Let the Bidding War Begin

In this episode of MarketFoolery, host Chris Hill and analyst Matt Argersinger hit on most of the biggest stories in the market today — not all of them, because there aren’t enough hours in the day to talk about how the last 24 have shaken out.

Disney (NYSE: DIS) came back with a counteroffer for those alluring Fox (NASDAQ: FOX) (NASDAQ: FOXA) assets, raising its bid from $52.4 billion to a whopping $71.3 billion. Starbucks (NASDAQ: SBUX) is down about 8% on some admittedly bad numbers, but this seems like a bit of an overreaction. General Electric (NYSE: GE) got booted from the Dow Jones Industrial Average, only to be replaced with… Walgreens? Really? Why? Tune in and find out more.

A full transcript follows the video.

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This video was recorded on June 20, 2018.

Chris Hill: It’s Wednesday, June 20th. Welcome to MarketFoolery! I’m Chris Hill. With me in studio today, thank goodness, it’s Matt Argersinger. How are you, man?

Matt Argersinger: [laughs] I’m good, how are you?

Hill: I’m good.

Argersinger: I sense some stress.

Hill: The news fairy went bananas last night.

Argersinger: She sure did.

Hill: There’s so much news. Here’s how many news fairy bombs got dropped. You mentioned right before we came in the studio, Jeff Bezos and Warren Buffett and Jamie Dimon decided to name the guy who’s heading up their healthcare initiative, and we’re not talking about that. We’ll probably hit that on Motley Fool Money this weekend. But there’s just too much other news to get to it.

Argersinger: Can’t fit that?

Hill: We can’t fit that in. But, we’re going to talk about GE, we’re going to talk about the Starbucks news. We have to start with the news that we talked about a week ago, the last time you were in the studio, which is the Disney-Fox-Comcast (NASDAQ: CMCSA) and the latest moves there. Disney raised their bid, and they raised their bid from $52.4 billion to $71.3 billion in cash and stock. First, what was your reaction when you saw the news?

Argersinger: I’m a little surprised. I left last week thinking, “You know, this might give Disney and its shareholders a bit of an out.” But Disney is coming strong to the hole here. Reading through, again, the assets they’re going to acquire, why they’re doing it, why they think this fits into Bob Iger’s long-term vision, I think it makes sense. They certainly didn’t want to get into a bidding war with Comcast. They didn’t want to raise their original bid about 50%, which is what they’ve been forced to do. But I do think, if you take a really long-term review, it’s probably a strong move, and I can understand why they’re putting their best foot forward right here.

The way I look at this deal is, they’re really not giving Comcast a lot of room. If they had just matched Comcast’s bid — which, in my view, I think that would have been maybe even enough for Fox to say, “We’re going to stick with Disney, we’ve been working with them for months.” But, no, they went ahead and trumped Comcast’s bid by quite a bit, and giving the option for shareholders of Fox to accept either cash or stock. That’s an interesting twist that I think is positive if I’m a Fox shareholder. I think Disney says, “We want to get this deal done, and we want to preclude Comcast from trumping us again.”

Hill: And, in the same way that we talked about last week that Comcast didn’t just come in with a higher bid, it was a significantly higher bid, same sort of thing here. I’m curious — you said you were a little bit surprised, were you surprised that it happened? Or, were you surprised at the number?

Argersinger: I think I’m surprised at the number more than anything else.

Hill: Okay, that was the same with me, because I thought, if I’m at a Sportsbook in Vegas and I get to bet on what I think Disney’s move is here, I think where I’m putting my money is what you alluded to, that Disney gets closer, gets in the ballpark, maybe even matches it, because the affinity from Rupert Murdoch — at least all of the public statements that come from Rupert Murdoch — clearly his affinity is with Disney. He feels like they’re going to be a better caretaker of the assets. So, I thought, “Well, they’ll get in the neighborhood. Maybe they’ll bump it up a little bit and go $66 billion,” or whatever. But, as you said, giving the option on cash and stock, that’s also an interesting twist.

Argersinger: Yeah. It helps strengthen the idea that the deal can get done. Disney, apparently, already has the credit markets lined up to give them the amount of cash they’re going to need to do this deal. It also adds some risk, though. If I’m a Fox shareholder, now I have a bit of a taxable situation, potentially. I think Murdoch and team liked the tax-free nature of the all-stock deal, and acquiring a significant stake in Disney. Now, that gets diluted a little bit. They don’t get that ownership. They do get cash. So, there are some tax situations there.

If you’re a Disney shareholder, there’s also now more leverage involved. In other words, the deal is a little more accretive, because I’m giving up less stock. It’s less dilutive to me as a Disney shareholder. But because Disney’s going to need a significant amount of cash to do this, they’re going to take on more debt. So, now I have a higher-levered asset, when all is said and done with Disney and Fox.

Hill: Disney executives did a call this morning. Among the comments from Bob Iger, “We’re even more enthusiastic about this purchase,” and said, “We are already six months into the regulatory process, and we see a clear and timely path to approval.” That’s a nice reminder that Bob Iger is not messing around, not even a little bit. Also, I kind of like the shot across the bow of Brian Roberts at Comcast, where it’s basically like, if it’s a poker game, it’s Bob Iger saying, “You should fold your cards. You should not raise me.”

Argersinger: Right. “We’ve been in this, we’ve been working on this for months. By the way, Brian Roberts, you came and tried to acquire us.” Comcast tried to acquire Disney 15 years ago. “I gave you the door then, I’m going to give you the door again here.”

I think Iger reiterates some of the potential that these assets can do. I think a controlling stake in Hulu, I think all of those U.K. assets with Sky, I think the regional sports networks — although, there is a caveat there. They said they might be willing to divest those if it’s necessary to get the deal done. There’s control of a major media company in India. There’s just a lot on the table. And he said, “It has been that long, but since we announced this initial deal, the value of those assets has probably gone up — based on growth, based on the tax reform bill. So, we’re OK with paying more. We think they’re worth it.”

Hill: I’m glad you mentioned the regional sports networks. A week ago, I started to see stories pop up in the sports media — this was in the wake of Comcast raising the bid — I started to see these stories of, “Wait a minute, what happens if Disney comes in?” and raising the prospect of, “Are they going to have to divest these regional sports networks? If so, who’s going to buy them?”

I mean, this is fascinating to watch unfold. Even if Comcast decides, “You know what? We’re not going to try to match this. Go ahead, Disney, it’s all yours,” there are still a bunch of dominoes to fall in this whole thing.

Argersinger: Oh, I agree. And, I think Comcast is going to come back. [laughs] If you’re a Fox shareholder, you have to be loving this. You have gotten 40-50% more out of this deal than you thought you were going to get. And you thought you had a great deal six or seven months ago. Now you’re just getting more and more. I do think this carries forward. I agree. I think, over the past week, there was talk about, maybe the two companies can surgically take apart Fox and take what they want and have a deal that way. But no, Disney wants it all, Comcast wants it all. The price is probably going up even more.

Hill: Let’s move on to Starbucks. Starbucks shares went down 8% this morning, with good reason — well, I don’t know if it’s a good reason. Let’s get to that. Starbucks came out, they lowered guidance for Q3. They said that they are slowing the number of store openings that they have planned, and they’re closing 150 company-owned stores next year. For context, that’s about triple the number that they typically close in a given year.

Argersinger: Right. This reminds me, kind of, of what they went through ten years ago, when they realized they’d over-expanded. Howard Schultz came back in and said, “Hey, we’re going to grow smarter now. We’re not just going to open a Starbucks every corner. That doesn’t work. Eventually, you have under-performing stores.” I think that’s where they are today.

I’m not surprised at the guidance for the same-store sales growth. I think that’s been trending that way. They have gotten so much out of their legacy store base. Whether it’s throughput, whether it’s new beverage ideas, whether it’s their rewards program — which, for some odd reason, just hasn’t taken off, it’s one of those weird things when I analyze the business — all of those initiatives, they’ve gotten so much out of their legacy stores that I’m not surprised growth has really slowed to a crawl.

Hill: Are you surprised that the stock is down 8%, though? That seems a little overreaction-y.

Argersinger: It feels that way, I guess. When they reported better-than-expected results last quarter, I think maybe the market said, “Okay, things are bottoming out here. Maybe we’re going to see a bounce back in same-store sales.” And now, again, you have further evidence that that the trend is still down with a lot of their stores. So, I think maybe a lot of investors are just throwing up their hands today and saying, “This is not where I thought it was going to be.”

Hill: Back to Disney for a second. One of the things Iger said — and this shouldn’t surprise anyone — he basically said, “Hey, that $20 billion share buyback plan that we announced last year? Yeah, we’re not going to be completing that because we found a better use for the cash.” And, good. We’ve talked before, we prefer to see that type of thing. If you have a better place for the cash, that’s great.

By the same token, I don’t know off the top of my head how much cash on the balance sheet Starbucks has, but it really seems time for Kevin Johnson, the CEO, to put his crack team to work on finding the best-in-the-business mobile app experience. I don’t know if all the restaurant CEOs know one another — maybe Patrick Doyle from Domino’s, he could give him a call, and say, “Hey, how did you make your app work? Because our app experience … ”

And really, it’s a little baffling that, for all of the things that Starbucks has done right over the past, say, ten to 15 years, not really doing a great job with both the loyalty program and the mobile ordering experience. They’re in the middle. They haven’t done a great job with it. They haven’t blown it to the point where … like, I almost wish that they had completely blown it, because then it would have been like, “Oh my God, we have to start over from scratch!”

Argersinger: Yeah, you’re absolutely right. They’re middling with this, and it just doesn’t feel like it’s gained the kind of traction that you see with, Panera Bread, for example, is the one name I’m thinking about. They had this mosh pit problem. Was it Ron Shaich?

Hill: Ron Shaich, yeah.

Argersinger: When you said they should bring someone in, I’m thinking, maybe that’s the guy they need to bring in. Because they solved their problem. For all intents and purposes, I eat at Panera Bread quite a bit. It’s an awesome mobile experience. It’s so easy and so efficient. I just feel like, why hasn’t Starbucks solved that problem? I thought Kevin Johnson, with his Microsoft background, his tech background, that’s what he was going to come in and do. Obviously, they still need to put more emphasis on it.

But, to your point, in a way, unlike Disney, they’re actually adding more to their share buyback. Starbucks is telling you, “Hey, we have a lot of cash. We don’t have a lot of great ideas right now, so we’re increasing the dividend 20%, we’re adding $10 billion to our capital allocation plan for shareholders. A lot of that’s going to be buybacks. We’re figuring this out.”

Hill: It’s not inspiring. I mean, there are worse uses for that money, so I suppose I should be thankful as a shareholder that they’re not just setting the money on fire. But, it really does seem like, in terms of initiatives, that that’s really probably front and center for Kevin Johnson over the next 12 months.

Argersinger: It has to be. I think, by all measures, the China business has really taken off. That’s going to be a great pillar for them.

I would just say, I think for Starbucks shareholders — you and I both are, and a lot of our listeners are — this is really a case in valuation, if you think about it. Starbucks shares have really done nothing for about three years. But if you go back to three years ago, when comps were still growing 5%, the trends looked great, unit economics were fantastic, the China business was taking off, the stock then was trading for about 30X forward earnings, and the dividend yield was around 1%. So, you look back then and say, well, it was a growth stock trading for a growth valuation. Today, it’s about 20X forward earnings. The dividend, with the raise, is approaching 2.5% yield. It has made that transition from a growth stock to a value stock. And I look at Starbucks today and I see a pretty good value, especially after today’s drop.

Hill: Especially when you consider that they sell a legally addictive product.

Argersinger: [laughs] I know, it’s a great business.

Hill: It’s a good business to be in.

The first bit of business from the news fairy — I thought that this was going to be our lead story today, and then the headlines just kept coming — General Electric is being kicked out of the Dow Jones Industrial Average. I mean, it has been a brutal 12 months for GE!

Argersinger: That is just kicking a guy while he’s down.

Hill: It is!

Argersinger: After 110 years! Come on!

Hill: I was going to say — 1907, ladies and gentlemen, that’s when General Electric joined the Dow Jones Industrial Average. So, that GE is getting kicked out of the Dow, while for sentimental reasons, it may be disappointing; for business reasons, it probably shouldn’t come as a big shock to anyone. Here’s the surprise for me: replacing GE in the Dow is Walgreens. And I’m calling it Walgreens because … stop trying to make Walgreens Boots Alliance happen.

Argersinger: [laughs] I know. I’ve never said Walgreens Boots Alliance.

Hill: Do you have any sense of what the rationale is here? Not to hate on Walgreens, it’s a fine business. It’s a big drugstore business here in the States. But, if you had given me 25 guesses … you could have given me 50 guesses, I wouldn’t have come up with Walgreens.

Argersinger: I’m right there with you. We talked about Starbucks, I wouldn’t be as surprised if Starbucks was getting in, just because McDonald’s is the only restaurant company in the Dow, and Starbucks is about the same size. I don’t know, it makes sense.

But, anyway, Walgreens? This was a shock. The thing with the Dow — and, I’m not an expert on this. I don’t know how this committee makes these decisions. But they definitely look for household names. I think they look for recognizable brands. They look for businesses that are large businesses. Walgreens is about a $65-66 billion market cap company. It’s a consumer staple. It is, by a small hair, the largest retail pharmacy company, so it has that going for it.

But the next logical question is, well, why not CVS? CVS is a bigger company. It may end up merging with Aetna, which then creates one of the largest healthcare companies in the country. I would say, that seems the more logical choice than Walgreens Boots Alliance.

The one thing to remember about the Dow that a lot of people don’t know is that, unlike the S&P 500 and most other indexes which are market-cap-weighted, the Dow is price-weighted. It seems illogical to me, but basically, the higher the price of a stock, the more influence it has over the average. That’s why a company like Amazon or [Alphabet], which you’d think would be natural blue chip companies to join the Dow — in terms of this average that’s supposed to measure an investment guide to the United States, or North America, maybe — if Amazon got in, it’d be about 25% of the value of the Dow. You’d essentially have one company influencing 25% of the change in the Dow.

It’s this price-weighted mechanism that really influences a lot of decisions that go in. So, Walgreens being the size that it is and the price that it’s at, it’s going to come in and be about a 2% weight on the index. It’s middle-of-the-road. It’s a logical choice if you’re just saying, “Alright, this is a company that has a lot of aspects, household name, it’s going to come in and have an average, middling influence on the Dow, it’s an easy choice.” I think there could be a lot better choices, though.

Hill: Just for the sake of context, we’ve mentioned before the Fool 100 Index — we have our own index here at The Motley Fool, and you can learn more about it just by going to fool100.com. 100 companies, just like the name suggests. Walgreens is not in the Fool 100 Index, but it’s in the Dow 30. I don’t know, it’s a mysterious move.

Argersinger: Yeah, it is.

Hill: I like to think that, at some point in the next week or two, a long-form story is going to show up, maybe in the Wall Street Journal or something else, that’s a behind-the-scenes tick-tock of how this decision was arrived at.

Argersinger: And looking at the Dow today, the one area that seems very under-represented to me — maybe just because we’ve been talking about it a lot — is media entertainment. You have Walt Disney. Maybe Verizon‘s in there, as well. I know they’re doing a lot with content these days. But I feel like there’s a lot more, given what we’re seeing the industry — depending on how this AT&T-Time Warner deal goes; I mean, AT&T used to be a member of the Dow — I feel like there’s room for that kind of business.

The one name that I thought actually could get some consideration at some point is — and this would be a strange one — Activision Blizzard. If you think about it, where entertainment is going, it’s a $60 billion company, roughly the same size as Walgreens. It’s the right size, it’s global, it’s the future of entertainment. I eventually think you’ll see a company like that, probably, in the Dow.

Hill: I love that, and I think that speaks to, in some small way, the makeup of the people on the committee who decided this, because Activision Blizzard is at the other end of the spectrum as a business from Walgreens.

Argersinger: Yes, totally.

Hill: Thanks so much for being here!

Argersinger: Thanks, Chris!

Hill: As always, people on the program may have interests 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 Market Foolery. The show is mixed by iron-man Austin Morgan. I’m Chris Hill. Thanks for listening! We’ll see you tomorrow.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. Chris Hill owns shares of Amazon, Starbucks, and Walt Disney. Matthew Argersinger owns shares of Activision Blizzard, Alphabet (C shares), Amazon, Starbucks, and Walt Disney. The Motley Fool owns shares of and recommends Activision Blizzard, Alphabet (A shares), Alphabet (C shares), Amazon, Starbucks, and Walt Disney. The Motley Fool owns shares of Verizon Communications. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.

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