GEOFF COLVIN: Welcome to Wall $treet Week with FORTUNE, I'm Geoff Colvin.
KAREN GIBBS: And I'm Karen Gibbs. While the final numbers have yet to be tallied, this year's holiday shopping season looks like an improvement over last year's. Luxury retailers are thanking the rising stock market and economic recovery for ringing the cash register. But surprisingly, discount chain stores came in below expectations, despite having changed the way America shops.
One of the best barometers of the holiday shopping season is toy sales. Herb Greenberg of TheStreet.com joins us with his take on Toyland.
Greenberg on toys
HERB GREENBERG: Well, you've got the hottest toys probably out there right now are the Bratz dolls, but also from LeapFrog you have the Leapster or the LeapPad, Little Touch. LeapFrog has probably been one of the hottest toy companies over the past few years, and it's a company that went public just a year or so ago, and its stock has just done wonderfully, as has the company.
But of course that raises the question: Can it still do well?
KAREN GIBBS: And is there a correlation between how well a toy sells versus how well a company does?
GREENBERG: Early on there usually is, Karen. But then you know what happens? You end up getting knock-offs. For instance, let me give you an example. You have some products there, right? You have the Leapster or the LeapPad, some of those?
Well, all of a sudden, after the LeapPad was so popular and the Leapster was so popular, Fisher-Price, which is owned by Mattel, came out with a line of its own products to compete with the LeapPad. So, for instance, I have a product they sent me here. It's called the Pixter. I don't know much about it, but it's a Fisher-Price type product that is meant to compete directly with the LeapPad products. And when that happens, you end up getting a lot of competition on pricing eventually.
And you also have to ask -- look at this entire market, especially this learning, this learning products market. It's geared to kids 3-to-8 years old basically. And if you ask a bear, "Why would you bet against a company like that?" or "Why do you think the stock may not continue to go higher or may have some risks that could cause it to go lower?" the question is really that the demographics get saturated. And after a while, the company will continue to sell all these products and there will be a lot of demand, but the problem then will be that the growth will slow down. You won't have the growth that supported the stock.
GIBBS: So what's the investor angle for those that want to invest in LeapFrog?
GREENBERG: Well, if you're looking at LeapFrog, you really want to pay attention to right now after Christmas, because you want to look in the newspaper and you want to see if you're watching, if you see any markdowns in the prices of these products. If you start seeing them really marked down from their list price, that's telling you that the channel was really stuffed with product. And that may mean that in the future, going into next Christmas, you might not have the big buyers like Wal-Mart, which are their biggest customer, Wal-Mart or Target buying as many products. And it's going to be very important to watch over the next few months if the company talks about getting additional space from a company like Wal-Mart or Target.
If you don't hear them talking about getting additional selling space in those stores, the growth story again could get muted a bit, and that could cause the stock to sort of settle down.
GIBBS: So we should watch very carefully what we see this weekend and next week in terms of markdowns on toys.
GREENBERG: Yeah, and I want to mention one other thing, because there was a story in the Wall Street Journal about LeapFrog about a week ago, and it talked about how they had a product, very successful, called the Little Touch, and they had, they just shipped them over before Christmas. It cost them like 10 bucks a product to air ship over. That again cuts into the margins of the products.
I have to tell you something. LeapFrog's done a very good job. The company believes its diversification and its international exposure is going to make it a, you know, is going to cause the growth to continue. But again, the reality is demographics, competition. These are things that in the end could take what was the hottest toy company and turn it into just another toy company.
GIBBS: Well, let's talk about some hot things, because I've heard wonderful things about this Bratz doll.
GREENBERG: Oh, boy. Everybody seems to love the Bratz doll, but the Bratz doll, one problem, if you want to invest in it, you can't. It's made by a company called MGA Entertainment.
But what the Bratz doll has done is it's hurt Mattel. Because now, if you want to go buy, is your kid going to want a Bratz or a Barbie? Well, there are Barbie fans out there, but right now there are a heck of a lot of Bratz fans out there.
GIBBS: So this is hurting Mattel. What about the other big name toy maker, Hasbro? What have they got?
GREENBERG: Well, you know, Hasbro has some toys. I'm not as focused on Hasbro. Hasbro is considered a pretty solid and a pretty good company. But like most of the toy companies, its gain comes before Christmas. If you're looking to invest in a toy company, you start looking at these companies in February when Toy Fair starts. And that's when you're going to start getting an eye on what the retailers are going to be looking at.
So Hasbro got a good boost up, as did LeapFrog. It's almost the old buy on the rumor, sell on the news. Come Christmas, you start having a lot, see them discounting, and you start seeing these companies get cut and the stocks get cut.
GIBBS: So what about Toys R Us? Have we changed the way we shop for toys?
GREENBERG: Well, absolutely. Wal-Mart is now the largest toy retailer. Target's in there right behind it. And what you have is basically a situation where the way people are shopping for toys, they're going into a place like Wal-Mart, which is using toys as a loss leader. So they go into Target, and then they go there to buy other things and they buy their toys while they're there.
But that has a spillover effect to the toy industry, because now, say you're Mattel. Say you have a whole line of Barbies. Well, Wal-Mart's going to have the hottest Barbies or the hottest LeapFrog products or the hottest of anyone's products. But you're not going to also maybe be shopping the aisles and picking up some game that you might not have picked up because you hadn't seen it before. So that's going to hurt, that could hurt and is hurting the toy industry and could hurt the likes of Mattel as we go forward.
This has been a year of tremendous price cutting in the toy industry, led by Wal-Mart and Target. And the toy manufacturers have really been, you know, shuffling to try to adjust to this. So it's been all new to them, too. Next Christmas we'll see how this affects how people, how the retailers buy toys and how consumers buy toys.
GIBBS: That price cutting, though, can't be good for a company's bottom line.
GREENBERG: No, of course not, because you might see great revenues because they'll sell more toys, but remember, the lower the prices -- if somebody is, you know, Wal-Mart is going to ask for a bigger discount, you would think, from a company like LeapFrog or Mattel or Hasbro, and that's ultimately going to affect the earnings.
GIBBS: Well, I'm going to switch gears now, because the last time you were with us you talked about a stock, MedImmune, and of course its nasal FluMist virus.
GREENBERG: Yes, and rightly so we pointed out that there was some caution there because I didn't think people were going to roll, I thought more people would roll up their sleeves to get a shot than look for something that's going to be, you know, go up their nose and all this other stuff.
Well, I was right on one hand. But then we had this big flu scare and the big flu, the demand for flu vaccine, you know, was tremendous. And of course what that did was, that meant that in the end, people needed whatever they could get, and that was a boom for MedImmune and for their FluMist product.
But the question there is, you know, they had to lower (the price of their) products. If the government's going to give some of this away or charge a lower price, if the price of the product comes down, again that lowers the profit potential for MedImmune. This is good news for MedImmune.
It may not be as good as the bulls originally expected, and you still have the issue that if you are under 5 years old, if you have certain health concerns like asthma, if you're over 49 years old, you know, the people who really need the flu vaccine, you still can't use the FluMist.
GIBBS: All right. Herb, thanks again for joining us.
GREENBERG: Sure.
Movie industry discussion
COLVIN: Besides being flu season and toy season, it's movie season, when Hollywood suddenly releases the good movies they were sitting on during the year while they were putting out disasters like Gigli.
Lording over them all is Lord of the Rings: Return of the King, looking like a blockbuster of historic proportions. But in fact the whole vast media and entertainment industry faces an uncertain future as new technology threatens to knock its financial foundation out from under it.
So what's next? Who wins? Who loses? Will Ben and Jen's next picture gross more than the price of a box of popcorn?
Larry Haverty analyzes this business as a managing director with State Street Research and Management; Larry, welcome back. Hal Vogel was for years a top media industry analyst at Merrill Lynch and now he runs his own firm, Vogel Capital.
Look guys, we've got to start with Lord of the Rings. It is on the cover of everything: That's GQ with Orlando Bloom, one of the actors in the picture; Entertainment Weekly, not too surprising; Premiere, a movie magazine, not too surprising; and other magazines as well. It looks like it will gross over $1 billion worldwide, a true giant blockbuster.
Now, down to business. It's from New Line Cinema, part of Time Warner; how significant is this, Hal, in Time Warner's overall business?
VOGEL: It really isn't all that significant for two reasons. One, it's hard to move the earnings needle when you have 4 billion shares outstanding. And, second, New Line, because of the risks involved in making three films at the same time -- which added to about $330 million of investment -- actually hedged their bet by giving away 66 percent of the picture to finance it. So at the end of the day, they'll do very nicely, but it won't show much in terms of the bottom line.
COLVIN: So even one of the biggest movies -- actually, biggest movies of all time -- doesn't translate into much on a stock price?
VOGEL: Not necessarily. It depends on how they structure the deal when they make it and how big the capitalization is.
COLVIN: Larry, what's going to happen with this whole media and entertainment industry? We've got two huge trends. One, we do seem our obsession with entertainment more than ever; we love it more than ever. On the other hand, technology is threatening to drain the profits. It's happening in the music industry where people are copying and sharing files on the Internet. I am certain that today on the street in Manhattan you can buy a pirated copy of the new Lord of the Rings film from which Time Warner won't earn a dime. So does this industry boom or does it bust?
HAVERTY: I think you have to look at it on several planes.
First of all, at the same time the technology is happening, the dollar is extraordinarily weak. The entertainment industry, I believe, is our second biggest exporter, so the foreign profits are being translated at vastly higher dollars as the dollar weakens. That's a big help.
Second, you can't help but notice what happened at Wal-mart and Best Buy over Thanksgiving, where people were almost killed buying $25 DVD players. And the DVD penetration is going to be probably 75 percent by the time we finish the year. And that is very, very good for the video software industry. Most of the video software right now, most of the industry, is probably going to be up in the neighborhood of 40 percent in dollars. And the thing that's happening in the film industry that the record industry missed is, the film industry is making the products available.
You could buy Legally Blonde in Best Buy last week for $6. New copy of Pirates$20. These are affordable products. You could actually buy Nemo, Thanksgiving weekend, the DVD for less than you paid for the CD. So the film industry keeps the prices down, which discourages the use of piracy.
COLVIN: Of course, it also reduces their revenues. Hal, what do you think, big picture?
VOGEL: Near term, it's excellent for the industry, that is, DVDs. They're priced right, the consumer likes them they're booming in terms of the unit sales.
COLVIN: And right now, you can't, technologically, get copies over the Internet too easily.
VOGEL: It's still difficult to do. That will change in about five years, but it's still difficult to do. The offset to that is that there is a whole videotape industry behind it that is now evaporating. And so you lose some of that momentum because of it.
Also, there will be in three or four years a saturation point, at least domestically, in terms of over 50 percent of the households in the U.S. already have DVD players. We'll reach 70 or 80 percent; at that point, it will start to level off.
COLVIN: Five years from now, how will we be entertaining ourselves?
HAVERTY: I think most of it will be electronic distribution.
COLVIN: Meaning getting it over a wire of some kind?
HAVERTY: You just push a button, similar to what you've got in MP3 right now, where you can put 1,500 songs on one player. The media will change, but hopefully by the time that happens, the technology problem of the piracy will be resolved.
And this is a terribly important problem for the country to solve because of the export dollars that are earned by this industry abroad. We've had Airbus take away our airline industry. We have a massive balance of payments deficit. This is really our last great hope as an exporter. And it's something where we have a comparative advantage. The Indians and the Chinese aren't going to do what we do with this product.
COLVIN: We have a huge advantuage, and as you say, it all depends on finding a way to protect the integrity of these products. Hal, big picture, are we going to find a solution?
VOGEL: I think we're going to find a partial solution. Technology always runs faster than we can keep up with it in effect, in terms of stomping out piracy. So I think it's going to be difficult.
I hope the film industry has learned lessons from the music business. The music business was in denial and in a state of delusion for about five years. They missed the whole thing.
COLVIN: Now they are finally having to cut CD prices for the first time in their history. Are they going to get it back? I mean, sales are declining. They are in crisis.
VOGEL: They are in crisis, but I think it is stabilizing now. There is a consolidation that is ending in the industry. We're down to just a handful of companies.
VOGEL: Right.
COLVIN: That's a great point about the media and entertainment business. In general it has consolidated to a few titans: Time Warner; Viacom; News Corporation, Rupert Murdoch's company; and Disney. Who's strongest right now?
HAVERTY: Well, from the point of view of the stock price, the stock I like the best is Disney.
And I don't think what's going on in the film business is reflected in Disney's stock price, and there are three or four other catalysts that I think will drive the stock. The film profit right now is running around $600 million; I think they've got the potential before this cycle closes out, to be well over $1 billion.
And to go back to Hal's comment on Lord of the Rings -- Disney did not sell the rights to foreign video or theatrical for Finding Nemo or Pirates of the Caribbean. And in addition, they bought the rights from Universal for Bruce Almighty, which is a very, very successful film. So Disney is going to hemorrhage cash in its film business; that's going to reduce the debt level, and the stock is very attractive on that basis. And there's some other things going on, too.
COLVIN: Will the palace revolt that took place on the board result in anything significant? Is Eisner secure as CEO?
HAVERTY: I think the only thing that's significant is that they'll save money on two board directors. I think that Mr. Eisner has a very, very strong hand of cards, and when we take a look at the next couple of quarters in this company and the cash build-up, I think the thing will speak for itself.
COLVIN: Hal, look at the big titans, the four huge companies, who's strongest?
VOGEL: I like News Corp.
I like to use a "high concept" in picking stocks, and that's a Hollywood term, meaning you can describe the theme of a movie in one sentence. And my one sentence for News Corp., which is my favorite, would be that here you have a billion television households around the world and they (News Corp.) are, in effect, selling satellite services to all of these households, and this is a very big advantage compared to the other entertainment companies.
COLVIN: Right. This is actually a big point. I have this theory that big picture -- what people really want is more television, television broadly defined, produced full motion, full-color video on a screen. We're going to be watching it on our computer screens and cell phone screens and any other kind of screen we can get.
Basically right or basically wrong?
HAVERTY: I agree with that, and it has to be good content. I mean, clearly, the power app, the killer app, throughout the world, which Rupert has absolutely understood, is sports.
COLVIN: Live sports.
HAVERTY: If you look at who is doing the stuff in the United States, clearly the guy that has cornered the most sports rights is Disney. And ESPN is raising prices.
Now what has Rupert done? He's used sports, the Premiere League in BSkyB and they've broken out to a new high, and he has the rights to most of the Italian soccer and he has the satellite monopoly in Italy, and the numbers are terrific. But what Rupert has -- and I agree with Hal on (the satellite TV advantage of) News Corp. -- what Rupert has, is the right programming in terms of sports to sell to those masses. And that's a pretty powerful combination.
COLVIN: Hal, what was your favorite movie this year?
VOGEL: I don't know. I don't have a particular one in mind. Master and Commander was pretty good, I thought.
COLVIN: You see them as businesses?
VOGEL: Yes.
COLVIN: (turning to Haverty) How about you?
HAVERTY: Finding Nemo. It's really a guy flick. And it's about a bond a father has with his son. And I found that people my age liked it, teenage boys like it. Everyone liked it. I just came out of the film feeling really good because a very powerful lesson about father-son bonding was taught in film, while it was very, very enjoyable. You were given some good stuff and allowed to have fun and of course, it became very, very commercial.
COLVIN: It did indeed. One of the huge, huge hits of the year and probably many years.
HAVERTY: That's Hollywood working right.
COLVIN: It really is, it really is. And the consumers at least have had a lot of fun. The companies may or may not have had fun. We've had a lot of fun. Larry, Hal, thank you so much.
Investor Spotlight: Ave Maria fund
GIBBS: If the toys under the tree left you underwhelmed, and like Little Nemo you're looking for something a little more spiritual in life, maybe it's time to turn to a higher calling. The holiday season is a time to reflect, and many investors look for ways to make a difference by turning to socially-responsible investing. But often that means giving up returns in order to feel good.
That's not the case with George Schwartz, manager of the Ave Maria Catholic Values Fund. Investors in this fund are in seventh heaven, enjoying a 35 percent (1-year) return, compared to the S&P's 26 percent gain.
George, how do you do it? Is it divine intervention?
SCHWARTZ: We feel very fortunate. Some of our shareholders say we're very blessed. We are basically a company of good analysts, good portfolio managers, CFAs (chartered financial analysts) and we look for good investments. And that's the reason the investment performance has been so good.
In the process of looking for good investments, we screen out certain companies that violate core teachings of the Catholic Church. We screen out companies that are related to abortion, pornography; companies that contribute to Planned Parenthood; and lastly, companies that offer their employees non-marital partner benefits. When you screen out those companies, it screens out about 400 companies out of the Russell 3000; the Russell 3000 is the universe that our analysts and portfolio managers look at. Even screening out 400 companies, it still leaves us with about 2,600 companies to choose from in making up a portfolio of about 75 stocks.
GIBBS: You've got a very incredible niche in this marketplace in terms of investing style. How did you come up with this Ave Maria fund idea?
SCHWARTZ: Just about three years ago now, Karen, a group of Catholic laymen came to me and asked me to start a Catholic mutual fund. And I said to these fellows, "Well, what do you mean a 'Catholic' mutual fund? You want me to start a mutual fund that invests in companies that make rosaries or prints Bibles or builds churches or something like that?" And they said "No, no. Just invest in the best companies you can find, but screen out companies related to abortion." So that was the genesis of it.
And then the Catholic advisory board was put together -- and as I said, that's a group of six prominent lay people -- and they said we should expand the screens beyond just abortion to include the other items which I mentioned.
GIBBS: A lot of people when they talk about sinful industries, they think of gambling, tobacco, alcohol and firearms. And I didn't hear you mention any of those as one of the methods to screen out stocks. Why?
SCHWARTZ: I want to emphasize that I'm a portfolio manager, and my staff is made up of portfolio managers. We're theologians, we're not experts on the Catholic Church, although many of us are Catholic.
But we're looking for the best investments we can find, and we operate within the parameters established by the Catholic advisory board. And they have not indicated that alcohol per se or gambling per se or firearms are violations of the core teachings of the Catholic Church.
GIBBS: As society shifts and and becomes more accepting of some of these things, are you afraid that you might run out of investment options, companies that you could invest in?
SCHWARTZ: Certainly, it has not been a problem so far, Karen, as our performance indicates. A lot of people assume that we're not going to be able to have good investment performance because we have to screen out several of these companies. Well, I always point out that we wouldn't have wanted to invest in most of those 400 companies anyway.
GIBBS: What are some of the companies that you do like now?
SCHWARTZ: We like a company called Harley-Davidson. I'm sure you've heard of it.
They're celebrating their 100th anniversary of business this year. It's an extraordinarily well-managed company. It's a cash machine. They produce significant amounts of excess cash flow, very strong earnings. They have a real franchise in that name, in the brand name. They have what Warren Buffett calls a "moat": They have a moat around the business whereby the competition can't get at them, and they just dominate the market.
GIBBS: You wouldn't necessarily think of the biker image in the Ave Maria fund.
SCHWARTZ: No, definitely not.
GIBBS: Give me another one that you like, another company.
SCHWARTZ: We like a small cap company called Brookstone Stores.
It's a specialty retailer, operating mostly in malls, (but) they have several stores in airports, and after 9/11 those stores were basically shut down, so it really whacked their earnings for a year or so. But the company has come roaring back, and they have about 265 stores now in 39 states. It has a pristine balance sheet, no debt. Plenty of cash on the balance sheet. The earnings are growing at 15 to 20 percent annual rate.
GIBBS: And you hold these stocks for the long term.
SCHWARTZ: Yes. We are long-term oriented investors. We're value investors. We tell shareholders they should be thinking about a 3-to-5 year investment. We're not speculators. We're not interested in the short-term swings of the market. We have a long-term focus, and we hope that shareholders buying today can double their money in five years' time, which would be a 15 percent compounded annual rate of return.
GIBBS: George, thank you very much for joining us.
SCHWARTZ: Nice being with you, Karen.
Next week: 2004 predictions
|
