Fri, 6 Nov 2015
Activision, Expedia, and Visa each announced acquisitions this week, while Facebook had a great quarter and Tesla's stock popped despite an earnings disappointment.
Jason Stipp: I'm Jason Stipp for Morningstar. Welcome to the Friday Five--Morningstar's take on five stories in the market this week. Joining me with the Friday Five is Morningstar markets editor Jeremy Glaser.
Jeremy, thanks for being here.
Jeremy Glaser: You're welcome, Jason.
Stipp: It was another big week of earnings and M&A news. Let's start with Facebook (FB) earnings. They had a really good quarter in contrast to Twitter (TWTR). What were the drivers?
Glaser: They had a great quarter, and it really was driven by mobile. Facebook is really dominating this mobile-advertising game right now, which is becoming incredibly important. It's growing very quickly. Users are spending a ton of time on Facebook. They are spending a ton of time on Instagram and WhatsApp. Facebook has done a great job of monetizing those views, particularly on the Facebook app, but increasingly doing so in Instagram and they haven't even started on WhatsApp yet. So, that shows that--yes--they are seeing a lot of growth now, but there's also room for even more growth given how much time people are spending with all of their properties.
Unfortunately for investors, this is very much priced in right now. The shares have a lot of this growth already baked in, so right now doesn't look like a very compelling entry point for Facebook. But looking over Facebook's history, there do seem to be times when the shares have fallen out of favor, where people worried about maybe the investments that the company is making or worried about various things that led to a sell-off and led to better entry points. So, I think that investors with a long-term time horizon really can be patient and wait for that pullback. That would be the time to take a close look at this very high-quality wide-moat name.
Stipp: Mobile is really driving Facebook. Activision (ATVI) is also hoping that mobile will be a driver for them. In fact, they spent $6 billion to acquire King (KING), which is the maker of Candy Crush. What's our take on that deal?
Glaser: If people are spending a lot of time on Facebook, they are also spending a lot of time on Candy Crush. And Activision Blizzard really wants to be a part of that mobile experience--an area that's been a weakness for them. But they are spending quite a bit of money in order to get access to a company that's really only had one hit and has yet to prove that they are able to produce something outside of Candy Crush and the sequel of Candy Crush that really can be as successful.
Given the amount that they are paying, Neil Macker--who is our analyst here--thinks that even if there is some strategic sense to getting into the mobile space, it's outweighed by the price they are paying. They could have sat on this cash a little bit longer, maybe looked for other smaller developers that would be able to help them come up with apps that might be compelling for consumers. They might have looked at other situations like that, but they've kind of lost some of this option value by spending so much on King. Time will tell if it works out in the short term as Candy Crush is popular; but if that starts to fade, we'll have to see how this deal looks a couple of years down the line.
Stipp: In other deal news, Visa (V) announced this week that it's going to acquire Visa Europe. These were two separate entities. What's the rationale behind that deal, and what does it mean for Visa shareholders?
Glaser: Visa Europe is still a member association. It's owned by the banks that use Visa in Europe, and the rationale here is just that Visa is trying to extend its geographic reach. Right now, they are very much concentrated in North America, and this gives them access to developed Europe and to developing Europe, and that's really something that they've wanted probably for quite some time here. But they are paying quite a steep price for it--at least 16.5 billion euros in order to get this deal done.
Jim Sinegal, who covers Visa for us, really thinks this kind of outweighs the strategic benefits, and that it ends up being virtually neutral. Our fair value is going up by just $1 off of a $71 base, mostly likely. But one of the wildcards here is going to be how much Visa is able to improve the profitability of Visa Europe. That's one thing they did very well after their IPO--boosting their operating margins. If they are able to get that margin parity between current Visa and Visa Europe, that's something that would make that purchase price look a little bit less eye-watering and make the deal look a little bit more attractive. That's something people are going to be watching in the quarters and years to come as the integration starts.
Stipp: So, if that deal didn't move the needle on our fair value very much, I have another one for you. Expedia (EXPE) is spending $4 billion to buy vacation-rental firm HomeAway (AWAY). What does that mean for that firm, and did we change our fair value on Expedia?
Glaser: We did. Dan Wasiolek, who covers Expedia for us, raised his fair value by 5% on this deal to acquire vacation-rental company HomeAway. That's really on the back of the idea that online vacation rentals is going to be one of the fastest-growing parts of the online-travel space in the years to come. You hear a lot about maybe Airbnb, but HomeAway is also a very important player here.
When Expedia takes this company into its network and [HomeAway] able to have its distribution, its better technology, and it's able to get in front of that many more eyeballs, we think it's going to be able to grow revenue even faster than HomeAway has been able to on its own. This will be an important driver of Expedia's growth. It's going to be an important contributor to its network effect and help its competitive advantage, which is something that we're always looking for. So, I think that this deal from both a financial and a strategic sense is a good one for Expedia.
Stipp: And lastly, Tesla (TSLA) reported earnings--and they disappointed. They weren't as good as expected, but the stock popped. So, what was happening with the results and the forecast?
Glaser: Investors often seem to be very focused on that delivery forecast and what's happening with the deliveries on Tesla more so than earnings in any given quarter. And as you mentioned, the stock did pop because that delivery number looked pretty good. It was in line with what people were looking for there.
But Dave Whiston, who covers Tesla for us, really thinks that investors need to be focused more on the long term as well and that the real value of Tesla is what happens over the next decade, not what happens over the next couple of weeks or next couple of quarters. You have to ask how successful is their Model 3 sedan going to be. That's the one that's going to start at $35,000--their push into being more of a mainstream car company. How successful are they on that front? What kind of competition emerges from traditional car companies? Are they going to be able to produce electric cars that get people as excited as Tesla's do now and get to that quality level that people associate with Tesla? I think those are the big-picture questions that are going to determine what that real value of Tesla looks like down the road.
When you look at the share price today, we actually don't think it's ridiculously priced. It's somewhat overvalued, but it's in that 3-star territory. But before you consider investing, you really have to look at the uncertainty. It is very high. So much of that value is years into the future. You just don't know what's going to happen, so you'd have to demand a pretty big discount, which just isn't there now, before jumping in. So, this is one that's probably better to just watch from the sidelines.
Stipp: Thanks for helping us make sense of all the headlines this week, Jeremy.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.