In this podcast, Motley Fool senior analyst Bill Mann discusses:
- Shares of Altria Group (MO +2.82%), owner of a 35% stake in Juul, taking a hit after the FDA's decision.
- Why one of Altria's main competitors is unaffected.
- How he thinks about "sin stocks" as a category of investing.
Motley Fool producer Ricky Mulvey talks with Bill about how the billions of dollars of Bitcoin (BTC +1.00%) on MicroStrategy's (MSTR 5.19%) balance sheet affects the view of the business, and what a potential margin call means for its 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.
This video was recorded on June 22, 2022.
Chris Hill: We've got another reminder that when Uncle Sam comes knocking on a company's front door, it's not to give them candy and flowers. Motley Fool Money starts now.
I'm Chris Hill and joining me back by popular demand, Motley Fool Senior Analyst Bill Mann, and thanks for being here.
Bill Mann: Can't get rid of me, can you?
Chris Hill: Let me just pull back the curtain for the dozens of listeners, don't happen often, but sometimes there's a miscommunication and scheduling and the analysts who is scheduled just falls through and then you go to the emergency route and call up Bill Mann and say, "Bill, we need you back on the show." [laughs]
Bill Mann: Given that I don't know what I'm talking about in the best of times, I'm ready. [laughs]
Chris Hill: I think you're going to have informed opinions and analysis on this story because this is a pretty big story, which is that the US Food and Drug Administration is preparing to order Juul Labs to take its e-cigarettes off the market here in the US. The Wall Street Journal is reporting this. We'll see if the actual ruling comes down by the time this episode gets published. Altria Group has a 35 percent stake in Juul Labs, and not surprisingly, shares of Altria down eight-and-a-half percent on this news, which for a stock like Altria, not historically a big mover day-to-day in either direction, pretty significant drop.
Bill Mann: I find it amazing in this country that Juul cigarettes may actually be made illegal before cigarettes are made illegal. There are a couple of things that are going on here. Actually, on the one hand, you also have Altria, one of the biggest makers of cigarettes, there's a theory that I think probably holds water, that if they take Juul away, our people are just going to go back to cigarettes or start smoking cigarettes because one of the issues is Juul has applied for an FDA license to continue operating and it is a license that has been given to their competitors. Reynolds has a product called Vuse Solo and they're legal. They have been given FDA permission, they were last year. There are plenty of e-cigarettes and Juul-like devices out there on the market. Juul is the most successful, even though it has been a disastrous investment for Altria. They were applying to the FDA because they are making the claim that Juul e-cigarettes are effective in helping people stop smoking actually, and the additional carcinogens that are introduced in your body from actual cigarette smoke. The FDA has said no to them, but it's important to note that vapes aren't leaving the market, Juul is the one that is currently at risk.
Chris Hill: Do you think there's a world in which Altria just pivots and says, look, we want to be part of the vaping market if it's not going to work with Juul, and by the way, thank you for pointing out that this really hasn't been a great investment for Altria, taking the stake and at the time there was speculation that this is just a prelude to Altria just buying Juul outright. I'm sure there are institutional shareholders and individual shareholders who are thrilled [laughs] that that did not happen. But do you think Altria pivots now and says, look, we just want to be included in this market somewhere.
Bill Mann: I don't think they can. The biggest issue for Altria and it's a funny, regulatory arbitrage. There was an original Juul device like all these other devices that were in existence before federal regulators before the FDA came out and said that they had regulatory authority over e-cigarettes. Now, Juul had a device that was somewhat faulty, so in 2017, they redesigned it. It was called product Jaguar. When they redesigned it, the FDA had them, they had them because they had to come out with something that was before the FDA had stamped at regulatory authority over the market. Now any changes that any company wants to make to play in the market, assuming the thing they would like to go through the full regulatory process, which I would say that a lot of the vape shops on the corners of America don't seem to. But for a company that has got the backing of Altria they have to, and so I don't really know how they could pivot without triggering the FDA at another review again, which I think we've learned today, the FDA is not that excited to let Altria and let Juul stay on the market.
Chris Hill: How much do you think this investment in Juul and again, bad day for the stock. If you look over the lifetime of Altria Group, formerly Philip Morris, this has been a stock that has rewarded shareholders handsomely over its lifetime. We'll get to the idea of sin stocks in a moment, but just historically this has been a great stock. In the last five years, shares of Altria have basically cut in half. How much of that is due to Juul and how much of that is due to the overall environment when it comes to cigarettes, particularly here in the US?
Bill Mann: I would say that it's probably as much to Juul as it is, anything else, but not so much. Altria is still a tremendously profitable company and it bears reminding that they also pay a massive dividend. When you say the stock is cut in half, their dividend now was nearly eight percent. Now I understand that that is right after the stock has dropped 10 percent, but they've been averaging six or seven percent, so it's not been a great investment over the last five years, but I think that has something to do with the timing of when Juul really became a big part of their portfolio and then has disappointed the market since then, our shareholders since then. In terms of the company itself, they make as much money on their cigarette division now as they did 20 years ago, but they don't sell an 1/8 as many actual cigarettes as they do, to the extent that it's the company that you can be comfortable with owning, it has done nothing but become more profitable over that period of time outside of Juul.
Chris Hill: How do you think about sin stocks, which is a phrase that gets kicked around, and the older I get, the more I realize that sin stocks are in the eye of the beholder. There are things that people just don't want to own, whether it's tobacco, alcohol, firearms, casinos. When you hear the phrase sin stocks, what comes to mind?
Bill Mann: I think any industry in which there is a general argument that can be made that the overall influence of that industry is maligned, I think that you could look at, pornography, you to look at icon makers, you can look at cigarettes, you can look at alcohol, you can get yourself wrapped around a tree-like, for example, hotel companies used to make an enormous amount of their profits from pay-per-view primarily from adult videos. Would you then argue there Marriott who's a sin stock? You can easily get wrapped around the three. I think it's important for people to have a sense of David Gardner always talks about having your portfolio reflect the world you would like to see. If you don't care that much about whether people smoke or not, whether they exercise the right to smoke or vape or drink, then it's a fine segment for you to be in. It is and has been the case that a lot of these companies have been tremendously profitable. I don't judge people at all for having a framework in which they say these are not areas in which I choose to invest, but at the same time, it is legal. Maybe Juul will be tomorrow, but everything else that we've talked about is in fact legal in the United States of America.
Chris Hill: Bill Mann, always great talking to you. Thanks so much for being here.
Bill Mann: Thanks Chris.
Chris Hill: MicroStrategy is an enterprise software platform with a market cap of two billion dollars. But there's an important caveat. MicroStrategy also has billions of dollars of Bitcoin on its balance sheet. Ricky Mulvey caught up with Bill Mann to talk about this software slash Bitcoin holding company and what a potential margin call might mean for its investors. The conversation begins with an interview clip from MicroStrategy's CEO, Michael Saylor.
Michael Saylor: I'm not terribly concerned with the volatility. I think they'll be accelerations and pullbacks, but the institutions are collaring it on both sides. The capital was not consumer leveraged capital of day traders. The capital right now is insurance companies, big public companies were coming in to buy it forever. Ask me when I'm going to sell it. Never, I'm not going to sell ever.
Ricky Mulvey: Sometimes an investment thesis changes. Some investors may be feeling that way about MicroStrategy and the enterprise software platform that went headfirst into the world of Bitcoin. Joining me now is Bill Mann. Bill, good to see.
Bill Mann: Hey Ricky, how're you doing pal?
Ricky Mulvey: We just played that quote from Michael Saylor. He's the CEO of MicroStrategy. Our CEO, Tom Gardner, interviewed him in March of 2021. We ran that interview on this podcast in March of 2022. Bill, what's your reaction when you hear that quote today?
Bill Mann: At the time that he made the quote, MicroStrategy had yet to take on a huge amount of debt in order to buy more Bitcoin, they have essentially swapped their cash for Bitcoin. While he may feel that he is never going to sell, it may not be up to him because if you are leveraging Bitcoin against the price of Bitcoin. The answer then becomes not so much what do you believe you're going to do, but what can the people who are in lending you that money, what can they compel you to do?
Ricky Mulvey: Let's get into financial engineering in a moment, but backing up first, what is MicroStrategy supposed to do? What is the business?
Bill Mann: They made $500 million in revenues in 2021, which is basically the same that they made in 2011. This company, what they do, their operating business is not all that important to the valuation of the firm. It is a no-growth, barely profitable software company at its core, but that is a teeny slice wrapped around a massive Bitcoin position.
Ricky Mulvey: The first sentence of MicroStrategy's business overview in its 2021 Annual Report reads, "MicroStrategy pursues two corporate strategies in the business of its operations. One strategy is to acquire and hold Bitcoin, and the other strategy is to grow our enterprise analytics software business" [laughs]. What's that signal to investors?
Bill Mann: The fig leaf is covering the right bits, is what that says. At least they did put it in the right direction. I think what's interesting to me, getting into regulatory conversations, it's terrible radio, but I'm going year anyway, Ricky. This is an investment company. It's an investing company and the only reason there's not being regulated as an investing company, I think is because Bitcoin has not been declared to be a security by the SEC. This is what I was saying earlier. What happens with MicroStrategy's enterprise analytics business is almost unimportant, except that it is that fig leaf for the private bits.
Ricky Mulvey: Yeah. You mentioned earlier that it used Bitcoin as collateral to borrow money to buy more Bitcoin. Can you explain a little bit of how that financial engineering happened? Because it seems odd.
Bill Mann: Well, basically, they've swapped their balance sheet cash into two convertible debt securities that are backed, basically they used it to buy Bitcoin. The price of MicroStrategy at this moment on a per-share basis is call it 171 bucks. They have two convertibles that they've put in place, that can be put to the company by the investors in December of 2023, in February of 2024, which are convertible at 397 bucks a share, which is more than twice as high and $1,432 a share. They have an incredibly volatile asset and we've seen what's happened with Bitcoin. It's down about 70 percent backing these bonds. Essentially, since you've got a conversion component at the end, they may not be able to satisfy the bonds should Bitcoin drop to low-end price, which is not something that MicroStrategy itself has that much control of.
Ricky Mulvey: Is MicroStrategy unique and putting Bitcoin on its balance sheet as a publicly traded company? Or are they unique to the degree in which they're doing it?
Bill Mann: I love that question, they are not unique at all, but most of the other firms are more frank financial companies. The company formerly known as Square, which is now Block, has plenty of Bitcoin on its balance sheet, both as an asset that it owns and then also as something that allows its customers to trade-in. Primarily financial companies will have some. What's unique about MicroStrategy is that it has about $2.5 billion in Bitcoin and an enterprise value of $4.3 billion, which in enterprise value is basically what's the market cap plus the debt. About 60 percent of its total enterprise value is made up of Bitcoin and its Bitcoin holding is 125 percent of its market cap. It is not alone, but it is very, very far to the extreme and it is as far as I can tell, the only company that's being regulated as an operating company instead of a financial company that has any level of exposure like that.
Ricky Mulvey: At this point, would you say it's closer to being similar to like our Grayscale holdings Bitcoin-style ETF than a company?
Bill Mann: I love the way that you're thinking about that and I would say yes, except that it's not being regulated that way. I'm not a regulatory expert by any stretch the imagination, but it would not surprise me at all given the numbers that I've just told you that the SEC is at least looking at MicroStrategy in terms of, is this a financial company that needs to be beholden to a whole different regulatory regime? Or is there still an operating company?
Ricky Mulvey: Now, they might get the margin call or forced to sell Bitcoin in order to pay back their lenders. What are the implications of this on the folks who own market MicroStrategy stock?
Bill Mann: A margin call sounds really scary. We all know what a margin call is. That means basically the assets that you have do not cover the debt that you add. It's really important to note that MicroStrategy is not at great risk of evaporating tomorrow based on a margin call. If Bitcoin drops low enough that these convertible preferred securities are not covered by their debt in terms of assets. They may have a call, but it's not going to hit MicroStrategy that hard. I don't think MicroStrategy has a risk of going out of business now. A margin call, I don't care who you are, is not good news. It's not good news at all. It is a forced transaction at a time that it is probably inopportune for you. When I said at the top that Michael Saylor said, we're never going to sell. This is exactly what I was talking about. They may have to add additional collateral to sufficiently back these bonds.
Ricky Mulvey: I feel like we're at a little bit of a negative spot right now.
Bill Mann: It's reality.
Ricky Mulvey: It is reality. To close out we have a balance sheet that is, let's say, surprising and maybe a bit of a negative way. Is there a company or stock that maybe has a balance sheet that surprised you in a positive way, right now?
Bill Mann: There are a bunch and in fact, there are companies that I think that we really ought to be looking at right now as the ones that probably with their great balance sheets might be in the market of buying other companies. Maybe at the top of the list is the company formerly known as Facebook. Meta has a huge cash balance. Nvidia is another with a big cash balance. Adobe Systems is another one with a tremendous amount of cash and if you are nervous about the types of companies that you are in now, one of the best ways that you can find a company that has, I guess, what you would call a safety valve is looking for ones that have those types of cash balances.
Ricky Mulvey: Bill Mann, thanks for your time.
Bill Mann: Thanks, Ricky.
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 them. Don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.
