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Apple’s Upcoming Credit Card and a Major Fintech Acquisition

Matthew Frankel, CFP, The Motley Fool

Apple (NASDAQ: AAPL) and Goldman Sachs (NYSE: GS) are teaming up to offer a new credit card product, so Industry Focus: Financials host Jason Moser and Fool.com contributor Matt Frankel, CFP discuss what we know so far. Plus, one of Moser's favorite fintech stocks is being acquired at a hefty premium -- should investors sell or hang on? As if that weren't enough, Warren Buffett just released his annual letter to investors, and we'll discuss the key takeaways. You'll hear all of this and more in this week's episode.

A full transcript follows the video.

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This video was recorded on Feb. 25, 2019.

Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, February 25th, and we're talking Financials. I'm your host, Jason Moser, and joining me in the studio via Skype as usual, certified financial planner Matt Frankel. Matt, how's everything going?

Matt Frankel: Just great! A sunny day for the first time in about a week down here.

Moser: [laughs] We got rid of the rain up here, too, finally. At least for a day or so. It's been the kind of weather that makes you want to stay inside for a while. 

Frankel: Definitely. I hope it stays like this, but I have a feeling it's going to rain for another 30 days and 30 nights again. 

Moser: Spring's just around the corner. On today's show, we're going to dig into Apple's latest foray into services. We're going to talk about an acquisition in the home mortgage space. We'll take a gander at Buffett's annual letter. As always, we'll have "One to Watch."

Today we're going to begin with a listener email. This question comes from Noel Sayers in freezing-cold Edmonton. I tacked on the "freezing-cold" there, Matt, because that's what he said. He said he was sending the email from "freezing-cold Edmonton." Noel says, "Hey team, what do you think about a segment or episode on the stock exchanges sub-sector, including ticker CME, CBOE, ICE, and NDAQ? I'd appreciate comments on the factors that impact these stocks, a comparison of the different company financials, and favorite picks."

Well, Noel, you're in luck, my man! We are going to talk about this today for you. Matt, I'm going to kick this right over to you. I know this is some research that you've recently done into this space. It's an interesting one, for sure. What are the main points that you want to hit here for Noel?

Frankel: The main ways that these companies make money is from trading volume. This is an interesting dynamic in the market. If you have a market that's pretty much slowly going straight up, nothing exciting, low volatility, these companies can actually suffer because trading volumes are low, and that's how they make their money. Like we saw over the past three or four years for the most part, it's been a pretty calm market. When markets start dropping or volatility spikes, these companies can actually start doing better than they were before because people are trading more actively, buying options contracts to hedge positions, things like that. So, these companies can actually do better. 

The biggest risk, I would say, especially if you think the Democrats are going to start really taking control of the government, is regulation. There's a lot of potential regulations, especially when it comes to futures markets, that people should be on the lookout for. 

Having said that, my favorite in the group that you mentioned is CBOE because they have a pretty huge market share in the options market. 

Moser: That's the Chicago Mercantile, right? 

Frankel: No, it's the Chicago Board Options Exchange

Moser: OK.

Frankel: CME is also another good one. They have a very good market share in what they do.

Moser: Oh, you said CBOE! Sorry, we had a little bit of an audio glitch there. CBOE, OK. 

Frankel: Well, they're both great! 

Moser: OK! [laughs] 

Frankel: [laughs] CBOE has about a 70% market share in options. Anytime you have that kind of market share in something where you can actually do well when the market's going down, because of high trading volume, I think it's a pretty good business. 

In the financials sector, it's not my favorite space to invest. I think there's better value to be found in commercial banks, some of the smaller banks we've been talking about, and a lot of the war on cash stocks, which you didn't want us to talk about, but I just snuck in there. You see how I did that?

Moser: [laughs] Oh, yeah!

Frankel: [laughs] But, having said that, CBOE is, in my opinion, a great business and one that I would not mind owning in my own portfolio.

Moser: Let me ask you a question. You mentioned something at the beginning of this, talking about volume. That makes a lot of sense. These guys want to see more activity. That gives them a chance to make more money. I get that. Obviously, we invest with a bit more of a hope in not trading too terribly much, so I don't know that we would be, on paper, at least, the best customers for these exchanges. But when we talk about the options index there, we talk about CBOE, it just strikes me that with options, there's inherently more volume when it comes to options based on the strategy that you're employing from the very beginning. Options seem to me to inherently have more volume anyways. No. 1, is that a correct assumption on my part? No. 2, if so, is that what could separate CBOE from these others, the fact that they're going to have inherently more volume anyway?

Frankel: Yeah. It's kind of like how I recommend Walmart as a retailer from time to time, just because they do well in pretty much any market. You're correct that options are a more high-volume activity, even for long-term traders. One of our Fool services recommends options strategies for long-term traders. In that mind-set, there's a lot of trading volume that's just options, more so than stocks. 

Options strategies are really useful as hedges, especially when times get uncertain, when things are volatile either to the upside or downside. A lot of people try to hedge through options, so you'll see a really big spike in volatility. Some of the more volatile quarters in the market have been CBOE's best quarters. The same can be said for some of these other exchanges you mentioned. Yeah, options is definitely a good play on volatility, but tends to have high-frequency volume anytime.

Moser: I feel like probably, these businesses are pretty safe plays, in the sense that we know they're going to be fairly consistent businesses, as far as the demand for their services. In good times and bad, the markets are going to be open, there's going to be volume, and these companies are going to be doing their thing. 

I noticed, it seems like there's a consistent...I don't want to say they're all riddled with debt, I did notice that their balance sheets do carry some debt, some a little bit more than others. It strikes me, they're kind of like a utility in that regard, right? They can get away with doing that because they can rely on a pretty steady flow of business in both good times and bad.

Frankel: Yeah. I'd liken that to almost a commercial bank, in some senses. They have steady revenue coming in from people depositing money and loading out that money. It's a forever business. It's not something that's going to be easily disrupted, unless somebody creates a new stock exchange or a new options exchange, which, the barriers to entry are just huge. But, yeah, it's almost like a utility-like income, especially when you get to a 70% market share like I was just talking about with CBOE. It can become utility-like income. 

Moser: You mentioned something there in regard to barriers to entry. That's the one thing that stands out to me with these types of businesses. The barriers to entry from a number of perspectives are probably pretty high. From a tech perspective, certainly from a regulatory perspective, it would take a lot of work for a new competitor to jump into that space and really start taking share away from some of these established players. From a competitive advantage perspective, from a competitive positioning perspective, these are businesses I think that hold fairly admirable competitive positions.

Frankel: Definitely. It'd be really tough to, like I said, make an options exchange that significantly steals share from CBOE. Even for someone who's trying to do it with low fees and doesn't care about making a profit, getting past the regulatory headaches and the established relationships in that space, especially...Can you imagine trying to make a competitor to the NASDAQ at this stage?

Moser: [laughs] No.

Frankel: Right? It's something you laugh about. That's how good of an advantage they have. I mentioned competitors, and you laugh about it. That in itself tells you what a good, solid, forever business these are. 

Moser: Yeah. We'll move on to the next topic soon, but, it also strikes me -- a lot of times, we look at businesses, they're really big businesses with tremendous balance sheets and tremendous resources. You can have all the money in the world, and it doesn't mean you can go in there and immediately start competing. Finances are just one piece of the puzzle there. I'd imagine, even if you had someone that wanted to go in there and compete, we always like to frame it on the investing team by saying, "OK, I'm going to give you $20 billion. Go in there and compete with these guys. How are you going to do it?" It shows you that money is not the only thing. You look at companies like Facebook or Alphabet, they obviously have very admirable competitive positions in regard to the markets they serve. But money isn't necessarily everything. They can't just go in there and do whatever they want. It still takes some expertise when you're pursuing a given market. That's probably something worth noting with these companies.

Noel, I think that's a great question! I'm glad you asked it. I hope we were able to give you a little bit more insight there as to the market itself. Clearly, Matt thinks a little bit more highly of CBOE than the other names you mentioned, so, hey, you got a recommendation out of it, too, buddy. 

OK, Matt, we wanted to talk a little bit today about Apple's new foray into a credit card offering with one of our favorite banks here on Industry Focus: Financials, Goldman Sachs. I have to admit, when I was reading this thing, my first inclination was to say, "This is not going to matter at all." Then I took a step back and said, "Wait a minute, let's keep an open mind and think about how this could matter, how this could play out for Apple." After giving it some deliberate thought, I came to the same conclusion. I just don't know that this is something that's going to matter really at all. But I could be totally wrong. What's your take on this?

Frankel: I'm with you in the sense that I don't think it's going to matter that much to Apple. It doesn't matter who their credit card partner is. Whoever gives them the best deal is who they should probably go with. It could matter big-time to Goldman Sachs, depending. 

A lot of the early reviews are exactly what you just said, that this is not going to be a needle-moving credit card. It's not going to be a big deal. The rewards rate is nothing you can't get anywhere else. What we know so far, based on a Wall Street Journal report, is that the new Apple-Goldman Sachs credit card will offer a 2% reward rate on most purchases, which is not unheard of. I could ramble off a list of five credit cards that do the same thing. But how they phrased it, and it's kind of vague, is higher rewards on Apple products. Does that mean a 3% rate on Apple products? In that case, you could probably find something that beats it with rotating categories or just buying them on Amazon and getting the Amazon credit card.

Moser: But how many Apple products are you going out there and buying? I buy a phone, maybe a set of headphones or whatever. But, I mean, it's not like you're going out and buying Apple products on a regular basis, right?

Frankel: Well, that's fair, but Apple products are expensive.

Moser: True.

Frankel: If you have something like a 5% rewards rate and combine it with something like zero-interest financing on any Apple purchase forever, now you've got my attention. 

The way most credit cards work is, you have a 0% introductory period, say, 0% interest for the first 12 months you'll have the card. If you were to offer something like 0% interest for 12 months anytime you buy something from Apple, regardless of how long you've had the card, that could be an interesting proposition. Something like that. 

So, the big question mark is, what do they mean by "better rewards on Apple products"? Like I said, no matter what the answer to that is, it's probably not going to matter to Apple that much. This could be huge for Goldman Sachs because they're just trying to build up their consumer banking business. I really can't think of a better way to break into the credit card space than to partner with Apple.

Moser: Yeah. The other thing I noticed here that I was at least happy to see is that they're going to be utilizing MasterCard's rails to make this all work. When we talk about payments, you'd be very hard-pressed to not see MasterCard or Visa playing a role in that transaction in some way, shape, or form. It sounds like MasterCard is getting the nod here over Visa. Again, probably not the biggest impact to MasterCard's business, but I think it would be certainly some additional incremental revenue that wouldn't hurt the cause.

Frankel: It's going to come down to whether this card offers value over what else is on the market. Right now, competition in the credit card industry has really never been higher. There are some pretty good credit card offers out there right now. That's what all the reviews are getting at. This will need to be a really unique product to move the needle for either company.

Moser: It sounds like they're trying to present that unique offering by incorporating it to your phone. They integrate the card into your phone. It's supposed to let consumers set spending goals, track your rewards, manage your balances. In theory, it should help folks manage their money a little bit better, perhaps a little bit easier to do if you're just using your iPhone to do all of this stuff. Maybe there's something there. I don't know. I feel like online banking certainly gives you all of these tools already. It's pretty easy to manage your money with whatever online banking tools you have, card or bank. Again, I don't know. I certainly don't see this offering as something geared toward someone like me, given that I already have credit cards that I've established and I'm happy with. But, I could certainly see a younger generation of users that are coming up that are looking to get their first credit card, or perhaps add another credit card to their arsenal, maybe this does provide some value-add in those additional services, in being able to manage your money a little bit better.

Frankel: For somebody like me or you, it would have to be, like I said, something extra special to get me to sign up for yet another credit card when I have some that I'm very happy with. We'll have to see. There's still a few big question marks. I think it has the potential to be a bigger deal for Goldman than it does for Apple. 

Moser: OK. We were off last week due to the market being closed. There was some news that cycled through, and it's directly relevant to a company that we've talked about here a few times on Industry Focus. Listeners probably recognize the name Ellie Mae (NYSE: ELLI). We wanted to give this a quick look, just to make sure everybody caught this. 

Ellie Mae, the mortgage software provider, has entered into an agreement to be acquired by Thoma Bravo, which is a private equity entity that's going to buy Ellie Mae for $99 a share. That's an all-cash offer. I've had Ellie Mae as a One to Watch for a number of weeks. It's a stock I've owned, still own. This is a little bittersweet, Matt, I'm not going to lie. It's always nice to realize gains on our investments. By the same token, I wish we could watch Ellie Mae run a little bit further. But it looks like Ellie Mae may be leaving the public markets and becoming a privately held company here soon. What did you think when you saw that news?

Frankel: I was happy for you! [laughs] 

Moser: Well, thanks! Thanks a lot! That's very thoughtless of you.

Frankel: Credit where credit's due, you were suggesting that. You got it on my radar. I wish I had listened to you and bought some shares. 

Moser: I said thoughtless, I really meant thoughtful. I was just giving you a hard time.

Frankel: [laughs] One thing I would like people to know about this is, the deal could get even better. Normally, when an acquisition offer like this takes place, I'd suggest that people sell the stock. The offer that was made is for $99 a share. The stock is trading right around $99 a share as we speak. Looking over there, it's almost $99 right now. So, it may seem like a good idea to just go ahead and get rid of the stock and move on to something else. But, like you said, you're holding on to your shares. I bet I can guess why. There's what's called a 35-day go-shop provision in the deal which allows Ellie Mae to try to find an even better offer. It looks like the market's somewhat pricing this in. 

If you hold on to your shares right now, worst case scenario, you're going to get $99 a share, which is exactly what they're worth. Unless you think that there's going to be regulatory obstacles to this deal going through -- which I don't foresee at all -- then you're going to get your $99 back. And there's always the possibility that somebody could swoop in and try to acquire them for a higher price. Very little downside here with a lot of upside, is my take. 

Moser: Yeah. Speaking as a shareholder, I agree with you. I'm going to hang on to the shares that I have. Ninety-nine dollars is going to be basically the worst-case scenario. I don't anticipate any type of regulatory issues with this acquisition. Ellie Mae is still a fairly small company in the grand scheme of things. I'd love to see a competing bid come in there. I'm not really sure I'm counting on it. In a few weeks or so, we'll have our answer one way or another. But yeah, like you said, there's no real cost in hanging on to that position and just waiting. I guess everybody could sit there and argue the opportunity costs for being able to put that money to work somewhere else. But you have to have a better idea in the first place, Matt, and then you have to be right, too. Sometimes that doesn't work out as well, at least timing-wise.

Frankel: I'd say at least hang on for the 35 days. 

Moser: Yeah, I think you're right. That's what I'm going to do. I think that's what most investors would probably be best served doing, as well.

OK, Matt. I have an idea of what you were doing Saturday morning. Now, granted, I'm in Virginia, you're in South Carolina. But I bet you we were doing the same thing. Were you reading Buffett's letter Saturday morning?

Frankel: I was, and I was writing about it. I tell you, my wife loves these two weekends a year when something significant happens with Berkshire, because it always happens on a Saturday, so I always have to leave the kids with my wife and read what old Uncle Warren has to say.

Moser: [laughs] Your kids eventually will be old enough where you can just let them sleep in, and you can just wake up early. That's basically what I did. The kids were still sleeping in my house, I just woke up, had some coffee, sat there and read the letter. It was a peaceful time to do it. 

All sorts of opinions, all sorts of little nice saws to pull out of his letters every year. What stood out to you in this year's letter?

Frankel: The fact that they're still having trouble making a big acquisition. The biggest question on my mind going into the letter -- let me back up. The biggest question on my mind going into reading what Warren Buffett did with his stock portfolio this quarter was, "The market was tanking in the fourth quarter. He must have been on a buying spree." Well, it turns out, he wasn't.

Moser: Yeah, what's the deal with that? I was!

Frankel: Yeah, that's the question. I was hoping he would have spent $50 billion in the stock market during the fourth quarter, but that didn't happen. He was actually barely a net buyer of stocks.

Moser: Killing me.

Frankel: He keeps mentioning how valuations are just insane when it comes to acquisitions. He mentioned this in his letter. On CNBC this morning, he said Berkshire was very close to making a really large acquisition in the fourth quarter. I'm curious as to what it is. He won't tell.

Moser: I was going to say, what was that, Matt? What was it?

Frankel: I know! I'm wondering what it could possibly be. He said it was a big acquisition, even by Berkshire standards. In his letter, he said that stocks were still the best way to put money to work. Now that we see that Berkshire was trying to make a big acquisition, they were probably holding cash back for that, that's my big takeaway as to why we didn't see more stock-buying activity. He also said going forward in 2019 to expect the same. He said valuations remain -- not his words, but, what he's trying to say is valuations are kind of ridiculous right now when it comes to what companies want to be bought out. So, expect stocks to be the best driver of value going forward. That's what Berkshire wants to put its money into. 

It's also worth noting that Berkshire did buy back a little bit of its own stock this quarter. Not a ton. Warren Buffett says that over time, he expects these to continue. In fact, Berkshire's dropping book value as Buffett's preferred performance benchmark, and the buybacks was one big reason. He said not only do Berkshire's businesses distort the book value over the years, but the buybacks, as he buys back shares at a premium to book value -- you're not going to find Berkshire for less than book value -- as he buys shares for greater than book value, it's going to further distort the company's price-to-book ratio. So they're scrapping book value altogether. I take that as a positive sign that Buffett expects future buybacks, because he can only buy back stock when him and Charlie Munger agree that it's a good deal. It seems like he still thinks that.

Moser: Everything you said, I agree with totally. I thought it was interesting to hear him harp a little bit on that $20 billion cash position. He wasn't going to breach that. He always wanted to make sure that they were never caught needing cash for any reason. We always get that question from listeners. "How much cash should I keep in my portfolio at any given time?" That's always a debate. Everybody's got their own opinion on that, and what they do. But it was an interesting perspective there. I encourage folks to go read that letter and read that part about what he said in regard to keeping cash in his balance sheet.

The other thing that he was talking about that -- I was a little bit giddy when I was reading this, Matt, I'm not going to lie. I'm not a Berkshire shareholder anymore. I sold those shares a little while back because I felt like, to me, there was more opportunity in Markel, given the size of Markel versus the size of Berkshire. It was less about Berkshire and more about the opportunity with Markel. But he was gushing about their wholly owned businesses being that most valuable grove in the Berkshire model. I get excited about that because I see Markel doing the same kind of thing with their venture side of their business. And they're just getting started there. That Markel venture side of the business now brought in $2 billion in revenue over the past year. We've seen a lot of growth there. I do think that they are trying to build that side of the business out very much the way that Charlie and Warren have built out Berkshire Hathaway. Made me think a little bit of the position of Markel, and how happy I am to be an owner of those shares.

Frankel: I don't disagree with you. I own both. I think Berkshire still has market-beating potential, but it's nothing that's going to really excite you. It's not going to return 20% a year for the next two decades. But Markel certainly could. Not that it will, but it could.

Moser: It could.

Frankel: It's not possible with Berkshire. 

Moser: Yeah. Certainly, we recommend anyone listening go to the Berkshire Hathaway website there, click on that Annual Letters tab and read the most recent letter. There's always something in there that makes you see a new angle. That's why we read them. They're always really enjoyable.

Before we tap into Twitter here, Matt, I do want to read off one housekeeping note for our listeners. This week, we are going to be in Austin, Texas. When I say "we," Matt, unfortunately I don't think you're going to be in Austin, Texas. We're going to miss you there, buddy. But I'm going to be in Austin, Texas. Chris Hill is going to be in Austin, Texas. Aaron Bush is going to be there, and a lot of other Fools are going to be there. We're actually going to have a listener meetup on Wednesday. If you're in the Austin, Texas area and you want to join us for the listener meetup this coming Wednesday, the 27th, just drop us an email at radio@fool.com. We'll send you all the deets.

Frankel: I could actually mention that I'll be in Vegas next week. 

Moser: Hey, now!

Frankel: Along with fellow Industry Focus regular Dan Kline. If anyone wants to meet up with us, it's nothing official, but we'll be in Vegas.

Moser: Very good! I didn't even realize that! That's right, you sent me a note there a little while back. We were going to get some more content for the shows coming up. That's right, I forgot about that. All right. Good deal! We've got Austin, Texas and we've got Vegas. Vegas, baby!

Frankel: I'm not as cool as the bunch that Jason just mentioned, but if anyone wants to meet up with me and Dan --

Moser: I would beg to differ. 

Frankel: [laughs] Dan's more fun than I am.

Moser: You guys are all good! Before we get into our ones to watch for the coming week, just wanted to read off a couple of tweets. Listen, whenever we read tweets that sing our praises here, they make us smile, so we want to read them off here again. 

A tweet here from @JLongstaff1123. He said, "I was really impressed with CEO Dennis Zember. He seems like a good guy to have running the show. Will work toward getting a position started. Nice work!" Well, thank you very much! We appreciate that! It was a fun interview. I agree, Dennis Zember does seem like a really nice guy. I feel good about the fact that he's running that ship over there at Ameris Bancorp

@VivekChirps wrote, "The trio of Motley Fool Money, MarketFoolery, and Industry Focus is wholesome education for anyone interested in investing. Best of all, it's free." Listen to Vivek. Listen to him! That's exactly right! We are wholesome. We are free. We will make you smarter and richer and happier!

OK, Matt, it's that time of week. We've got "One to Watch." Looking at the stocks on our radar here this coming week, what is your One to Watch? 

Frankel: I have to go with Square. I'm sure a lot of people won't be surprised. They report earnings on Wednesday. I have a few questions in my mind. Of course, I'd love to see them give an update on how their Cash app is doing. They historically haven't released too many concrete details about how many people are using it. But if they do, it's usually at their fourth-quarter, year-end results. So I'm looking to see about that. I want to see if their growth is continuing to accelerate and top-line revenue. I want to see that their business lending platform is doing well, especially Square Installments, which was recently rolled out. We barely got any data on that in the third quarter because it had just started. I'm curious to see how that did. I want to see that their payment volume is picking up and that their business is doing well all around. Their growth has been extremely exciting for the past few quarters. I hope to see that continue, and I don't have any reason to think it won't.

Moser: Yep, me too. I hope to see good things from them. I'm going to be keeping an eye on MercadoLibre, ticker MELI. Their earnings come out tomorrow, Tuesday the 26th. We know this is the e-commerce giant of Latin America, but they also have integrated their payments solution, Mercado Pago. I'll tell you what, it's an interesting point management noted last quarter that in September, for the first time ever, Mercado Pago not only processed more total payment transactions off-platform than on MercadoLibre's platform, but also the total payment transactions surpassed the 100 million mark in a single quarter. 

We had talked about this a couple of shows back, different companies that could be war-on-cash considerations. I remember saying MercadoLibre was certainly one of them because of that right there, Mercado Pago, which they've integrated into their ecosystem. So MercadoLibre will be on my radar. I'll be paying attention to their earnings out tomorrow.

Matt, listen, always a pleasure to talk with you! Glad you could join us this week! You have a good rest of the week, all right?

Frankel: Yeah! See you guys next Monday from Vegas!

Moser: For sure! 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 or sell stocks based solely on what you hear. Today's show is produced by Austin Morgan! Austin, good to see you back behind the glass there, buddy! Hope you're feeling well! For Matt Frankel, I'm Jason Moser. Thanks for listening! We'll see you next week!

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. Randi Zuckerberg, a former Director of Market Development and Spokeswoman for Facebook and sister to CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Jason Moser owns shares of Alphabet (C shares), Amazon, Apple, Ellie Mae, Markel, Mastercard, Square, Twitter, and Visa. Matthew Frankel, CFP owns shares of Apple, Markel, and Square. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, CME Group, Facebook, Markel, Mastercard, MercadoLibre, Square, and Twitter. The Motley Fool owns shares of Visa and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Cboe Global Markets Inc, Ellie Mae, and Nasdaq. The Motley Fool has a disclosure policy.