|Shares Out. (in M):||44||P/E||0||25x|
|Market Cap (in $M):||605||P/FCF||0||25x|
|Net Debt (in $M):||23||EBIT||0||0|
Summary: CommerceHub (“CHUB”) is a unique and mispriced long opportunity that has ~50% upside over the next 12 months. The investment thesis in summary:
CHUB has significant runway for growth (growing high-teens organically) driven by overall e-commerce growth (+15% CAGR) and continued market share gains for virtual inventory (enabled by CHUB’s solution). The Company’s entry into the Brand Direct market via the 2015 acquisition of Mercent will expand CHUB’s TAM and should drive growth in excess of the high-teens organic growth of the core business beginning in 2017+. CHUB represents a pure play way to invest in the growth of e-commerce/omnichannel spend via an extremely high quality business model that is new to the market and not yet well understood.
CHUB has a unique business model with no real comparables. It has all the elements of a top-tier software business model:
Extremely stick customer relationships with very low churn rates
Pure cloud-based SaaS model
75-80% gross margins
Dominant market position with no real competition and network effects to the business model
Strong organic growth (high-teens/20%) with a long runway
Sector-leading profitability (40% EBITDA margins in 2017+ after sales and marketing investment)
Sector-leading sales and marketing expense (low-teens % of revenue which compares to typical 30-50% for other SaaS-based software companies). Note this low level of sales and marketing reinvestment is unique to CHUB’s business model and is discussed in more detail below
Sector-leading stock-based compensation (7% of revenue vs. 15-50% for comparables)
CHUB was spun-out of Liberty Ventures on July 22, 2016. CHUB represented ~10% of Liberty Ventures’ Enterprise Value. Most investors of Liberty Ventures were invested as a cheaper way to invest in Liberty Broadband/Charter and Expedia. As a result, many of these investors have not done diligence on CHUB and have been selling post-spin creating technical pressure. There has been minimal investor education with no formal road show and no sell-side coverage (which will likely change shortly). Additionally, there is no good comparable company given the unique nature of CHUB’s business. Note CHUB is controlled by John Malone which ensures intelligent capital allocation and shareholder value maximizing behavior.
Margins are currently understated due to the 2015 acquisition of EBITDA negative Mercent and noise from the spin (~$5mm/yr in public company costs, change in accounting for R&D capitalization) combined with higher investment behind the Brand Direct strategy in 2016. These costs will leverage in 2017+ and see EBITDA margins revert to ~40-45%. Note CHUB’s core business (pre-Mercent) was doing 60% EBITDA margins with 5-7% sales and marketing spend as a % of revenue
Valuation is very cheap versus SaaS companies with similar growth but structurally lower margins and more competition (trading at only 10.3x 2018 EBITDA and 16.7x 2018 P/E using a full 38% tax rate which CHUB actually pays because unlike most software companies it’s profitable).
The asset has strategic value with potential acquirers including SPS Commerce, EBay, Google, among others.
Target price: CHUB could easily rerate to 15x EBITDA / 25x P/E multiple on 2018 earnings which would represent almost 50% upside over the next 12 months with optionality for higher value in the event of a sale of the company (one of the reasons John Malone may have spun it off). There is arguably even greater upside than we are underwriting given its closest but imperfect comparable of SPS Commerce (with a similar growth rate but structurally lower margins) trades at 24x 2018 EBITDA.
Background: In addition to the S-1 from the spin in July 2016, the best overview of CHUB comes from the presentation the CEO, Frank Poore, gave at the Liberty investor day last week (http://files.shareholder.com/downloads/AMDA-6ELUYM/3217897347x0x916872/082D0DF7-A22F-4820-AFE5-527089484064/CommerceHub-Investor-Presentation-Liberty-Investor-Day-FINAL.pdf). I encourage you to read this as it does a really good job framing the opportunity and the uniqueness of CHUB’s business model.
CHUB’s primary business is a cloud-based SaaS solution that enables retailers to expand product assortment online through virtual inventory whereby supplier partners/brands directly ship product (a.k.a. “dropship”) to consumers without the retailer needing to make a capital investment in inventory. It’s important to note that the provision of drop shipping is significantly more complicated than traditional EDI-based supplier relationships (the standard supply chain protocol that enables shipments from suppliers into a retailer’s distribution system) because you are dealing directly with the end customer and delivery date is a critical component of performance. For this reason, traditional EDI-related software does not enable dropship/customer-direct shipping. Retailers are rapidly adopting CHUB’s dropship solution as a way to gain competitiveness in e-commerce/omnichannel while spending minimal expense (minimal upfront onboarding costs, no need to expand DCs/logistics to hold and ship inventory directly, etc). A broad assortment of product is increasingly essential to customer acquisition / conversion for retailers due to the success of Amazon and other online marketplaces and has been shown to be one of the leading drivers of conversion in online transactions. CHUB has no third party competition of scale as it benefits from network effects working with most of the leading retailers and over 9,900 of the leading brands. Its customer base is extremely sticky. It has lost only one major retailer (Circuit City to bankruptcy). CHUB has three revenue sources that it receives from both retailers and suppliers: 1) Usage (68%) where CHUB receives revenue per transaction, 2) Recurring Subscription (27%) and 3) Non-Recurring Services (5%).
CHUB is a capital light business (only $4mm of annual capex and no working capital) with ~40-45% EBITDA margins. Unique compared to most SaaS-based models is that it also requires minimal sales and marketing dollars to win customers as it only markets to the largest retailers in the US since the Top 25 E-Commerce retailers account for ~80% of total E-Commerce sales. The retail customers direct suppliers onto the CHUB platform creating a network effect as the CHUB value proposition increases with every supplier added. The Company overall has just under 10,000 customers.
CHUB works with the vast majority of the top retailers within its addressable market. Our diligence/customer calls suggests that the non-CommerceHub retailers are all potential targets (currently not using an external solution in a meaningful manner).
As noted above, the Company recently entered the Brands Direct business via the acquisition of Mercent in 2015. This market serves the nascent but growing number of branded companies that are increasingly selling directly to consumers via their own websites, marketplaces (AMZN, EBAY, etc), and retail e-commerce site. CHUB’s core dropship business is the only provider of this service in the market. CHUB is now bundling this with a broader offering that allows brands (many of whom are already CHUB dropship customers) to control their direct to consumer offering across all these channels. Given CHUB’s dominant dropship position, no other competitor will be able to offer the same service. We believe this Brand Direct strategy will expand CHUB’s TAM and is already bearing fruit with early wins over the last few quarters (Mattel in Q2, a large footwear company in Q3). We believe brands selling direct has reached a tipping point and will be a growing trend as they become increasingly comfortable selling around retailers (historically a channel conflict they always avoided).
Further Detail on Key Components of the Investment Thesis:
Long Runway of Growth Potential: E-commerce has been consistently growing mid-teens as it continues to take share away from brick-and-mortar retailers. Within e-commerce, virtual inventory is gaining penetration as retailers look for a capital light way to grow product assortment and sales to better compete with Amazon (see CHUB presentation cited above for discussion of virtual inventory penetration %). Our diligence suggests that CHUB’s penetration of e-commerce should continue to increase for the following reasons: 1) white space opportunity with unpenetrated retailers, 2) increasing the number of brands into the network, and 3) increasing connections between brands and retailers already in the network.
Revenue of CHUB is less sensitive to macro risks as it is a 100% US-based asset with growth determined primarily from the structural shifts of E-Commerce and virtual inventory penetration as opposed to overall retail sales.
Technical Pressure Related to Spin-Out from Liberty Ventures / Lack of Coverage: Pre-Spin of CHUB, Liberty Ventures was comprised essentially of three assets: Liberty Broadband (Charter), Expedia and CHUB. CHUB represented only ~10% of the Enterprise Value of Liberty Ventures. Post-Spin, there are many investors who are either uneducated or uninterested in CHUB as it was not core to the thesis on Liberty Ventures. This dynamic has created technical pressure on CHUB’s stock price as investors have unload unwanted shares. CHUB did not do a formal roadshow prior to its spin out (only one day of meetings through Stifel). As a result, the CHUB spin out did not get meaningful attention and investor education was extremely low on this small-cap asset. Making matters worse, CHUB is not covered by the sell side. As a potential catalyst, CHUB management expects the company to be covered as soon as the end of this year. We think coverage could better help investors understand recent investments that CHUB has been making into its business and raise attention of this high-quality asset.
Misunderstanding of Stock-Based Compensation: In 2015, CHUB reported Adjusted EBITDA of $43mm. Of that amount, $42mm was Stock-Based compensation. There are questions as to how profitable CHUB really is given the magnitude of the reported Stock-Based compensation. This misunderstanding results from CHUB as a newly-minted public company. Pre-Spin, CHUB was part of Liberty Interactive. As a private subsidiary of a public company, CHUB was forced to mark-to-market its Stock Option Liquidity Program that provided eligible option holders the opportunity to tender stock options at the fair value. To determine fair value, CHUB would engage a third party to conduct an independent valuation. Given the extraordinary value creation of CHUB in recent years, the majority of the stock-based compensation recorded represents fair-value adjustments. Post-IPO, CHUB has canceled its Liquidity Program and is recording Share-Based compensation in a manner consistent with public companies resulting in a significantly lower expense. In Q3, CHUB reported share-based compensation of $2.2mm ($9mm annualized which is significantly lower than the $42mm that was recorded in 2015). We are modeling ~$9mm/yr going forward which represents an industry-leading 7% of sales.
Margins Understated From Mercent Acquisition / Brand Strategy: In 2015, CommerceHub acquired Mercent. Mercent is a technology that enables brands to easily sell on marketplaces (AMZN, Google, Facebook, Jet, etc.). Mercent is a distant #2 to Channel Advisor in its offering. Mercent was losing money at the time of the acquisition. By our estimate, Mercent was losing $4mm. 2015 EBITDA for CommerceHub would have been 10% higher without this acquisition.
What is misunderstood is that CHUB acquired the Mercent assets not for its current book of money losing business but for its technology. CHUB is currently in the first inning of intentionally churning the unprofitable Mercent customers as it adopts a new strategy. The old Mercent strategy was offering low margin digital marketing services. This is not an attractive business. CHUB is taking the Mercent technology and building it into its core CommerceHub solution. The new product offering will be a high-margin, more-scalable solution. In the interim, however, CommerceHub is investing ahead of any revenue contribution. As a result, the historical Mercent product has gone from a $4mm headwind at acquisition to a $9mm headwind in 2016. Our 2018 EBITDA of $61mm excludes any revenue benefit from the brands strategy but includes all the costs. Adding back the $9mm would result in EBITDA that is 16% higher. In reality, the brands strategy will ultimately either be successful resulting in accelerated revenue growth (no benefit to date) or CommerceHub will pull back on the investment. CHUB is already having success with its new brands offering. It has signed up Mattel and an iconic footwear company. We think CHUB’s strategy makes a lot of sense because it already has 9,990 suppliers in its network to which it can cross sell the new offering (an opportunity Mercent didn’t have). The brands strategy of enabling suppliers to sell into marketplaces enables brands to take more control of their business by selling directly to the customer versus being exclusively reliant upon brick-and-mortar retailers for sales. Through the CommerceHub integrated solution, brands can now manage all of their drop shipping operations through one integrated solution.
Potential Acquisition Target: We believe that CHUB could be a potential acquisition target. Greg Maffei (CEO of Liberty Interactive) said the following in November 2015 regarding its decision to spin out CHUB from Liberty Ventures, “It’s not inconceivable that this company could be part of a larger enterprise. And we would have been loath to do that given a very, very, very low tax basis inside this thing.” We think CHUB could be an acquisition target for companies that are interested in providing supply chain solutions such as SPS Commerce. Similar to CHUB, SPS Commerce offers a cloud-based architecture to help brands integrate into retailers’ supply chain operations without having to make a direct EDI connection. Additionally, the solution could be of interest to Marketplaces such as EBay and Google that try to more effectively compete against Amazon by having stronger relationships with suppliers.
Returns: There is no historical valuation for CHUB. There is no great comparable for CHUB either. The most similar is SPS Commerce however CHUB is a better business in our view because CHUB faces no significant competition for its core solution (SPSC and others say they do drop shipping but our VAR suggests that only CHUB does it at scale) with much higher margins (low-teen margins at SPSC). SPS Commerce trades at 24x 2018 EBITDA versus CHUB at 11x EBITDA. We are not anchoring on SPSC valuation – just pointing out the upside potential from a rerating. Taking a step-back, we think a business that grows its top-line high-teens in a capital light manner with recurring / sticky customers deserves to trade at a multiple in excess of current valuation. Assuming just 15x EBITDA provides nearly 50% upside.
Continued ~18% organic growth in the core dropship solution. Modest revenue headwinds in 1H 17 from the churn of legacy Mercent customers that began in 2H 16 with the rollout of the new Brand Direct strategy that anniversaries in 2H 17). 2018+ growth > than core 18% as Brand Direct begins contributing revenue
Gross margins expand to reflect new R&D capitalization policy implemented in Q3 (will lead to lower D&A which flows through gross margin)
Higher R&D expense to reflect new R&D capitalization policy
Modest incremental investment in sales and marketing to drive Brand Direct strategy (~150bp as % of sales)
G&A run-rates at ~$22-23mm/yr which incorporates the ~$5mm of public company costs. This will leverage going forward according to management
$9mm in stock-based compensation expense (current run-rate)
38% tax rate (could change if Trump/Republicans reform corporate tax)
Investor awareness that comes with post-spin seasoning
Guidance on 2017 cost structure
|Subject||Value add question|
|Entry||11/15/2016 02:57 PM|
Thanks for the idea, very interesting. Would you say that most of the value add for commercehub's services flow to the suppliers who can access the retailers' customer base or to the retailers being able to offer more SKU's with the virtual inventory? I'm a little surprised that AMZN would be a partner/user. Isn't this what Amazon does independently or has CommerceHub been in the background the entire time?
|Entry||11/15/2016 04:37 PM|
Perhaps a silly question - How is the larger CommerceHub business distinct from ECOM? Thanks.
|Subject||Re: Value add question|
|Entry||11/15/2016 09:32 PM|
The value is on both sides. CHUB is essentially just a small toll road like Visa. The retailer is gaining incremental gross profit dollars without having to make an inventory investment. Just as importantly, the retailer is gaining traffic to its site to sell additional product / create a customer relationship. For example, imagine a consumer that starts a search on Google and ends up at Home Depot because they can advertise a CommerceHub SKU that they wouldn't otherwise carry in a store. The supplier gains value in that most brands can't generate customer traffic directly, but can leverage the traffic of retailers for incremental sales.
AMZN works with brands independently and through CommerceHub. With CommerceHub, a supplier can load its product catalog into the CommerceHub system which can then syndicate that listing to Amazon, Home Depot, EBay, etc. This is a very efficient way for brands to manage their listings to multiple sites. Alternatively, the brands could go enter their information multiple times directly to each of these sites.
|Subject||Re: ChannelAdvisor (ECOM)?|
|Entry||11/15/2016 09:57 PM|
Prior to the 2015 acquisition of Mercent, CommerceHub only provided drop shipping services to brick and mortar retailers. Brick and mortar websites (ex Walmart and Staples) don't have marketplaces. A marketplace is where there is very loose rules enabling almost any supplier to post product. On a marketplace, the supplier controls pricing, advertising, and inventory availability. Examples of marketplaces include Amazon, EBay, Google/Facebook Buy Buttons, Walmart, Jet, etc. By contrast, in the traditional CommerceHub product, the retailers control the process. The retailer determines which SKUs to include in the product assortment, pricing, has visibility into supplier inventory and is willing to advertise against that inventory since it can control pricing and see inventory.
ECOM works with Marketplaces. Similar to CommerceHub, the value of ECOM is that it allows suppliers to load a product catalog to their system and then syndicate that listing to multiple different marketplaces in a much more efficient way than managing a bunch of marketplaces independently. ECOM however doesn't work with the brick and mortar retailers. The ECOM business is of much lower quality than CHUB because it relies on signficant sales and marketing to get suppliers onto its system. By contrast, CHUB spends very little on sales and marketing because the retailers direct the suppliers to CHUB if they want to sell on their websites. In 2015, CHUB bought Mercent. Mercent was a distant #2 to ECOM in selling product on marketplaces. CHUB bought it so that it could offer a comprehensive solution to suppliers in providing a drip shipping solution for both brick and mortar retailers and marketplaces. This combination is something that is unique to CHUB.
|Subject||Re: Sales and marketing expense|
|Entry||11/15/2016 11:13 PM|
The ECOM business as well as the old Mercent business is low quality in that heavy S&M investment is needed to both attract brands and offer low margin digital marketing services where essentially internal employees are managing much of the digital process for suppliers. CHUB does not want to be in this business and is in fact intentionally churning off legacy unprofitable Mercent customers as contracts come up. CHUB bought Mercent (as opposed to ECOM) because it primarily wanted Mercent's technology (which we understand is supperior to ECOM's technology despite being a much smaller company). CHUB has now integrated the Mercent technology into the core CommerceHub product so that it is all one offering. CommerceHub has a strategic advantage in that it can cross sell its existing suppliers into the Brand Direct Strategy. The Brand Direct Strategy will have higher S&M spend than the traditional CommerceHub product (particularly as it invests ahead of revenue) but we think CHUB has no desire to compete for unprofitable small business customers through an aggressive S&M approach. CHUB's positioning is enabling it to attract large brands such as Mattel and an iconic footwear company. These wins are evidence that the S&M spend is bringing in large profitable clients as opposed to targeting small suppliers that don't justify the S&M investment.
|Subject||Re: EBITDA margin|
|Entry||11/15/2016 11:38 PM|
How are you getting to 20-25 points of margin? In 2014, CHUB spent $2.4mm on capitalized software or 4.5% of sales. In 2015, CHUB spent $6.5mm or 7.4% of sales. You are correct that CHUB will be expensing more of the software going forward than historically. For example, in Q3, CHUB expensed $1.7mm incrementally that previously would have been capitalized. Our price target in 2018 is based off an EBITDA that includes the incremental R&D expense. For example, if you look at our 2017E R&D expense of $20.5mm that represents the $5mm of Q3'16 R&D expense annualized.
|Subject||Re: Re: ChannelAdvisor (ECOM)?|
|Entry||11/16/2016 11:13 AM|
That is helpful. Thank you.
|Subject||Excellent Write Up / Several Questions|
|Entry||11/20/2016 10:38 PM|
This is an excellent write up!! I worked on CHUB at the time of the spin off and I have been following it since then (though never had a position). I agree that 3Q 2016 brings to light a lot of new information of CHUB.
I wanted to ask a few questions that I have been thinking about. Apologies in advance if my questions get too detailed and / or too technical. The reason for that I agree with your big picture view while I am not so sure about more nuanced elements of your thesis.
1. 1. Current Growth Rate
a. Excluding Mercent, CHUB’s revenue grew ~18% in 3Q 2016.
b. CHUB core revenue has the following growth drivers:
i. Overall e-commerce growth.
1. Let’s assume that CHUB’s customers grow their e-commerce business at the same rate as the industry ex-AMZN.
2. In 2015 the entire industry grew ~14.9%.
3. If you exclude AMZN (retail sales only; I am excluding AWS), the retail industry e-commerce growth was 12.6%. Still a nice tailwind but lower than 15%.
4. Let’s call it “a”.
ii. New clients – both retailers and suppliers.
1. In 1Q – 3Q 2016 it was between 5.8% and 8.1% y-o-y.
2. Let’s call it “b”.
iii. Increasing penetration (i.e., wallet share) within existing customer base.
1. This growth driver has not been disclosed in percentage terms.
2. Let’s call it “c”.
c. The overall CHUB growth (ex-Mercent) should be
i. Growth = (1 + a) * (1 + b) * (1 + c) – 1.
d. What bothers me is that a = 12% - 13%, b = ~7%, which implies that “c” (penetration) is actually not growing!
e. Penetration is mostly likely growing which means that something wrong with “a” – CHUB’s customers are not growing their e-commerce as fast as the industry (ex-AMZN).
f. It is also possible that the ramp up of new customers skews the math above but I do not think such skew should be so large.
g. In any event, I would be curious to know what you think about it. In my view, CHUB should be growing at (1+12.5%) * (1+ 7%) * (1 +at least 5%) – = 25%.
2. 2. SBC as % of Sales
a. One of the most interesting things that came out in 3Q 2016 results was dramatically lower SBC vs. 3Q 2015 (even after taking out fair value adjustments).
i. SBC was only ~$2.2M in 3Q 2016.
b. You wrote “Sector‐leading stock‐based compensation (7% of revenue vs. 15‐50% for comparables)”
c. Why do you think that the annualized rate of $9M will stay in place for the next few years?
d. We know that the total SBC in 2015 was $42.15M, which includes $12M of fair value adjustments. It means that the “ongoing” SBC = ~ $30M or a quarterly run-rate of $7.5M.
e. I was thinking that smth in between $9M and $30M would be a better proxy but I am happy to be wrong here.
f. Have you been able to figure out why the ongoing SBC dropped so much in 3Q 2016?
g. Also, I was not able to figure out how much fair value share-based compensation adjustments were in 1Q, 2Q and 3Q 2016. Would you mind sharing it if you you had more success than I did?
3. 3. Sales & Marketing
a. You wrote that “CHUB’s core business (pre‐Mercent) was doing 60% EBITDA margins with 5‐7% sales and marketing spend as a % of revenue”.
b. I was able to track Revenue, Adj EBITDA, SBC, and D&A for 2011 – 2013.
c. In 2014 revenue grew ~30% while Adj EBITDA margin was ~60% and S&M expense was ~10% of revenue.
d. Would you mind sharing you data re: 5% - 7% of sales?
4. 4. Competition
a. You wrote
i. “CHUB has no third party competition of scale as it benefits from network effects working with most of the leading retailers and over 9,900 of the leading brands.”
ii. “CHUB’s core dropship business is the only provider of this service in the market.”
iii. “The most similar is SPS Commerce however CHUB is a better business in our view because CHUB faces no significant competition for its core solution (SPSC and others say they do drop shipping but our VAR suggests that only CHUB does it at scale) with much higher margins (low‐teen margins at SPSC).”
b. Would you mind elaborating more on this? How are their products different and why is CHUB offering stronger / better?
c. SPS has ~24K customers and ~$158M in revenue in 2015 vs. CHUB’s ~$87.6M. So SPSC has to be doing smth right.
i. However, I want to recognize that SPSC’s revenue per customer was ~$6.7K in 2015 while CHUB’s revenue per customer was $9.16K (though it includes Mercent’s revenue).
5. 5. Customers
a. You wrote “CHUB works with the vast majority of the top retailers within its addressable market. Our diligence/customer calls suggests that the non‐CommerceHub retailers are all potential targets (currently not using an external solution in a meaningful manner).”
b. Would you mind sharing which larger retailers fall into this category?
6. 6. Brand Direct Product
a. You wrote:
i. “CHUB is now bundling this with a broader offering that allows brands (many of whom are already CHUB dropship customers) to control their direct to consumer offering across all these channels. Given CHUB’s dominant dropship position, no other competitor will be able to offer the same service.”
b. If SPSC buys / merges with ECOM, will the combined company be able to provide very similar service offerings as CHUB does?
7. 7. Sellside coverage
a. Do you have any thoughts on potential initiations?
b. Not that I care much (i.e., if we are right on fundamentals of the business, who cares when big banks initiate coverage) but I am definitely still curious.
8. 8. Mercent
a. How did you back out Mercent’s revenue and EBITDA in 2015?
9. 9. G&A
a. You are modelling $22M - $23M.
b. 3Q 2016 G&A was $8M which included $1.5M of Spin Off related expenses. So excluding that G&A would be $6.5M which is $26M annualized.
c. At the same time we admit that G&A was ~$4.7M in 2Q 2016 which would indeed translate into ~$19M + $5M of standalone company costs => $24M of G&A.
d. In the grand scheme of things, this is only $3M of difference but I would be curios to hear your thoughts on what gives you comfort with $22M-$23M of G&A.
10. 10. D&A
a. Why are you modelling lower D&A in 2017 ($7.7M) and especially in 2018 ($4.6M)?
b. My thinking was that amortization of the software that has been capitalized until 3Q 2016 when CHUB changed the accounting treatment, would keep D&A at about current levels? However, I did not dig very deep into it.
11. 11. Share Count
a. I do not mean to be neat picking on an excellent write up but just wanted to bring a couple of items to your attention in case if it is helpful.
b. You are using 42.7M of S/O.
c. 3Q 2016 weighted average diluted shares outstanding were 43.56M.
d. On top of this there are ~5.034M of anti-dilutive securities which should become dilutive if the stock goes well.
e. This does not break the thesis but takes some upside away.
f. On top of that share count would be increasing due to ongoing stock-based compensation.
Again – excellent write up and I agree with 80% of your thesis (we are pretty much on the same page as the business model goes and how attractive it is). I hope through a discussion here I will be on the same page with you on the remaining 20%!
Thank you in advance or your answers.
|Subject||Re: Excellent Write Up / Several Questions|
|Entry||11/21/2016 08:05 AM|
OK a lot to answer, let me run through each:
1) I agree on your build up with big difference that I think you are overstating #2. They have deeply penetrated top retailers and we don't expect a lot of growth there (perhaps in #s it will grow b/c the #26-200 retailers can be added but these are small GMV customers). The # of suppliers really drives #3. Also you need to add on any Brand Direct revenue on top of this core organic growth to get to overall revenue growth.
2) Stock-based comp is going to run-rate at current levels as we have modeled ($9mm or perhaps even less). This was a big misunderstanding when they did the spin - the high SBC when CHUB was private was a function of the marking to market exercise they had to do every year (accounting quirk based on the way the SBC was treated for their specific compensation system when they were private). Also consider the underlying owners (Malone etc) are shareholder value focused and are focused on minimizing dilution.
3) 2014: adjust S&M spend = $3.7mm on $66mm in revenue = 5.6% of sales. This grew to 8.7% in 2015 and was negatively impacted by including Mercent.
4) SPS Commerce isn't a competitor - they do cloud-based EDI (i.e. small suppliers who need to ship a pallet of goods to a retailers warehouse). They serve small suppliers where the economics don't justify investing in a direct EDI connection/integration to the retailers EDI system
5) Some retailers like Nordstrom or Gap don't use CHUB but that is primarily because, as of now, they are focused on a limited assortment of brands so there is no need for dropship solution.
6) ECOM doesn't do dropship - they are just the core Mercent business. We think CHUB is the only one able to bundle the offering to brands and sell across not only marketplaces (Amazon, Ebay, etc) like ECOM offers but also direct to customers via retailers (dropship). This is the primary reason we are constructive on their Brand Direct strategy - it will be differentiated in the market and already has 9,000 suppliers as customers that it can cross-sell to (lower CAC)
7) Not sure but Stifel could be a possibility, they took CHUB out on the road for the spin and have a strong tech practice
8) They give you Mercent revenue. We looked at where CHUB margins were in 2014 and looked at margin delta from Mercent mix dilution and calculated it that way
9) Adj G&A (ex SBC, intangible amort) was $6.2mm in Q3. As you note $1.5mm was spin-related and goes away but the Q3 # also has some expenses that aren't at full run-rate yet (will be in Q4). So we came to $5.5mm x 4 = $22mm run-rate. This will be flat here
10) D&A will come down. All D&A flows through COGS and this included software amortization. Now they are expensing software which hits R&D but there is a large until D&A fully normalizes (will happen over the next 1-2 years as that is amortization period for prior software spend). This means gross margins will increase in '17/'18 as old software capitalization burns off
11) Fair point on shares thx for flagging
|Subject||RE: RE: Excellent Write Up / Several Questions|
|Entry||11/22/2016 12:00 AM|
Thank you for your responses. I will follow up on a few items where I think we may have misunderstood each other.
1. 1. SBC.
You are using 3Q 2016 SBC to get to ~$9M run-rate SBC per year. To back this, you are referring to prior fair value / mark-to-market adjustments.
I get it and I agree that they should be backed out; in fact that SBC mark-to-market adjustments presented a reason why I thought CHUBK could come out mispriced right after the spin off. So this is not new information.
My point is that 2015 SBC compensation after taking out mark-to-market adjustments was ~$30M (~$42M of total SBC minus ~$12M of MTM Adjustments = $30M).
You are bringing it down to ~$9M.
Hence, I am trying to understand what would drive such a big decrease in on-going SBC.
“Stock-based comp is going to run-rate at current levels as we have modeled ($9mm or perhaps even less). This was a big misunderstanding when they did the spin - the high SBC when CHUB was private was a function of the marking to market exercise they had to do every year (accounting quirk based on the way the SBC was treated for their specific compensation system when they were private). Also consider the underlying owners (Malone etc) are shareholder value focused and are focused on minimizing dilution.”
I agree on Malone point but the rest does not really help bridge a gap between $30M and $9M.
If my numbers are wrong, please tell me as I will be happy to fix whatever may be broken in my math.
There are two other reasons why I think $9M is way too low:
a. 4Q or 1Q includes annual bonuses and I would expect that quite a bit of bonuses would be options or RSUs.
b. 3Q 2016 SBC probably had negative MTM adjustments (similar to 2Q 2016) for the first 21 or 22 days of the quarter (before the spin off). This is what 10-Q says:
a. “For the three months ended September 30, 2016 the estimated share-price input was based on the fair market value of CommerceHub's Series C common stock traded immediately following the Spin-Off (for shares granted prior to the Spin-Off) or the fair market value of CommerceHub's Series C common stock on the grant date (for shares granted after the Spin-Off), which decreased as compared to our most recent internal valuation and resulted in a reduction to expense”
b. This is my guess / guesstimate and I do not have hard evidence to support it.
2. 2. ECOM
I know that ECOM is more similar to Mercent and has nothing to do with shipping / drop ship. I was asking what you think about a merger between SPSC and ECOM as a threat to CHUB dominance. However, based on your commentary on SPSC, you think that SPSC is not a competitor to CHUB in its core product, and any merger with ECOM (if that ever happens) is not likely to change it.
3. 3. 2014 Adjusted S&M
So you are using S&M excluding both MTM Adjustments and Ongoing SBC. Is this the case?
It is obviously fine and everybody uses his/her own metrics, but I want to confirm your approach.
Again – I am not trying to prove that my math is better; I simply want to figure out the best estimate of most critical metrics here (and as you pointed out SBC is one of them!). If I am wrong, I will revise my forecasts for 2017 – 2019. I hope this discussion will help with this.
Thank you in advance.
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|Entry||11/22/2016 01:16 PM|
1. The Mark-To-Market adjustments in 2015 were much greater than the $12mm you cite. The $12mm is only the YoY increase (not the total amount). IR has been clear that the vast majority of the $42mm in stock-based compensation was related to MTM adjustment. Additionally, they gave guidance for 2H'16 of $4mm-$5mm which incorporates the seasonality of bonuses in Q4 you mention.
2. SPSC is not a competitor to CHUBK. SPSC will say they do drop shipping but they do not offer a scalable solution.
3. As discussed in #1, SBC isn't that great post MTM adjustments. We model the individual line items (S&M, R&D, etc.) ex SBC to calucluate Adjusted EBITDA (consistent with mgmt definition) and then subtract SBC from Adjusted EBITDA to get EBITDA including SBC expense. The beauty of CHUB is that even after subtracting SBC, CHUB is extremely profitable unlike most fast growing tech companies.
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|Entry||11/22/2016 11:10 PM|
JSO and Clark, big thanks to both of you for your responses! Very helpful. That's why I love VIC and VIC community!!
JSO, thank you for elaborating on $12M of "incremental" MTM adjustments instead of "total" MTM adjustments as I was interpreting it. Much appreciate it.
Clark, thank you for mentioning Erik. I am coordinating a call with him as I am writing this.
Let me follow up on SPSC and competition. I was re-reading 1Q 2016 SPSC transcript today, and I keep getting a feeling that they do dropship + shipments from supplier to retailer's warehouse. I also checked sellside reports (not the best source but still) and they say that SPSC does dropship.
JSO and Clark, would you mind sharing more on ths front (my SPSC is not doing "actual" dropship)?
Changing gears, have you guys thought much about capital allocation? CHUB will be generating strong cash flows. So far it has been using it to pay down revolver (both in 3Q and, as expalined on the earnings call, in 4Q). But what's about going forward? Share buyback? M&A?
Thank you again for a great discussion!
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|Entry||11/23/2016 07:46 AM|
Yes thanks - the stock-based comp argument is clearly misunderstood by the street based on historical accounting, we think this continues to clean up/clarify in 2017. Also keep in mind CHUB is controlled by John Malone who runs his entities for shareholders - so that is another check on excessive stock-based comp. THis also applies to your capital allocation question - i'm not sure what they will do with FCF but I'm comfortable saying it will be intelligent and well thought out. Buybacks wouldn't surprise me given the Liberty DNA.
On SPSC: they are primarily a cloud-based supplier of tradtional EDI links to retailers - this is the software that manages traditional supply chain relationships (i.e. ship a pallet of widgets to Target's distribution center on this date and Target takes it from there). They technically do drop ship but have presence significant presence here (this is coming from the SPS CFO I spoke with). A dropship relationship requires a totally different level of integration because you are allowing suppliers to deal directly with your customers - you need real-time visibility into their inventory so when they advertise the product they can commit to delivery dates (critical in e-commerce).
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|Entry||11/27/2016 10:18 PM|
Thank yo, JSO. I agree re: capital allocation though I tend to think that M&A transactions are quite likely in adjacent spaces.
Re: SPSC. You wrote "They technically do drop ship but have presence significant presence here (this is coming from the SPS CFO I spoke with)." Would you mind repeating it? Did you mean "do not have signficant presence" or "have significant presence"?
I agree that dropship requires a way deeper integration and it is more difficult to build a dropship product and integrate it. However, based on what I have read, it looks llike SPSC does quite a bit of it. I would post below various quotes to move the disucssion forward. If you have feedback on those quotes or if you could share your own diligence findiings on this issue, it will be great.
1. 2016-01-13 SPSC at Needham & Company Growth Conference
- SPCS presented a case study of Grainger that several years ago wanted to move from 50,000 SKUs to 1M SKUs and the only way do it was through dropship.
- While discussing Grainger case study, CEO talked about a totally different level of integration: "each morning, you need to know what inventory levels do your suppliers have. When you send them a purchase order, you want to know real time that they're acknowledging it, and they're going to ship it, because the expectation is same day shipment . ... When you ship it, I need to know what the UPS or FedEx shipping number was. I need a packing slip in it. ... the whole level of integration between a retailer and a supplier is changing, and that's the challenge for a retailer and a supplier."
- CEO belives that dropship "ideal" share in a total revenue mix is between 15% and 20% because if a product is having "sales velocity", a retailer wants to bring it to the distribution center to control customer experience. [Ares: he is obviously talking his book and CHUB is talking its book when CHUB refers to 30% to 50% dropship penetration with some customers]
- When asked about CHUB, CEO said that CHUB has dropship part of the business (overlaps with SPSC) and the order managmenet systems that allows retailers to decide where to buy goos (does not overlap with SPSC). CEO said that SPSC competes with CHUB.
- Finally, CEO said about CHUB “I think long-term, CommerceHub is in a tough spot ... because they're 100% focused on drop-ship suppliers, and ... most retailers are realizing there aren't distribution suppliers and drop-ship suppliers, your suppliers are ... going back and forth.”
- The last point is what I kept thinking back in June and July. Would not a customer need to be using some other SaaS or legacy solution for direct shipments to retailer if such supplier is using CHUB for dropship? More on this below.
2. 2016-02-29 SPSC at JMP Securities Technology Conference
- “we see CommerceHub periodically. ... [CHUB ]is focused ... at least today, on e-commerce and the drop-ship component of it, and only the drop-ship component of it. So, they've got a segment of the marketplace.” Then CEO added that SPSC has not seen CHUB more often in terms of competing with CHUB than it used to.
3. 2016-08-10 SPSC at Stifel Technology, Internet and Media Conference
- “Our retailers are trying to go after drop-ship and they're trying to expand their item count.”
4. 2016-08-10 SPSC at Oppenheimer Conference
- CEO again gave Grainger example (see more on this above)
- About CHUB, CEO was asked about CHUB again. CEO said (1) CHUB has 3 products which are Mercent product, order managmenet system that CHUB sells to retailers, and drophsip. SPSC overlaps only in dropship.
- CEO mentioned that dropship ideal mix is between 15% and 25%.
- CEO also said that in his opinion that Manhattan Associates, NetSuite, SAP and similar providers should be the ones who sell order management system to retailers. His message here was that CHUB is in a "wrong" business.
- CEO said that dropship fullfilemtn module "competes directly with us".
- "If you're a retailer and you don't have an order management system, CommerceHub is compelling because they sell the order management system. If you have the order management system, [and ] ... you use CommerceHub, you are forcing your suppliers to use SPS or somebody else for your product that goes to the distribution center and then CommerceHub for the drop-ship” .
- "Most of our customers ... blended. ... It's a meaningful amount.”
- "Dropship is a meaningful part of our business".
5. 2016-08-11 SPSC at Canaccord Genuity Conference
- Case study of Grainger (yes, again) with focus on Dropship.
- “we have billions of dollars of drop-ship product going through our network”
Based on all these quotes, I think SPSC is a real competitor for CHUB. It is also clear that many customer use both. This makes me think that at some point either SPSC will try to upgrade it drophsip offering and kick CHUB out or CHUB shoudl build or buy offering which is similar to the core SPSC offering (ship good to retailers' distribution centers). That's why I mentioned that M&A is a likely venue for capital allocation.
In any event, I would be very interseted to hear what you have found and what you think abot my concerns.
Thank you in advance.
|Subject||Re: Re: Excellent Write Up / Several Questions|
|Entry||11/29/2016 06:06 PM|
JSO, on #3, 2014 S&M was $9.966mm, and SBC in there was $4.249mm, so I get $5.717mm of adj S&M, or 8.7%. That grew to 10.4% in 2015 (likely due to Mercent) and has gone to 12-13% in FY2016 as they invest. Are you excluding anything else I should be backing out? Thanks.
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|Entry||11/29/2016 06:20 PM|
Sorry my mistake, looked at wrong line please disregard
|Subject||Re: Re: Re: Re: Re: Re: RE: RE: Excellent Write Up / Several Questions|
|Entry||11/29/2016 07:04 PM|
SPSC enables drop shipping but they don't provide a solution that enables retailers to effectively scale a drop shipping program. CHUB does not sell an order management system. They perform sophisticated integrations into a retailer's IT ecosystem, including their OMS and frequently accounting ledger as well. This integration effectively "extends" the retailers own systems so that each supplier acts as it own virtual warehouse.
The important point to understand is that SPS provides no software to the retailer. The retailer is simply telling their suppliers that if you want to receive drop-ship orders they will look like this, and if you want me to pay, then send me invoices that look like this. The supplier can either figure out how to do that themselves (which includes configuring their ERP systems to import and export data in a specific way) or pay SPS to do it for them. The retailer has no visibility into the fulfillment process or control of the customer experience - they just log into their EDI mailbox and see if there are invoices, shipment confirmations, etc. back from their suppliers. This kind of approach is fine for a small drop ship program, but breaks down at huge volumes where orders are shipped late or never shipped at all.
With CommerceHub, the retailer logs into a software application and sees the order activity and status of potentially millions of orders. They are able to configure the platform to proactively identify fulfillment problems (late orders, etc.) before they ever impact the retailer's customer. This kind of control and visibility allows a retailer to scale their drop-ship program to the point where it can enable billions in revenue for the retailer. You can't do that with EDI alone becuase the retailer simply can't manage that amount of EDI without software to control the fulfillment experience.
There are no signs right now that SPS is looking to compete more directly with CommerceHub. The reason is because CommerceHub has a deep moat where it is already the system of choice for the majority of leading retailers with a proven and tested system.
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|Entry||11/29/2016 07:42 PM|
Thank you, JSO. This is helpful.