In the financial media, Apple (NASDAQ: AAPL) and Amazon.com (NASDAQ: AMZN) soak up a whole lot of bandwidth -- and that's natural, considering their sizes and leadership in their segments. And one this week had an upbeat reason for grabbing a piece of the limelight: Amazon's Cyber Monday was its biggest sales day ever. The other endured a bit of a bruising from President Trump, who has said he doesn't think he's likely to make a deal to end the rising trade war with China, and that its next phase could include 10% tariffs on Apple's devices.
But it was a third company's "revelation" that MarketFoolery podcast host Mac Greer and his guests, senior analysts Andy Cross and Ron Gross, chose to lead off with: $100 billion industrial giant United Technologies (NYSE: UTX) is officially preparing to divide itself into three parts by spinning out elevator and escalator maker Otis and HVAC major Carrier. In this episode, the guys weigh all three stories and offer some suggestions as to how investors should respond to them.
A full transcript follows the video.
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This video was recorded on Nov. 27, 2018.
Mac Greer: It's Tuesday, November 27th. Welcome to MarketFoolery! I'm Mac Greer. Joining me in studio, we have Motley Fool analysts Andy Cross and Ron Gross. Gentlemen, welcome! How are we feeling today?
Ron Gross: How are you doing, Mac?
Andy Cross: I'm feeling great! Post-Thanksgiving, doing great!
Gross: Still a little full.
Cross: Me too!
Greer: Oh, my gosh! I made the mistake of stepping on the scale right when I got back.
Gross: Rookie move! Total rookie! You've got to give the body a little time to adjust.
Greer: Water weight. That's what I'm going with.
Cross: Still eating leftovers, guys?
Cross: All done? I still have some stuffing left and some pies.
Greer: We're going to dig into some business news. How'd you like that? I did good there?
Gross: [laughs] Good work!
Greer: We're going to talk Amazon and Apple. But guys, let's kick off with a story about United Technologies. This is an industrial manufacturing giant. Andy, a lot people don't know this name, but they may know the brands, like Carrier and Otis, as in the elevators. United Technologies is splitting itself up into three companies. One company will be called, yes, United Technologies. That'll focus on aerospace. A second company, Otis, maker of elevators and escalators. The third company, Carrier -- yes, heating and AC. Andy, what's behind the breakup here?
Cross: This is the worst-kept secret on Wall Street. This has been in the news and rumored for at least a year. Actually, the company's been talking about trying to unlock shareholder value, that euphemism, for a couple of years. Now, they finally announced it. They just acquired Rockwell Collins for $23 billion. They talked about, after that acquisition, it might be time to split up the company. And now they are.
They're splitting into three different companies. This is a $100 billion company. It's not a small company. It's actually very well-run. The operating margins and returns on capital are very good for industrial companies. Not the fastest-growing thing in the world. But this is an example of, we see what's happening with Honeywell, another competitor of theirs. We see the disaster at General Electric and what's going on there. That's now a $66 billion company, so it's smaller than United Technologies is. These are companies that are trying to get nimbler, faster, able to operate in growing markets, and deliver for shareholders what they may want. If you want aerospace, now you have an opportunity to invest just in aerospace. Same with elevators, same with HVAC businesses, which are both very good businesses. Not the fastest-growing businesses, but good businesses.
I think this is actually a good move for shareholders. I don't know if I'll be buying the stock now ahead of this spin-offs and split-ups. I may just wait to be able to pick which one I want to buy. Also, we have to see how they spin off. They do have a lot of debt on the balance sheet. We have to figure out how that's going to get distributed among the companies and figure out what they're going to do with the dividends, depending on if you're a dividend hunter or not. United Technologies pays a 2.2% difference. For dividend-seekers, it does matter which companies you own on that regard.
Gross: I agree. I think this makes good sense. Long been pushed by Dan Loeb over at Third Point, a pretty well-known activist investor who is famous for things like Yahoo, Nestlé, Baxter, lots of different large companies that he's gone after in the past.
Sometimes the conglomerate model makes sense, and sometimes it doesn't. It works in the case of a company like Berkshire Hathaway because it's very decentralized, and he makes sure he keeps CEOs in place of each autonomous business unit. They can run the way they always have. In a very centralized conglomerate, it's very difficult. It's a totally different cost structure and operating structure to run an aerospace business vs. a heating and air conditioning business. So, those often don't work. Splitting it up is often the best way, as Andy said, to create shareholder value.
Greer: Ron, we were talking before the show, and you mentioned that your dad worked for an elevator company, but it was wasn't Otis.
Gross: It wasn't Otis.
Greer: I thought Otis was the only game in town here.
Gross: I'm racking my brain to recall if they were a competitor to or a supplier to Otis. I really can't remember. It was in my younger days. But there was always a lot of elevator talk going on in my home, rails and wiring and cables.
Greer: I have to ask, your dad worked for an elevator company. Did the job have a lot of ups and downs? Ba-dum-tss.
Gross: I don't even know where to go with that.
Cross: Looking at these looking at these two businesses, Otis is the largest elevator and escalator operator by a large factor. They're 30% larger than the next nearest competitor. It's a lot of high recurring revenues. Both these businesses, Otis and Carrier, require very little ongoing capital investments. And they're very profitable. Profit margins are somewhere in the high teens. They're already profitable. They don't grow particularly fast, but they're very stable businesses. And they're large businesses. We're talking $12-18 billion businesses in sales per year. They are large businesses. Smaller than the faster-growing, more exciting aerospace business.
To Ron's point, shed those. There's very little overlap. Get rid of those businesses, let those teams go off and manage that. Let investors choose which ones they want to own. I do think it's interesting. There are studies done about the value of spin-offs 18 months, two years after the spin-offs happen, and how lucrative they can be for shareholders. This is something I'm interested in watching, which one actually does well over the next five years.
Gross: Andy is right that Otis is not a fast-growing company, but it would have been a wonderful one if you got in on the ground floor.
Gross: Thank you!
Greer: And I enjoyed Andy's elevator pitch there. Oh, man!
Gross: This is going downhill quick.
Cross: Does the show get better from here?
Greer: It can only go up. We're on the lobby, people. We're moving up. OK, let's move on to a Wall Street Journal interview where President Trump suggested that the United States could slap 10% tariffs on iPhones and laptops imported from China. Ron, 10% tariff. That sounds like a lot. What would that mean for Apple and Apple's business?
Gross: First off, I don't think it will actually happen. I think it's a negotiating tactic. A lot of bluster. This is not a political show, so I'm going to let everyone decide for themselves what they think about that bluster. But I do think it's a negotiating tactic. It's ahead of the G20 meeting where there'll be further discussions with China about the tariffs and about our trade war, for lack of a better term. I don't think it's actually going to happen.
But if it did, certainly a company the size of Apple could weather that storm, and they could do it by passing along price increases to consumers. Although, I have a feeling they would not do that. They probably would eat it. 10% might translate, I've read some research, to about a $1 billion decrease in operating profit. It wouldn't be permanent. It would be over a few quarters until things got worked out. $1 billion in total. If it was a 25% tariff, then of course, you're getting maybe triple that, $3 billion or so in lost operating profit. Again, a company the size of Apple could easily weather that storm. It would certainly be a loss in their earnings per share, which impacts valuation. But again, these are all short-term concerns. If you believe in Apple as a company you want to own for the next 10-20 years, you probably can just ignore it.
Cross: Yeah, I agree with Ron. A lot of bluster right now coming from the White House, especially ahead of the G20 meeting this Friday and after the news with General Motors closing the plants, and the frustrations that President Trump has with them, talking about them bringing jobs back and not selling and manufacturing cars in China. I think this is piggybacking on top of that, trying to show a little muscle ahead of meeting with the G20 countries on Friday.
Gross: You're hitting Apple a little bit while it's down. The stock has come under a decent amount of pressure, as most of the FAANG stocks have. Apple in particular is down 23% from late August, early September. Now this kind of talk has people jumping on the bandwagon and selling Apple off even more. Those are short-term investors, people who are more concerned about the stock going down 5-10% in the near term rather than wondering where Apple's going to be five years from now. Again, for Foolish investors, for long-term investors, I would be more concerned about whether Apple continues to be an innovative company, whether its ecosystem is going to move forward, continue to generate profits. Worry less about what's going to happen over the next two, three quarters.
Cross: It's interesting to think about the pricing power Apple has. They've been able to raise the average selling price of the iPhone dramatically over the last five years. Now, some of the units are over $1,000. Whether they will decide, if this happens, if they keep it and try to figure out ways to offset that, or if they would actually try to pass that on to consumers. And, would consumers be willing to pay a little bit higher? We do know that iPhone sales have stagnated a little bit, and they've been able to make their revenue growth up on the pricing side, not necessarily unit side.
Greer: I think I'm part of the problem. I have an iPhone 6s. I have no desire to get a new phone. What I will do is, I'm going to get the battery replaced. I've already had it replaced once, and now it's awful again. But I don't need a new phone. Each new iPhone, I know it's better and it takes better photos and all that, but the difference is so incremental at this point. Aren't there a lot of people like me who are like, "I'm good with my old phone. I'm just going to change the battery."
Gross: I think there are a lot of people like you that have maybe the 8 or 8s. With a 6s, you're a little bit... They're going to stop supporting that at some point.
Cross: I have a 7, and I thought I was a little bit behind. But then, of course, I should always compare myself to Mac.
Greer: True story, I was the last guy at The Motley Fool with a BlackBerry. One of our techies was like, "Can we quit supporting you? Can you put that away?"
Cross: Do you have your Palm Pilot, too?
Greer: I do not. Guys, our final story, a good start to the week for Amazon. In a press release, Amazon called Cyber Monday "the single biggest shopping day in the company's history with the most products ordered worldwide." What does it mean?
Cross: They coined a new term that I had not heard called "the turkey five."
Gross: I love that! It sounds like a band, but a really bad band.
Cross: [laughs] A terrible band. Well, these are five very good things for Amazon. The five days between Thanksgiving and Cyber Monday. Clearly, the expectations of Amazon to do well were met relative to what people may have thought. They didn't announce the dollar numbers. But, clearly a good day. For a company that has probably near 50% market share of online sales, days like this are very important. We know the value of Singles Day over in China to the likes of Alibaba. I think it set a record this year, of more than $30 billion in one-day sales. Estimates are somewhere around $8 billion spent on Cyber Monday. If Amazon got about half of that, that's $4 billion in sales across Amazon's platform. Not bad, not bad at all.
Gross: They didn't release a lot of data, they just released a lot of big numbers. It's hard to know if they're good. The turkey five, they did 180 million items over those five days, which sounds like a big number, but I don't know if people were expecting 200 million or 150 million and what that translates into dollars. Obviously, it sounds like a big number. 18 million toys, more than 13 million fashion items on Black Friday and Cyber Monday combined. These are obviously huge numbers. Amazon continues, as Andy said, to be the major online player here. Most transactions are going through Amazon.
Cross: It's interesting. I did a little shopping this weekend and used Amazon, bought one or two things across their platform. Used it as the go-to place, rather than usually searching for Google. Now, I just go to Amazon. What's interesting about that is how they are starting to really leverage that into other businesses, including advertising sales. That's going to be a really nice business for them. We're already starting to see more and more advertising across Amazon's platform. Some estimates are that their advertising business is going to grow more than 35% per year over the next five years. One investment bank estimates up to $28 billion dollars of revenues per year in five years. As it continues to get more and more consumers to its platforms, they can leverage that. It used to be just AWS. Very important, clearly. But we're starting to see different value opportunities for Amazon outside of just traditional e-commerce sales.
Gross: We talk about Apple's ecosystem. You can also talk about Amazon's, as well. The three main growth drivers, I would have to say, going forward, are going to be Prime, which primes the pump, if you will. Over 100 million people pay for Amazon Prime right now. They recently raised the price from $99 to $119. People didn't seem to bat an eye at that increase. And then, as you said, Web Services. And then, advertising is really the up and comer. Those three things -- Prime, Web Services, and advertising -- are the future growth drivers of Amazon.
Greer: Amazon, that advertising comes at the expense of Google, right?
Cross: Google and Facebook are by far the largest online advertiser players. Amazon has probably only around 4% of the total market. Facebook and Google are the real giants in there through their various platforms. We know how hungry Jeff Bezos and that team can be when they are the smaller fish going after larger players, especially going after their margins. I'm actually a shareholder of Google and Facebook as well. And when I see that kind of market share and the potential for them to grow, and the way they're using those advertising placements inside the Amazon platform, both on traditional through your laptops or computers, as well through their mobile apps, you do think that's just going to be a really, nice very profitable business for Amazon over the next five, 10 years.
Gross: We talked earlier about Apple's stock getting smacked. Amazon is also right there with it, along with a lot of the other large tech stocks that led the rally up until now. Amazon's off about 22% since September. I'm a shareholder, it's not something I worry about. These things ebb and flow. It had quite a run. All of these stocks had quite a run. It depends when you bought, obviously, but you can't be upset with what's happened over the last several years if you own any of these stocks. It's something I continue to hold, I continue to be a proud shareholder. I don't worry about the dips.
Greer: Let's bring it back to Cyber Monday. Andy, you mentioned you picked up a few things. What'd you get?
Cross: I picked up last night, between 11:00 and 12:00 just got in to get my deal promos, I bought some things for the family for Christmas. Yesterday, I did not buy on Amazon. Friday, I did buy on Amazon.
Gross: I bought a ton -- maybe literally -- of protein bars. 15% off, Cyber Monday sale. thinkThin was the brand, for those who are interested. They're pretty tasty. High protein.
Greer: And it sounds like you got a deal.
Gross: I got a nice deal. I bought too many. They'll just sit in my pantry and my wife is going to be like, "What happened here?"
Cross: I need to be a little cagey because I think my wife listens to the show.
Greer: There's no way your wife listens to the show!
Cross: At least, she probably has not listened this long.
Gross: You know, the more you buy, the more you save.
Greer: I love that. I was eyeing some Crocs.
Gross: [laughs] Of course.
Greer: I have one pair, and I have a pair of imitation Crocs. They're not good. And Amazon had $9.99 Crocs. You're making money, essentially.
Cross: They're giving it away.
Greer: And then I'm like, I just can't get there. So then I looked at some fur-lined Crocs, which are really nice. You know, the winter Crocs? But then I'm like, I don't know if I can let myself go to that point.
Gross: Yeah, I think good decision.
Greer: Don't you think?
Gross: Yeah. I also think you need a hobby.
Cross: I want to know the decision-making process behind getting the imitation Crocs.
Gross: It's like imitation crab meat.
Greer: I'll tell you this, and I'm a Crocs shareholder. I will tell you that, I thought, Crocs, imitation Crocs, they're all the same. I picked these up for $7 at CVS. They're awful. They are not all the same. If you think, how difficult can Crocs be? Crocs is like the secret formula to Coca-Cola. No one else can make a Croc.
Cross: As Buffett says, price is what you pay, value is what you get.
Greer: I don't know what you're getting with my imitation Crocs, but it's not pretty.
Gross: Nothing good.
Greer: Let's close with my desert island poll. You should never invest this way. It's just a fun, fanciful way -- I never use the word fanciful. It's just a fun way to end the show. You're on a desert island for the next five years, and I present you with one of these stocks. Which one are you going with? We're going to go ahead and break United Technologies up. You've got United Technologies, Otis, and Carrier; you also have Apple and Amazon.
Gross: It's not so easy!
Cross: I'm going to say Amazon.
Gross: Yeah. I'm going to take off my value investor hat and take valuation out of the picture, and I'm going to say Amazon, as well. I think the avenues of growth that they have before them, not just for the next five years, but the next 10 or 20 years, are pretty special. I have to go with them.
Greer: I thought you were going to go Otis.
Gross: Definitely not!
Cross: It's going through the roof.
Greer: Oh, man! [laughs] It's a free show. Just remember, people, it is a free show! Marketfoolery@fool.com is our email. If you have any good elevator puns that we did not cover, we want to hear them. Your questions, your comments, email@example.com. Ron and Andy, thanks for joining me!
Gross: Thank you, Mac!
Cross: Thank you!
Greer: 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 it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Mac Greer. 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. Andy Cross owns shares of Berkshire Hathaway (B shares) and Facebook. Mac Greer owns shares of Alphabet (C shares), Amazon, Apple, Crocs, and Facebook. Ron Gross owns shares of Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), and Facebook. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends BlackBerry and CVS Health. The Motley Fool has a disclosure policy.