FARFETCH LTD FTCH S
August 08, 2019 - 8:41am EST by
aprovecha413
2019 2020
Price: 17.00 EPS -0.93 0
Shares Out. (in M): 257 P/E 0 0
Market Cap (in $M): 5,210 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 4,509 TEV/EBIT 0 0
Borrow Cost: General Collateral

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  • I'm not short but you should be
  • best timing ever

Description

This is going to be a quick-hitter and admittedly light on content, but I think that Farfetch may be a short. It trades at 6.5x revenue and isn't remotely close to being profitable. This isn't a big deal if you're betting on a category killer biz model, the "amazon of luxury goods" bull case. And of course, you can find plenty of other nose-bleed valued businesses to compare it to = fair enough even if naturally guilty of relativism. But I think the inherent problem with the business model is two-fold: 

a) Any time incipient stage luxury brands effectively leverage the platform to make a name for themselves, they're immediately going to shift as quickly as they can to building their own platform and not paying a 30% take rate to Farfetch. The counterpoint is that a 30% take rate is less than what an emerging brand would pay any traditional luxury goods physical marketplace player (and there are fewer of those every day...a la Barney's filing for bankruptcy in the last 48 hours). All well and good, but that's still more expensive than going it alone once a given brand has critical mass. Herein lies the core problem: even if FTCH provides a valuable service and curates emerging brands effectively, they're still constantly on the treadmill of replacing brands that either fade or graduate to stardom. That's a tough position to be in. Constantly. 

b) The second structural issue is that even if you're a luxury brand that finds value in the platform (in addition to pursuing your own channels), the name of the game in creating brand heat is managing inventory such that demand always outstrips supply. This means that any commercially conscious brand manager will sell the crerme de la creme skus through their own channels and leave the less sought after stuff for Farfetch. 

I think the behaviorally biased long-side retort is: "Hey man, shut up and go look on the website...they've got Burberry, Saint Laurent, and a bunch of other iconic brands, not to mention backing from the likes of Conde Nast and a strategic partnership with Chanel. Clearly, brands don't 'graduate' from the platform." That may have been true yesterday. I mentioned Burberry and Saint Laurent because they're two brands we recently spoke with at the deputy CMO level. While it's not surprising that old guard brands would be technological laggards, a wave of them are moving swiftly to invest in digital, and in the last several months keyword bids are ripping = cost of customer acquisition is doing the same. We also spoke with a woman who was offered the job running Farfetch's Americas division (turned it down for undisclosed reasons), who described this dynamic vividly, so we pulled a bunch of paid vs. organic search, web traffic, page view, and credit card data to see what it suggested. The shift appears to be violent. 

The other ugly signpost since they reported the last Q is that Conde Nast (mentioned above) pulled their investment, other exec level heads rolled along with them, and the CMO (John Veichmanis) got fired for his "exorbitant spendiness," as expressed by the former Chief Growth Officer (who we interviewed last week). On an interim basis, the COO, Andrew Robb, is stepping in to play both roles (CMO and COO) as “fixer." Not a good time for a headcount shake-up. Here's why: their businesses (% of rev, which they only break out annually) is 30% US, 40% Europe, and 30% Asia. All the data I referenced above is the most reliable and highly correlated in the US and doesn't look good. In Asia, Alibaba just launched an online market place in the last couple of months = just about the last company on earth you want to compete with in China. In Europe, LVMH, the global high fashion behemoth, launched 24S, a directly competing platform with Farfetch. Furthermore, our primary research suggests they're now putting the pedal to the metal on digital advertising.

All this is flying in the face of a company where the whisper expects revenue to only slightly decelerate yoy this Q vs. last and losses in profitability to lessen. Seems tough. More importantly, the longer-term picture for this business model, notwithstanding the aforementioned structural concerns, is that the winner takes most or all. If they win a market that is small and fleeting, Farfetch is probably worth a lot less. If they lose, it's worth pennies on the dollar. 

The risk is the stock has been pounded in the last week (like just about everything else), and my view on timing isn't terribly strong, nor is my history with the company, so it can def rip faces off in the immediate term for no particular reason. May make sense to watch the Q, do the work, and add on strength. But I still think any hint of weakness and (especially in this market environment), they will light this thing up. The downside is not 20% lower, it's zero + a little. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

I'm often suspect of hypothetical competitive entrants short theses largely because of frequent lack of evidence in support of actual changes in customer behavior and subsequent target company competitive response. However, while we're early in our work on this one, I think it may be happening now. Farfetch's promotional cadence has increased meaningfully yoy in the 2Q calendar period (if anyone wants a schematic of this happy to share it, just pulled via web scraping), and got even sharper in July. Note we can track promotional cadence from before the company's recent IPO, and we've not ever seen this level of heightened promotional activity. When we interviewed the former Chief Growth Officer last week, he specifically brought attention to the company’s inability to bring down its marketing and operating costs to sustainable levels. In his words, "Right now every order that goes out, like it or not, is a loss for Farfetch below the line. Every single product that goes out the door."

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