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Interesting Changes Afoot at Apple, McDonald's, and (Maybe) Bed Bath & Beyond

Chris Hill, The Motley Fool

As expected, Apple's (NASDAQ: AAPL) big event Monday delivered a whole lot of news on the software and services front: Apple TV+, Apple Arcade, and even an Apple credit card. What's clear is that CEO Tim Cook and his team see a need to pivot away from hardware if the company is to keep growing. Elsewhere in the world of software, Israeli machine-learning specialist Dynamic Yield is getting swallowed up by a somewhat surprising buyer: McDonald's (NYSE: MCD). The burger giant will be using its new unit's technology to create smarter menus.

In both of those cases, management is looking to the future, and making changes to stay ahead of the curve, and in this MarketFoolery podcast, host Chris Hill and analyst Abi Malin discuss the details that matter to investors. They also consider a management team that has been far less effective -- that of Bed Bath & Beyond (NASDAQ: BBBY). The retailer is now under pressure from a trio of activist investors who want to oust the CEO and the entire board.

A full transcript follows the video.

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This video was recorded on March 26, 2019.

Chris Hill: It's Tuesday, March 26th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today, Abi Malin in the house. Thanks for being here!

Abi Malin: Thanks for having me!

Hill: We're going to get to the stock of the day which, amazingly is Bed Bath & Beyond. We're going to get to McDonald's because I think what they've just done is pretty interesting. 

We should start, though, with Apple. We ended yesterday's episode, Jason and I, opining about Apple's event. Now there's any number of stories out there. For those who missed it, the headline is, they came out, they unveiled the Apple TV+, the Arcade gaming, the Apple credit card. We're going to dig into this further on Motley Fool Money this week. I'm curious, what's your main takeaway from their event?

Malin: I think the market in general was pretty underwhelmed, and I can't say that I differ so much, but I didn't necessarily have higher expectations. Apple traditionally has been a hardware company. We're really seeing them try to pivot. We're at this inflection point for them, and it's either going to be make or break as they start to look at more software. 

The good thing for them is that they do have an installed base of an estimated 1.4 billion active devices. If anyone should be able to do it, they have a pretty good head start. It's just unproven right now.

Hill: That's a keyword. I agree with you, by the way. The reaction from the analysts in general, it was sort of the analyst equivalent of a shoulder shrug. But I do think that there is a way in which this plays out that suddenly gets analysts on board. If you were playing a drinking game during this event yesterday, and you unfortunately drew the card that said, "take a drink every time Tim Cook says the word services," you were probably being rushed to the hospital about 30 minutes in. He was really emphasizing the services side. The thing is, look, if they can get enough people to subscribe, whether to the News service that they have, whether it's the TV service, if it starts to meaningfully move the needle on the services revenue, then I think all of a sudden, people get converted to believers pretty quickly.

Malin: Yeah. The good news is that services was only about 6.5% of total 2018 revenues. It's still relatively small for them. Just, at such high numbers, the law of large numbers in general works against them. To move that needle, it's going to have to be pretty impactful. I think a lot of analysts were looking for information on pricing for how those were going to affect both top and bottom lines. That just wasn't given yesterday.

Hill: I had mentioned on yesterday's episode that the thing I was going to be watching was, are they going to bring out showrunners? We know they're going to spend money on content, but who's going to be producing it? And they brought out, arguably, two of the biggest names in entertainment in Steven Spielberg and Oprah Winfrey, along with Reese Witherspoon, Jennifer Aniston, Steve Carell. And I was thinking more about it this morning, and I just thought -- and this seems weird to say, because you can make a pretty good argument for Steven Spielberg being the most successful film director of the last 40 years just in terms of commercial success and artistic success -- and yet, I couldn't help but think that people like Spielberg and Oprah Winfrey are aimed more at my generation and older. And I thought, "What if, instead, Apple had struck a deal with someone like Jordan Peele?" You know, a younger writer-director -- 

Malin: On the rise.

Hill: On the rise. Who is a fan of movies and is not curious about, "What is his next movie going to be?" In the wake of last year, with Get Out, and just recently, this new movie, Us. I don't know. It's not to say it can't work. But for all of the attention that Spielberg and Oprah Winfrey got, I felt like it wouldn't surprise me if that ends up being the weakest link of what they unveiled yesterday, and the credit card actually ends up moving the needle.

Malin: I think the credit card has the most potential, but that's probably one of the most difficult competitive landscapes that they're trying to break into. They did launch Apple Pay in 2014. They've had success there, but it's still a trickle. I don't know if it's as fast as everyone was anticipating it would be. I think Tim Cook gave the targets that he was looking for 70% of U.S. retailers and 40 countries by the end of the year. Again, large numbers, not necessarily humongous. I just think it's going to be more challenging.

Hill: Right. I think the fact that Apple said, "Oh, and by the way, we're also going to produce a physical credit card," I think that speaks to your point. It's like, "Oh, yeah, because if Apple Pay were truly ubiquitous, they wouldn't do that."

Malin: We wouldn't need that, yeah.

Hill: Let's move on to Bed Bath & Beyond. Shares are up more than 25% this morning. Three activist investor groups are gearing up to [laughs] replace the CEO and the entire 12-person board of directors. I should point out that these three activist investor groups collectively only own about 5% of the stock. I don't know, it's enough to at least get some people scared.

Malin: I think it's worth noting, though, that with Bed Bath & Beyond, about a third of their stock was sold short previously. A lot of that 25% bump is probably short-sellers getting squeezed and trying to jump out. It's still interesting, I agree. 

Hill: I don't own shares here, but I like when, whether it's a business leader of a company or activist investor groups, I like it when they take big swings. There's not many swings that are bigger than, "All of you need to go."

Malin: [laughs] "We don't like any of you."

Hill: "We don't like any of you. We don't like the CEO, who's been running this company since..."

Malin: 2003. That's a pretty long tenure to say, "Time's up."

Hill: Well, and I think if the track record for Bed Bath & Beyond were better, it might be like -- because typically, the move is, "We're looking for some seats on the board." No, in this case, they're looking for all of the seats. 

Malin: Also, I thought it was interesting, they mentioned that they're looking to align executive compensation with performance. That's something we at The Motley Fool do look at and value a lot. I appreciate that. From a shareholder perspective, I think that's a very admirable goal.

Hill: Also, and I've said this before on the show, I do think that there's underlying value to Bed Bath & Beyond. I think it has not been well-run, and certainly, bricks-and-mortar retail has had a rough go of it. But they're selling stuff that everybody needs. It's not like they're selling this esoteric, weird stuff -- or, for that matter, that they're in a business that is large purchases that are made once every 10 years, once every 20 years. No, this is stuff that everybody needs.

Malin: Right. I think it's interesting, in the goals, these activists mentioned a lot about how they saw missed opportunities with customers buying more online. Bed Bath & Beyond's been late to that game and definitely delayed in terms of user experience and things like that. Also, costs have crept up. You have overcluttered stores; the stores are a less appealing place to go. Online, they haven't really had that option at the degree that, say, Amazon has. I just think it's a competitive space.

Hill: I think back to 2012, 2013, when Best Buy was struggling. Another bricks-and-mortar retailer. Hubert Joly comes in as CEO. He and his executive team turn that business around in part because they invested in online, they remodeled the locations, made them just a much better in-store experience. The last time I went to a Bed Bath & Beyond...yeah. And I don't get claustrophobic, but they're a little claustrophobic in there. They could do with a makeover.

Malin: Yeah. Activists also want to sell some of their underperforming assets -- Buy Buy Baby and Cost Plus World Market, they want spin those off and unlock value there, which I think is another commendable strategy. I don't necessarily see those in line with what Bed Bath & Beyond is really aiming to do.

Hill: McDonald's has made its largest acquisition in 20 years. McDonald's is spending $300 million to buy Dynamic Yield, which is a tech company that is apparently going to help McDonald's personalize the digital menus, help with mobile ordering. This seems like a smart move if they can make it work. One of the things you and I talk about whenever we're talking about this space, in addition to mobile ordering and delivery, is just how important throughput is when it comes to restaurants. I don't know. It's McDonald's. They're huge. They've got the money. It seems like kind of a no-brainer that they made this move.

Malin: It is huge. The goal is really interesting. Like you mentioned, they want to have these interactive menus that can change based on time of day, weather, traffic conditions, other current trends. But I think actually, the most promising opportunity that they're looking at is doing predictive menus. If you add like a Bacon, Egg & Cheese, you probably want a coffee. 

Hill: Of course.

Malin: Right, obviously.

Hill: We all want more coffee.

Malin: Exactly, especially you. So, you've seen that a lot in the online space. I think it's interesting to bring it to fast food, where people are all about convenience. It's those almost impulse purchases, so, similar to how you have the candy right under the registers at a CVS. I think this is pretty smart. 

My only question is, I'm not really sure why the acquisition was necessary. I almost wonder why they didn't just hire them as a consulting third-party service. Why the acquisition, is my thought.

Hill: It's a great question. It is possible that they were so blown away by Dynamic Yield that they basically said, "Look, we need to make this move, we need to make it sooner rather than later. We want to be your only customer." And one way to get that done is --

Malin: Well, they're allowing it to operate as a third party still. They'll still have other clients other than McDonald's. I read that they work with Forever 21. They work with Fendi. 

Hill: What is Fendi?

Malin: The fashion luxury goods retailer. So, they have some huge names. It's just, I don't know the incentive to bring it in-house, especially for McDonald's. Again, we don't see them do a ton of acquisitions. So I'm wondering what this long-term vision or strategy is here. But, everyone's saying it's very large, but McDonald's is a $142 billion company. $300 million is really not that large relative to their size. Not criticizing, necessarily, just a little curious.

Hill: I think, similar to what we talked about with Apple and the subscriptions, sometimes a company makes an announcement and it's hard for us to envision how we're going to determine whether this announcement is going to pay off. Sometimes that's because a company is going to play things close to the vest. In the case of Apple, clearly, we're going to see what happens to the services revenue number, and if that goes up. Same thing with this. I think if they roll this out, if by the end of the year, throughput starts increasing at McDonald's -- I rarely go to McDonald's, but the last couple of times I've gone in, I've attempted to use their digital menus, and I will say, the user experience is not great, and I know I'm not the only one, because if everything was great with their digital menus, they wouldn't be making this move. 

Malin: Right. 

Hill: So I think that, obviously, there's the anecdotal evidence, but we'll actually see what happens with the throughput. 

It is interesting to see how different companies, particularly restaurants, how they offer up their mobile ordering experience. We've got the Panera right across the street from the office. At least once a week, I'll use that. They recently revamped their online ordering experience. I have to say, it's not an improvement. It might be an improvement for them on the back end, but as a user experience, it's not quite as intuitive as it was before. You've talked before about using, whether it's Grubhub, or different ordering experiences, are the ones that are so bad that you just go, "I'm interested in that food, but I just don't have the mental energy to navigate their system"? Or maybe you just use them less often.

Malin: In the case of fast food, so if you think about McDonald's use cases, at least for me, as someone who doesn't really eat fast food, this is about speed, it's about convenience. If you see more orders per period of time, or average order value increases significantly -- because maybe you weren't going to order the coffee, but now it's there suggested, and you're like, "Yeah, throw it in." That could be really powerful. At such low order values and such low item values, it can actually be really impactful in very subtle use cases. 

I think that McDonald's is making the right move. I think we haven't seen a lot of fast food on the low end in-store experience be upgraded in this way. So in some ways, again, they're leading innovation here, which I commend as well.

Hill: We've certainly seen fast food restaurants commit $X million, millions of dollars, toward store remodeling. In that sense, if McDonald's came out and said, "Hey, we're going to dedicate $300 million to remodel some of our locations," they're not going to be able to do all their locations with that amount of money, but this is something that can have an impact for every one of them.

Malin: Right. 2019 targets include about a billion dollars to upgrade 2,000 U.S. locations, so they are doing that as well. I think it's just about bringing McDonald's into this next phase.

Hill: Abi Malin, thanks for being here!

Malin: Thanks for having me!

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, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery! The show is mixed by Dan Boyd. 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. Abi Malin owns shares of AMZN, Apple, and GRUB. Chris Hill owns shares of AMZN. The Motley Fool owns shares of and recommends AMZN and Apple. The Motley Fool has the following options: short January 2020 $155 calls on Apple and long January 2020 $150 calls on Apple. The Motley Fool recommends Bed Bath & Beyond, CVS, and GRUB. The Motley Fool has a disclosure policy.