Description

Situation Overview:

Secoo (SECO) is a fast-growing (+40% CAGR) luxury e-commerce platform (website/app) that is benefitting from the rising upper-middle class in second and third-tier cities of China.  We think the recent partnership and $175M investment by JD.com and L Catterton will alleviate the concern about the legitimacy of SECO business as a business and its management. In addition, L Catterton’s affiliation with the family holding company of Bernard Arnault (CEO of LVMH, the world’s leading luxury products group) should help SECO get access to leading brands (vs procuring through authorized distributors). Overall, we think the company can grow earnings by +50% CAGR over the next couple of years and generate $2 of earning by 2020; giving us a one-year price target of $20 (80% upside).

The recent strategic partnership and investment by JD.com and L Catterton should be a catalyst for multiple expansion in addition to a potential earnings growth.  Trust (by consumers) plays a large role when shopping for luxury products online – SECO has done a good job building this reputation. Product authentication capability is very important to maintaining this reputation.  We think direct access to many brands via the L Catterton’s partnership will help enhance this reputation and eventually improve margins (vs buying from distributors). The JD/ L Catterton investment – having them kick the tires and writing a check – also helped us (as investors) to get more comfortable with the SECO operation.  As an upside optionality, we think SECO could grow faster and improve working capital efficiency if this relationship enables them to transition into more of a “consignment” business model.

The stock is a bargain here; currently trading 10x 2019 earnings and 0.5x 2019 sales.  We think the reason for the discount is lack of liquidity, size ($0.5B market cap), recent IPO with limited sell-side coverages (Jeffries), and getting comfortable with the management team and the operations’ legitimacy.  

Business Overview:

SECO is a luxury shopping platform.  The company offers a full range of high-end lifestyle products via its website, apps, as well as offline locations which it calls “experience centers”.  SECO offers over 3K brands (~300k SKUs). The company primarily makes money from merchandise sales (~98% or revenue); category mix and growth detail below:

SECO also generates some money (~2% of revenue) from its Marketplace and other services. These are services like repair and maintenance services and advertising services.

Offline Experience Centers: SECO currently has 10 experience centers. Offline centers accounted for ~6% of GMV in 2017 and are not meant to be a primary driver of sales.  The main goal of these offline centers is to provide one-stop service to address customers needs like product curation, pick-up, return, authentication and maintenance. ~80% of GMV sales came from mobile and ~15% comes from PC purchase.  

Growth:  We think SECO can grow top-line by ~35% CAGR through 2020.  Continued growth of merchandise GMV, active users, number of orders, to be the primary driver of this growth. According to Frost & Sullivan, China’s middle and high-income class reached 330M in 2016, and is expected to reach 595M in 2021e, with penetration increasing from 24% in 2016 to 42% in 2021e.

Margins:  Margin improvement should come from: (1) improved product mix. Today watches, a very low gross margin category, accounts for 30% or revenue. This is trending down and as more brands and mix with higher margin (apparels, footwear, and accessories) gets added to the platform, margins should improve. (2) improved product sources by buying directly from the brands vs buying from distributors. (3) operating leverage.  Operating expenses consist of fulfillment expenses, marketing, technology and content development expenses, and G&A. Further spending in the expansion of fulfillment infrastructure and inventory growth as they scale.

Ownership / Capital Structure:

• Two class of shares:  Class A share is entitled to one vote and Class B share is entitled to twenty votes.  
• The Founder, Mr. Li and his spouse control the voting rights and 25% of the company.  This will be diluted upon conversion of the JD/ L Catterton CD and warrants.
• A decent balance sheet with ~$60M of cash, $50M debt
• $175M convertible debt investment by JD/ L Catterton CD
  • 8% interest rate note
  • A conversion price of $13 (45% conversion premium)
  • Warrant entitles L Catterton to buy 500,000 ADRs
  • 3-year term
  • Convertible (principal amount of $175M) into Class A ordinary shares.
  • Right to appoint a director and an observer to SECO’s board for 3 years; or for as long as they hold 5% equity.

Competitors:  SECO is the largest player in the luxury e-commerce in China (25% share as of 2016) and in Asia (15% share in 2016) per Frost & Sullivan. Other key players include:

• Mei.com: Alibaba has invested/control Mei.com.
• Farfetch: JD.com has invested in Farfetch.
• Net-A-Porter:  Largest global luxury retailer. Asia is ~16% of revenue.

Risks:

• Loss of reputation/trust by consumers.  This could happen if SECO ends up shipping fake luxury products
• Relationship with brand partners and distributors
• Increased competition from Mei.com (a BABA company), and other players.

Catalysts:

• The JD / L Catterton investment alleviates the fear that SECO might not be a legitimate operation.  This should help with multiple expansion towards comparable peers’ multiple (high teens earnings multiple would be enough).
• Strategic partnership with L Catterton provides access to brands and favorable procurement terms.  Even better for FCF and WC if they get consignment deals from some brands.
• Partnership with JD.com provides additional marketing, logistics and technology support to SECO, like what JD did with Farfetch.  Potential financing access to SECO customer via JD Finance (JD Pay and JD Baitiao)
• More sell-side coverage.
• Faster than expected growth in GMV and improved product mix.

Catalyst

Catalysts:

• The JD / L Catterton investment alleviates the fear that SECO might not be a legitimate operation.  This should help with multiple expansion towards comparable peers’ multiple (high teens earnings multiple would be enough).
• Strategic partnership with L Catterton provides access to brands and favorable procurement terms.  Even better for FCF and WC if they get consignment deals from some brands.
• Partnership with JD.com provides additional marketing, logistics and technology support to SECO, like what JD did with Farfetch.  Potential financing access to SECO customer via JD Finance (JD Pay and JD Baitiao)
• More sell-side coverage 
• Faster than expected growth in GMV and improved product mix.