business and casual attire. It's more upscale than Plato's Closet.

But the reason I like franchising, is franchising is I'm going to sell you a system. I'm going to sell you a concept. You are then going to give me 5-6 percent of your sales gross. That is not net. You're gonna give me 5-6 percent of your sales off the top as royalty every month. Plus, I'm going to get you to contribute to fun for advertising. Franchising models tend to be extraordinarily capital-light. I'm not building the store, I'm not responsible for putting in the computer systems or what have you, I'm not even responsible for the lease. That's your job if you're the franchisee working with me. Now, maybe I can use my Cloud as the franchise or to get to a better lease rate. It's a win-win solution there. But these franchising companies as a bunch of restaurant franchisers as well out there that I like. But the common denominator is they produce a lot of cash for not much capital invested. If you've got winning concepts, they are often winning stocks, and Winmark, no pun intended happens to be a long-term winning stock.

Ricky Mulvey: The company itself has a couple of interesting angles it's got. In some growing franchises, it's trying to grow that Style Encore brand. Also has an interesting store credit system where you trade, let's say you go to play it against sports, you trade your softball glove in, and will either give you $10 cash, or $15 in store credit. It's also starting to pay a dividend a little above one percent.

Jim Gillies: We're going to talk about the dividend, Ricky.

Ricky Mulvey: Then I think you just picked where this conversation is going. What should investors watch of those three things that I just mentioned?

Jim Gillies: Well, first off, the store credit system is excellent. I abused Play It Again Sports a lot of kids and hockey up their kids and skiing. We have availed ourselves at the store credit system once or twice at the local Play It Again sports. I always go for credit because you've got more and I guess I'm a value investor through and through. They started paying a dividend in 2010. They started paying a dividend at two cents a quarter. What do you do? The stock is $216 this morning, so two cents a quarter, who cares? A year later they bumped it to three cents a quarter. A year later, they bumped up to four cents a quarter a year later they bumped into five cents a quarter and you can probably see where this is going. A year later they bumped up to seven cents then 10 cents then I believe 15 cents and I believe 25 cents. I think they paused a little bit for the start of the pandemic then they bumped it to 45 cents a quarter, and now they are paying 70 cents a quarter. The dividend in just over a decade is up 35-fold. I haven't done the compounded growth of a 35-fold gainer in 11 years.

But suffice to say it's high. What's interesting about that is if you bought the shares and fold disclosure, I am an owner and I have owned shares here since before they started paying a dividend. I think my cost basis is around $21 a share. You can hate me now, are heavy later it's your choice. But 70 cents a quarter now what they're paying, or 280 a year is what, 14 percent of my cost basis per year. That's a nice little thing, but wait, there's more. Winmark also has this habit of declaring a special dividend periodically. In 2012, they paid a five dollars special dividend, in 2014 paid another five dollars special dividend in 2020, they paid three dollars, and then in the end of 2021, they paid 750. If you add up the special dividends which have come on top of the regular dividend, I think they paid $20.50 in special dividends over the years.

Basically my cost basis and before we hit dividends, and again, they can pay all of these specials. They can pay this ridiculously growing regular dividend because of the nature we talked about earlier. This is a franchising business that requires very little capital. As you said, there's $11 million per employee in revenue. Very little capital is maintained. There's not much to do with the cash that this business generates aside from return it to shareholders and add its route. That's what we want out of any investment. No. It's wonderful to build castles to the sky. I would love to be part of the next big thing and in human evolution, as we go. In my investing stuff, you pay me my money because this is great. I get my money back and I own a business that's still growing. What's not to like. The dividend, and then the last piece of the dividend you might say it's up 35 times in value plus those specials. Surely the dividend growth is done.

What I would say to you as I'm looking over the past 12 months the company has produced about $41 million in free cash flow, just over 41 million. They paid 35 million almost in dividends. That looks like it's tapped out. Most of their free cash flow is going to dividends, except don't forget there with that giant $750 special dividend there, just the regular dividends. If we maintain just the regular dividend going forward, it requires just shy of $10 million to pay per year. Not only have they been paying its dividend and is rapidly growing dividend all specials, but they've also been buying back its own shares. Since the end of 2009, the company has bought back roughly a third of their shares. Even as the dividend goes up, there's less shares they have to pay the dividend on which then provides another driver for potential dividend hikes in the future.

Ricky Mulvey: If you get Jim Gillies talking about dividends, you're going to start running low on time. I'm going to see about a few questions.

Jim Gillies: Keep going.

Ricky Mulvey: One, I want to talk a little bit about competitive threats to the business. This might be concerned trolling. I don't know if it's a real threat, but when I went to Play It Again Sports to buy my used softball glove, I noticed that a lot of the goods there were new and according to, 70 percent of the inventory at Play It Again Sports is brand new and that seems to go against the grain or the promise, if you will, of a used goods reseller. Do you know if that practice is common across its other franchises and do you think that that strategy now opens Winmark up to having more competitors like the Internet, Dick'S Sporting Goods, and those types of outlets?

Jim Gillies: First-off, I don't believe it is common at that level across all concepts. I believe Play It Again Sports is more of a one-off on that front as someone who has taken used skis into Play It Again Sports and walked out with new skis. My son and daughter few years ago. Yes, absolutely there is new gear there and it's reasonably priced. My second part of that answer it'd be Ricky, take your used baseball gloves. Go to DICK'S Sporting Goods and ask them what credit they're going to give you. The answer is going to start with a zero and end with a zero.

Ricky Mulvey: They'll probably tell me to leave.

Jim Gillies: Yeah. That's the secret sauce is people are going in and they are taking their gently used goods and they are getting credit. Because again, I'm a lifelong skier. My kids are so far lifelong skiers. But you know when your kids are two years old versus the kids 18 years old, their gear is very different sized, use blah, blah, blah. I have probably traded in three or four pairs of skis over the years for each kid as they've grown up and I think in a weird way but a company like eBay, for example. EBay back in the day was auctions only. That's how it was. Now, most goods on eBay are buy now. They've made that transition. There is room for multiple business models within a single concept. But I think the real hook and the largest concept is concept followed by once upon a time Play It Again Sports in the middle and then Style Encore and Music Go Round are very small. But the real hook is used goods and the store credit system.

Ricky Mulvey: Then, anytime you're talking about a small-cap company, you want to pay close attention to leadership and I think Winmark has fewer than 100 employees. What should investors know about a CEO Brett Heffes?

Jim Gillies: Brett Heffes has been able and I think a good successor to the man that got me interested in Winmark back in the day his name I think is John Morgan. Basically, he'd already made a fortune frankly, in the small ticket leasing business, but it's something to do and so 2000 he comes and he buys, I think about 13 percent of the company at about seven dollars a share and then John Morgan, who is now retired. We're going to get the breakouts, but Morgan spends the next 14 years buying shares on the open market. At one point he own nearly a third of the company putting his money where his mouth is publicly and he installed this shareholder capital returns structure, lean expense structure and Brett Heffes was his basically handpicked under study. In 2016, I believe Morgan kicked himself upstairs from the CEO chair to the executive chairman and Brett Heffes who had been there under Morgan for a while, gets promoted to the CEO slot.

He has maintained the same culture essentially going forward even after the exit of John Morgan. What they've done essentially is you've already mentioned they run fairly lean employees. You look at things like their compensation across the senior executive. I think the CEO total compensation is about 10 or 11 times the average employee which most companies are in the 300s or something. That's come along with like 20, 21 percent annualized shareholder returns for the past decade. But as well, with Brett Heffes, I believe have signed the CFO, equal salaries, equal bonuses, equal equity awards. I believe that chief marketing officers, same deal or I think we may have changed over in the last year or so. But there is this we are all going to win together attitude, which is very much a John Morgan thing that was brought in. Then again, Heffes he was company president, I think for 2011-2016 and he worked in admin and finance before that. He has been and he is the CFO from 2002 all of it under Morgan. He got The Catbird Seat onto study for Morgan and Morgan setup and a great culture and have to continue and can act more than that.

Ricky Mulvey: Jim Gillies. I appreciate your time and your insights.

Jim Gillies: Thank you.

Chris 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 yourself stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.