Netflix(NASDAQ:NFLX)wants to keep streaming the way it is, but some consumers might not be so happy about that. And fellow streaming service Pandora(NYSE:P)saw its shares spike on positive developments in its royalty rate case.
Meanwhile, Disney(NYSE:DIS)was a primary investor in the most recent funding round for virtual reality company, Jaunt, as Hollywood assesses the growing new medium. Daily deals site Groupon(NASDAQ:GRPN)is facing continued setbacks in its turnaround.
This episode is packed full of investing tidbits, so buckle in for the latest developments at these companies.
A full transcript follows the video.
Sean O'Reilly: Netflix makes a solid argument against democracy, on this consumer goods edition of Industry Focus.
Greetings, Fools! I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. It is Tuesday, September 22, 2015, and joining me is the man who's living large and taking charge, Vincent Shen. How's it going today, Vince?
Vincent Shen: You had to go with that lead-in, didn't you?
O'Reilly: I had to. For all of our listeners, Netflix isn't actually arguing in favor of democracy, but they're limiting downloading options, basically. That's what I'm alluding to.
Shen: Yes, exactly.
O'Reilly: We've got lots to talk about today including layoffs at Groupon and Disney getting into virtual reality. First, I've been dying to talk about some statements that the product head of Netflix, Neil Hunt, recently made in response to Amazon Prime's move to allow users to download content to their actual hard drives.
Vince, what's actually going on here?
Shen: Amazon recently unveiled another perk for their Prime video service that allows users to download five hours of content for offline viewing. That's important if you're traveling or you're somewhere where you don't have Wi-Fi, or data access.
O'Reilly: Right, which is the reason they cited for doing this.
Shen: Exactly. Ultimately all these streaming services are pushing this idea that they want their users to have access wherever, whenever, and however they want to view it. Be it on a mobile phone, tablet, PC, laptop, whatever.
O'Reilly: Netflix says consumers are better off not being able to download content. Neil Hunt made that statement. What do you think? What are the nuances of the situation?
Shen: He has some interesting perspective, and insight into this situation in that he cited a few tests they did with their service where something as small as rating content, for example. Users can rate a TV show or movie with stars and even adding half a star option resulted in less people actually using that feature.
He's arguing that the added complexity of potentially letting people download their content for online viewing, having to prepare for that before a trip or something is not something he thinks users will necessarily want. He'd prefer to find other ways to make Netflix available for people even when there's no Wi-Fi access.
O'Reilly: They definitely are doing this.
Shen: Yeah. You mentioned that some of the servers they are installing on airplanes. I had heard that they're trying to work to get these open connect servers.
O'Reilly: They're open connect servers, which store all of Netflix's content within a small footprint device. I thought, "How are they going to get all of Netflix's stuff on these things?" Hunt thinks that those servers could be placed on planes and supplement to replace current inflight entertainment. This would essentially solve the problem of limiting bandwidth on a plane.
Again, it's tethering yourself to Wi-Fi. I'll drive one or two hours with my family and they might want to watch Netflix and not use our cell phone's data. I get what they're trying to do.
Shen: I think another reason why they're probably reluctant to do it, other than their argument of the added complexity, that they don't think potential users will actually download a lot of offline content; that would probably have an impact on their content costs. While Amazon has the ability to use ...
O'Reilly: Because they don't care about making money.
Shen: Yeah. People do, but the idea that Amazon can use their Prime perks like video as a loss leader to get people to sign up and then do a lot of shopping for physical goods with them, Netflix has their one business: streaming video. That's just not as big of an option for them. Each increase in their content acquisition costs hits their bottom line very significantly.
O'Reilly: I guess what I've taken away is that Netflix isn't necessarily arguing against democracy. They're really just following the KISS rule, which is Keep It Simple, Stupid!
O'Reilly: Well, moving on. We have a sad story, but it's interesting because we're talking about consumer goods stocks. Groupon is laying off 1,100 people at a cost of $35 million in severance charges, and it's shuttering operations in seven countries. Shares are trading hands around $4, down from a high of $25 following its IPO in 2012. What did you think when you read this headline?
Shen: Not really surprised. Ultimately, this company is, and has been, in a bit of a turnaround effort trying to transition from its original state of being a daily deals site to more of a diversified e-commerce platform.
O'Reilly: They're trying to be a Costco, bulk shipping kind of marketplace. I remember a year ago we did a show, and Groupon had a package of 16 razor blades for the daily deal, and you could get it shipped to your house.
Shen: That's an interesting comparison to Costco, actually.
O'Reilly: Yeah. It definitely is. This doesn't surprise me at all, but the marketplace is their Hail Mary throw, because the Groupons are great deals, and I still go to Groupon's website when I'm looking for a deal on getting auto detailing and cleaning the interior. That's fine, but immediately -- and I don't think I'm alone in this -- you call up the place and try to see if they're accepting it and the place is like "Come on in, don't worry about it." Because they have to pay Groupon.
That happened more recently. My wife cracked her cell phone screen, and we had to go get it replaced and fixed and the place said, "Yeah, we'll honor it. Just come in." Groupon didn't get anything out of that. They're basically playing advertiser at that point, and they weren't even getting money. Groupon figured out a way to block the people that are doing it, I guess.
Shen: With these layoffs that are coming from a lot of their sales and customer service departments, the markets that they're specifically exiting include: Morocco, Panama, Philippines, Taiwan, Thailand, Uruguay, and Puerto Rico. They also recently exited Turkey, Greece, and India. They're circling the wagons right now.
O'Reilly: So they're not pulling back on the United States market?
Shen: No. It just seems like they're circling the wagons, focusing their efforts on what I imagine would be their most profitable markets and their strongest markets. They've also been doing some interesting things diversifying into the potential food delivery with Groupon to Go. I think they've tested that in Chicago.
O'Reilly: That might actually have some legs, if I understand it correctly.
Shen: What's interesting behind that service is that they're trying to stick with their brand image of offering their customers good deals. A sell for their delivery services potentially getting 10% off your order if you order through the Groupon to Go service. They expect to start launching that out more into new markets over the next few months. That's just part of their consolidation efforts, really.
O'Reilly: Cool. Before we move on to discussing the future of Hollywood, I want to reiterate once again a very special offer to join The Motley Fool's Stock Advisor newsletter, for all Industry Focus listeners. As a loyal IF listener you have access to a special discount on Stock Advisor that works out to $129 for a full two year subscription to Stock Advisor. Just go to focus.fool.com to take advantage of that deal. Once again that is focus.fool.com.
Moving on to our next topic, it seems that Disney wants to lock us all in The Matrix. Vince, would you rather be Neo, or Morpheus? Red pill, or blue pill?
Shen: That's a good way to put this. I don't think that virtual reality is quite that immersive, but I get what you're saying. Basically, what happened was ...
O'Reilly: I would take the red pill.
Shen: Which one is that one again?
O'Reilly: I think blue is -- shoot, I don't even know. It's been 10 years since I've seen the first one.
Shen: Disney was involved in the latest series C round of funding for a virtual reality company called Jaunt. Jaunt's typically focused, or their core model, is based on the software and the cameras that are driving the technology.
O'Reilly: Correct me if I'm wrong, I have to think that's actually what's required of virtual reality. We probably have the technology with Oculus Rift and everything.
Shen: They're pushing on the camera front and the processing for the footage ...
O'Reilly: Massive amounts of data, right?
Shen: Exactly. That's kind of reflected in their previous rounds of funding, too. Most recently, this round that included Disney, Evolution Media Partners, China Media Capital, Madison Square Garden -- I want you to keep those names in mind because Jaunt's previous round of funding usually included more Silicon Valley names. Think Google Ventures, Highland Capital ...
O'Reilly: I'm sure Peter Thiel was in there.
Shen: I guess if you think about that more focused toward Silicon Valley side, more tech side. Now, this one has a lot of media companies.
O'Reilly: Madison Square Garden? Am I going to be able to sit in the stands at an NBA game?
Shen: I think that's potentially part of what Jaunt wants to do. They're starting to transition some of their focus to the content side. It's interesting, because the CEO of the company, Jens Christensen, previously talked about how virtual reality technology was basically outpacing content. People were really wowed when they tried on a headset.
I was. I tried the Oculus and it was really great, but the problem is that they need more quality content to keep people coming back.
O'Reilly: I imagine very few -- I assume you tried it out with a video game like I did, right?
Shen: Yes. Exactly.
O'Reilly: Not a lot of video games are equipped to work with this.
Shen: Jens wants to focus on non-video game, high-quality content. They have said that they'll create as many as 1,000 pieces of content over the next 18 months.
O'Reilly: Is this walking through a field or is this an NBA game or ...?
Shen: The interesting thing is that they have a three pronged approach to this. They want to cover live events like concerts, sports, like you mentioned Madison Square Garden having floor seats at a game would be incredible.
O'Reilly: I could be Jack Nicholson at a Lakers game.
Shen: Exactly. They also want to potentially cover journalism and news stories. I think they recently had a partnership with ABC News. They also want to cover more traditional storytelling. If you go to their website and go to their content, they have a bunch of examples. They have a scary, horror-based example that's called Black Mass. They also have a performance from Paul McCartney.
Their three pronged approach is very interesting, and it makes sense to have these partnerships now that they're establishing with these investors. This round of funding raised $65 million. In total they've raised about $100 million, making them the most well-funded virtual reality startup at this point.
O'Reilly: One third of that $65 million came from Disney, it appears. That's not a lot of money to Disney. They're clearly just throwing out a line, planting a seed, seeing what happens.
Shen: At the same time, though, the fact that they have skin in the game will make them more likely to work to be a partner to this company. I think a lot of Hollywood and media companies are seeing the opportunity here, but they're not sure how to approach it. I really think it's great what Jaunt's doing because they've opened up their own studio, they've hired a bunch of Lucasfilm veterans to run it. So they're really positioning themselves to be potentially at the forefront for the content production.
Then being able to start with all the cameras, the software, that technology side, but also the media and the content side could put them at a very powerful position if virtual reality really takes off. Some people are skeptical and think it might be like 3D, which, all those 3D TVs that came out have typically not done that well.
At the same time, mobile is going to be really important. You already have a lot of mobile devices that are capable of running VR content with something like Google Cardboard, and then you also have Samsung who's releasing its Gear virtual reality headset, potentially with a full consumer launch late this year.
We're at the beginning stages now, and great devices will be coming out, I'm sure, with Oculus as well. Is the industry going to be able to keep people coming back with engaging content?
O'Reilly: We shall see. Our final story, and on a bit of a positive note after talking about Groupon layoffs, Pandora's stock popped yesterday following a royalty case ruling. I have to assume that was in their favor.
O'Reilly: What was the deal?
Shen: I think the way I want to paint this story is to put in the context of the fact that, kind of like Netflix, Pandora's number one cost is their content.
O'Reilly: Right. They've got to pay the artists.
Shen: They've got to pay royalties, and the royalties are usually calculated on a per-stream basis. Basically, there are a lot of formal names, but the Register of Copyright basically recognized a previous deal between Pandora and Merlin and said that previous deal could potentially serve as a benchmark for royalty rate negotiations going forward and into the future.
The thing is, it's not a final decision. The Copyright Royalty Board will make the final decision later this year on what those rates will be, but it's a very strong sign that things will come out in favor for Pandora. Since it's in favor of Pandora that means lower costs, which could have a very direct impact on Pandora's bottom line.
O'Reilly: The royalty cost is half, right?
Shen: Yeah. Their content costs usually come out over 50%, if not over, of their revenue. They aren't small numbers by any means.
O'Reilly: Dropping that by 10% is an automatic 5% to their bottom line.
Shen: To put this into perspective, the party that Pandora is negotiating with, at least the more important one in this case, is SoundExchange. They want the rates to go to nearly double, about $0.0025 per stream. The fact that they're potentially able to bring that down, especially for their ad-based listening, which makes up the majority of their revenue; this could have a really significant impact on their bottom line.
The thing is, Pandora hasn't been profitable.
O'Reilly: I don't know if you know this, but regarding SoundExchange said they wanted to double it to a $0.0025? Could Pandora afford that?
Shen: It would have been a very big drag in the fact that they're already ...
O'Reilly: It's hard for everyone to not have music.
Shen: Exactly. The thing is, they need the content. It's something that they'd just have to take the hit on, but this is a really beneficial ruling so far. That is a big driver for the 15% pop. The stock came back down.
O'Reilly: Yeah, it came back down.
Shen: I think people tempered their expectations, which is understandable. Ultimately, the company has been in the red for some time, and this is potentially a turning point for them where I think a lot of bears were nervous about content costs consistently rising, basically preventing Pandora from ever locking in a profit. Now, assuming that problem is addressed over the next five years or so, we might see Pandora finally bring in some profits.
O'Reilly: Cool. Thanks for your thoughts, Vince. We covered a lot of ground today. If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com.
As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Vincent Shen, I'm Sean O'Reilly. Thanks for listening, and Fool on!
Sean O'Reilly has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns and recommends Amazon.com, Costco Wholesale, Netflix, Pandora Media, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.