While REAL's stock is speculative in nature, we believe that the business is nearing a fundamental inflection point, creating a scenario where the equity has the potential to materially re-rate. We think it is possible that REAL could be 5x+ over time if the new team executes on their new plan.

Background:

The RealReal is an online marketplace for authenticated luxury products. During Covid, the old profligate management team chased product and took on inventory risk with their balance sheet. Conversely, the new team is laser focused on earning a profitable take rate and being a global marketplace for authentic luxury goods with an asset-lite business model.

Industry and TAM:

There has been recent consolidation in the space as peer POSH was taken out last year by South Korea’s Naver Corp. The year before, Etsy spent $1.625 billion to acquire Depop or 10x forward revenue at the time. EBAY has also made signifcant investments in an effort that has so far showed only mixed success. Part of the reason for EBAY’s struggles may be that historically the site is known for fake products and cheaper goods; the debate remains whether higher end EBAY customers will “trust” the that platform to buy a Birkin bag or Patek Philippe watch.

Charts from last year’s REAL initiation from Jefferies shows a solid market opportunity estimate:

A second interesting chart:

Barriers to entry:

There has been a lot of capital invested in REAL that we, the newer shareholders, can finally benefit from. Our site visit to REAL’s distribution center in New Jersey and our meeting with various senior authenticator team members strengthened our belief in what we have long suspected—this is a tougher business to re-create at scale than most investors likely realize. REAL uses proprietary technology that they call their “Vision” software to quickly authenticate lower end items and for higher priced and rarer items, REAL uses human intelligence and seasoned professionals to authenticate such high-end products such as say Birken bags and other luxury goods. Further, the Company has 12 physical locations around the US to showcase and source additional product. Note: this store count is down from 18 stores, as the Company is focused entirely on profitable units. The goal is to keep the best and most profitable small footprint stores, such as the ones located in Greenwich, CT or Palm Beach, FL. The Company has now closed the unprofitable units in Chicago, San Francisco as well as several others.

Source: 2023 REAL Investor presentation

Company Positioning:

Presently, REAL shares have seemingly been “left for dead” but we believe that they have a “real” (pun intended) brand and a loyal customer base. REAL has more than 32 million active members with strong engagement. REAL has one of the strongest authentication teams out there, per our checks. We would also make the case that REAL might do surprisingly well in a recession scenario (will we ever have one of these??). In a recession, we think that rich people might be more willing to consign items, rich people are more apt to trade down, and people strapped for cash will also likely increase consignments. One could also legitimately make the case that TheRealReal should be someday acquired by an LVMH or another company in luxury. At this price, the stock and debt are quite small relative to the market caps of many of the luxury players to buy into the secondary goods market.

Balance Sheet:

When looking on Bloomberg, the Company looks levered. However, it is less so than it appears upon a closer review. There are currently 101.74mm shares outstanding, implying a $141.4mm for the equity market cap. Meanwhile, there is about $450 million of face value of their debt (the “converts”). However, the debt is trading at a discount in the market. We would note we also think the converts are attractive securities in our opinion, as well as the equity. Further, we believe there is a reasonable chance the Company may want to tender or try and retire some of the debt via open market purchases. In theory, the mark-to-market price of the debt is $236 million, while the Company has cash of $247 million. In addition, there is $27 million left of the Covid inventory (poorly purchased inventory during the prior leadership regime). Assuming zero value for that inventory (draconian in our view), the cash and debt essentially nets out. However, this also assumes that the company isn’t burning cash, which it still is. Importantly, however, we speculate that the company will become cash flow positive on a run-rate basis by Q4 ’23 or early 2024. That is well ahead of where Street models are currently projecting their estimates.  We base this assumption on our own cost cutting measure estimates and the decisive action of the new management team.

Bottom-line:

Overall, we are encouraged by the new CEO John Koryl, who was formerly president of Digital at Canadian Tire Corp and previously lead the digital group at Neiman Marcus. We also are impressed by the CFO Robert Julian. Robert was CFO formerly at Sportsman Warehouse (SPWH).

As mentioned, the Street expects negative EBITDA in ’23 and a more modest loss in ’24. The Street doesn’t expect positive EBITDA until 2025. We think that the Company is aggressively cutting costs and seem to be focused on profitability, likely for the first time in its operating history. We speculate that profitability will come much sooner than many currently believe. We don’t think our thesis is based on fantasy as a roughly $2 billion GMV business with 85% repeat buyers and a 30% take rate should be able to achieve profitability!

We also believe there is a significant advertising opportunity that is not currently priced into REAL shares. For example, targeted digital advertising and related partnerships have never previously been promoted on REAL’s website. While we don’t expect digital ads to be as significant as they are to an Amazon or Google, we similarly think that zero is also the wrong amount to forecast for REAL's potential advertising business. We think this high-end customer base could be a nice opportunity for targeted marketing from potential partners such as The Four Seasons Hotel chain or a NetJets.

The bottom-line is that the equity market cap sliver is only $140mm and the balance sheet is fine. The Company is exiting the direct business to focus entirely on growth in luxury consignments. Further, they have moved away from consigning lower cost items to promote a stronger margin profile. They have shifted the commission structure and are close to finishing working through the covid inventory bloat. We believe a more disciplined and profitable company will soon emerge.