The Wall.St Journal 21Feb2020

B12| Friday, February 21, 2020 ** THE WALL STREET JOURNAL.

Morgan Stanley Didn’t Get a Discount

There is sound logic to the purchase of E*Trade, but the rich price sets a high bar for creating value for investors in the near term

HEARD

ON

THE

STREET

FINANCIAL ANALYSIS & COMMENTARY

Business is hot atDomino’s

Pizza, but its stock is even hotter.

Fiscal fourth-quarter results out

Thursday were robust. Sales of

$1.15 billion and adjusted earnings

of $3.12 a share grew by 7% and

14%, respectively, from a year ago

and comfortably topped analyst ex-

pectations. Same-store sales grew

at a healthy 3.4% clip. For the full

fiscal year, free cash flow grew by

50% from a year earlier. Domino’s

also affirmed its longer-term fore-

casts for sales growth and unit

count after lowering them in Octo-

ber.

That performance certainly mer-

its a rally, but investors were feel-

ing especially generous—shares

rocketed nearly 26% higher on

Thursday to a record. Bears forced

to cover losing bets may have par-

tially fueled the stock surge. Nearly

10% of available shares had been

sold short as of Thursday, according

to FactSet. The surge leaves the

company’s debt-adjusted market

value at 24 times projected earn-

ings before interest, taxes, deprecia-

tion and amortization. Rivals such

asPapa John’s Internationaland

Pizza Hut parentYum Brandstrade

at about 20 times forward Ebitda.

There are arguments for a pre-

mium: Domino’s hasn’t had a quar-

ter with negative U.S. same-store

sales in nearly a decade, while its

rivals have stumbled in recent

years. Domino’s said Thursday it

has closed fewer than 100 U.S.

stores over the past five years. It

has also been far more reluctant to

embrace third-party delivery ser-

vices.

That decision, while controver-

sial, is looking good right now: The

biggest food-delivery companies in

the U.S., such asDoorDashand

Grubhub, are seeking to shore up

their finances through mergers or

public listings, The Wall Street

Journal reported earlier this week.

If their investors become less will-

ing to fund operating losses, they

may prove less formidable competi-

tors. Its carryout business is grow-

ing nicely, too.

Still, while Domino’s is leading

the industry today, a rosy future is

never guaranteed in this intensely

competitive business. It is possible

those delivery vendors could

strengthen through a round of con-

solidation or that rivals who have

slipped can regain market share. Its

valuation doesn’t leave much room

for error: Domino’s has traded at an

average of 18 times Ebitda over the

past five years.

At that temperature, investors

may want to pause before sinking

their teeth in. —Charley Grant

Domino'sPizzashareprice

Source: FactSet

$375

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225

250

275

300

325

350

2019 ’20

Many people stuck at home in

China due to the coronavirus epi-

demic may have become couch po-

tatoes, but Chinese online-video

stocks may not be binge-worthy.

The epidemic has led to wide-

spread disruptions: Schools are

closed, restaurants are shut down

and many people have been forced

to work or study remotely.

The extra time at home has nat-

urally meant more entertainment

online: People spent an average 7.3

hours a day on their phones for

the week ended Feb. 9, compared

with 6.1 hours a month earlier, ac-

cording to market researcher

QuestMobile. Online videos and

games are among the biggest time

drains.

Since many movie theaters are

closed in China, some online-video

platforms have bought the rights

to stream movies that were pulled

from the big screens to attract new

users.

U.S.-listed shares of Chinese on-

line video stocks have surged:IQ-

iyi, which has a Netflix-like video

subscription service, gained 17%

this year through Thursday, while

animation and gaming-video plat-

form Bilibili was up 50%.

Binge watching has no doubt

benefited these companies in the

short term. Some of their new us-

ers may even stick around when

the epidemic is over, but they still

need to worry about the old prob-

lems of rising costs and intense

competition.

IQiyi, which focuses on original

productions and long-form videos,

not only has to face direct compe-

tition fromAlibabaandTencent,

but other forms of online enter-

tainment such as short videos.

Bytedance, which owns TikTok

and its Chinese equivalent Douyin,

has been attracting young people’s

eyeballs.

Bilibili, on the other hand, has

the advantage of focusing on the

niche market of user-generated

content about animation and

games. Still, it is trying to diversify

its user base, which will involve

the same competitors.

Both companies remain unprof-

itable. Mounting costs for market-

ing and creating content to attract

users could continue to keep them

in the red for now.

Bilibili’s underlying video busi-

ness may be weaker than it looks

based on the company’s financials,

given more than half of its revenue

came from its profitable mobile-

gaming business.

Investors have done well, but

need to chill.

—Jacky Wong

17%

ThegaininChinesestreameriQiyi’s

U.S.-listedsharessofarin2020.

Nvidia is among the most expensive semiconductor stocks at 40 times forward earnings. Chief Executive Jensen Huang.

PATRICK T. FALLON/BLOOMBERG NEWS

There is a lot to like aboutMor-

gan Stanley’s most ambitious foray

beyond Wall Street, but there isn’t

yet a lot to bank on.

Morgan Stanley paid a hefty

price for growth and stability. By

acquiringE*Trade Financialfor

$13 billion in stock—about $3 bil-

lion above where the discount bro-

ker closed on Wednesday—Morgan

Stanley will likely dilute its tangible

book value by roughly 10%.

The question is whether the firm

can earn it back. From an overall

strategic standpoint, the deal is

fairly straightforward: Morgan

Stanley for years has been moving

more heavily into wealth manage-

ment, and the notable piece it was

missing was a truly mass-market

retail program. E*Trade, known for

its online-trading platform, brings

that. It has over five million indi-

vidual-investor accounts and a

brand that isn’t out of place in a

roster of Super Bowl commercials.

Like other wealth-management

businesses, its revenue isn’t nearly

as volatile as investment banking

and trading, and it can grow

steadily in a wider array of market

conditions. That latter feature is es-

pecially important when Morgan

Stanley is being put through the an-

nual Federal Reserve stress tests.

Still, given the premium paid and

the dilution, the deal merits further

scrutiny. E*Trade may no longer

generate as much in juicy trading

commissions in the era of zero pric-

ing, but it still brings loads of cus-

tomer cash: $39 billion of deposits

in its own bank and $18 billion

swept off-balance-sheet. By using

those off-balance-sheet deposits to

replace wholesale funding at Mor-

gan Stanley, this can help reduce

funding costs by $150 million

by year two.

Unfortunately, the bulk of

E*Trade’s deposits aren’t so readily

available to be redeployed. For one

thing, Morgan Stanley says it has

only so much business that can be

deposit-funded, though it is rapidly

expanding its lending book. Also,

E*Trade also is building its inde-

pendent adviser custody business, a

big growth area for its online-bro-

kerage rivals. Morgan Stanley’s own

adviser-driven business has tools to

accelerate that effort. E*Trade and

Morgan Stanley can also now jointly

build out a digital retail-banking of-

fering to compete with the likes of

Goldman Sachs Group’s Marcus

and fintech upstarts such as

Betterment.

There is one additional possibil-

ity: If the deal succeeds in greatly

expanding the firm’s steady fee-

generation capabilities across its

wealth business, book value might

just not matter as much any more

to investors, shifting the valuation

conversation to a forward price/

earnings ratio. On that basis, Mor-

gan Stanley sits at about 10 times,

well short ofCharles Schwab’s

more than 18 times.

An outcome like that is hardly

assured. But with this deal at least

it is in the realm of the possible.

—Telis Demos

E*Trade’s own core business needs

to fund margin loans, an intimate

part of why people trade with it. So

further funding-cost arbitrage gains

will take time.

Overall, considering both the

funding gains and an additional

$400 million in expense savings by

year three, Morgan Stanley fore-

casts an improvement to its return

on tangible common equity of 1 per-

centage point or more. That addi-

tional earnings power will most

likely cover the dilutive outcome of

the stock deal.

Whether there is significantly

more upside to the stock is some-

thing investors will have to figure

out on their own. A few possibilities

stand out: The biggest is that

E*Trade brings a workplace stock-

plan business that will complement

Morgan Stanley’s Shareworks,

which it built up by acquiring So-

lium last year. Morgan Stanley has

said it could add another million ac-

tive clients through this channel.

Now that number gets even bigger.

Surge in

China Video

Stocks Is

Overdone

It’s Feast or Famine for Chip Maker Nvidia

Cloud giants are feasting on

Nvidia’s chips again. The company

had better hope they don’t step

away from the table soon.

Nvidia’s fiscal fourth-quarter re-

sults last week were the latest

from chip makers enjoying a

strong uptick in data-center

spending.IntelCorp. andAd-

vanced Micro Devicesreported

solid results for their respective

data-center businesses last month.

But for Nvidia, the comeback is es-

pecially sweet since the data-cen-

ter opportunity is what caused

Wall Street to significantly re-eval-

uate the company previously

known mostly for videogaming

processors. Thanks to sharp gains

since last week’s results, Nvidia’s

shares finally crested their peak

value before a brutal selloff

late in 2018.

That also sets a high bar. At 40

times forward earnings, Nvidia is

once again among the most expen-

sive chip stocks. It falls upon its

data-center business to justify that

multiple. Data-center revenue

surged 43% year over year to $968

million in the quarter ended Jan.

26—nearly twice the growth rate

Wall Street expected. Analysts ex-

pect Nvidia’s data-center growth

to average 54% on a year-over-

year basis in the next four quar-

ters.

That is possible as long as its

largest customers don’t move into

another “digestion” period. Cloud

giants Google,MicrosoftandAm-

azon.comspend billions a year

building out their networks, but in

a lumpy and unpredictable way.

Capital spending by those three

rose only 9% in 2019 after surging

49% the year before. Intel, which

logged pronounced weakness in its

own data-center business earlier in

the year, said major cloud players

were taking time to “digest” previ-

ous investments. In its fourth-

quarter earnings call, the chip gi-

ant predicted a similar phase later

this year.

Nvidia made no such projection.

In its own call, the company said a

growing portion of its data-center

business is coming from demand

related to “inference” in which ar-

tificial-intelligence systems start

making decisions based on

trained models.

Several analysts believe the

market for AI inference is ulti-

mately much larger than that of AI

training, where Nvidia’s graphic

processors have also been popular.

In other words, Nvidia seems to

be at another early stage of a po-

tentially big market. That is great

for the long term, but it doesn’t

shield the chip maker from the un-

predictable cycle of spending by

large customers.

Those lumps can be painful. Af-

ter the stock hit its last peak,

Nvidia shed more than half its

market value in less than three

months. That selloff was sparked

by a dual slowdown in data-center

revenue and the collapse of the

cryptocurrency mining bubble,

which had inflated demand for the

company’s videogaming proces-

sors. Stacy Rasgon of Bernstein,

who upgraded Nvidia to a “buy”

rating on Wednesday, noted that

“investors will need to be pre-

pared for more volatility” as

Nvidia’s business keeps driving

higher.

Digestion can sometimes be

painful.

—Dan Gallagher

OVERHEARD

Thanks to this diet com-

pany’s struggles, investors are

shedding pounds. Shares of fit-

ness firm Tivity Health, which

owns diet-nutrition provider Nu-

trisystem, plunged more than

45% Thursday after its fourth-

quarter results missed analyst

expectations.

Tivity also took an impair-

ment charge of $377 million re-

lated to its $1.3 billion acquisi-

tion of Nutrisystem, which

closed less than a year ago.

If that weren’t enough, the

company announced that Chief

Executive Donato Tramuto has

stepped down and left the

board of directors, effective im-

mediately. The head of the nu-

trition division left the company,

too.

Tivity’s next leader will have

to contend with some unsightly

bloat on the balance sheet: It

ended 2019 with more than $1

billion in debt on its books and

generated less than $60 million

in free cash flow last year.

Domino’s Surge Looks Like Pie in the Sky

Morgan Stanley CEO James Gorman

MICHAEL BUCHER/THE WALL STREET JOURNAL