WAYFAIR INC W S
January 28, 2020 - 3:56pm EST by
NZ
2020 2021
Price: 106.20 EPS 0 0
Shares Out. (in M): 93 P/E 0 0
Market Cap (in $M): 9,700 P/FCF 0 0
Net Debt (in $M): 1,000 EBIT 0 0
TEV ($): 10,700 TEV/EBIT 0 0
Borrow Cost: General Collateral

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Description

I'm sure most VIC readers have heard of Wayfair - this company has been discussed before and I encourage you to refer back to 2 previous write-ups (jls and TheSkeptic) for company history etc and related discussion boards. For a company that is trading at a multiple of revenues and considering the short-term nature of this thesis, I don't think it is worthwhile to give a price target. Instead, by presenting Q4 web traffic data, I believe we can draw a conclusion that near-term results will compress the multiple. The company is scheduled to release results on Feb 28, 2020.

TAM and long-term possibilities:

I would be remiss if I didn’t acknowledge the tremendous TAM and tailwinds that e-commerce offers the home-goods and furniture industry. The growth of Wayfair and Overstock has disproved the claim the furniture and home goods industry is defensible from the growth of e-commerce due to its bulky and large ticket nature.Taking a long-term short position would be risky, and not the thesis here.

That being said, until some company shakes-out the competition, or accomplishes what AMZN has done (create a platform that sells every item under the sun and scales, becomes a retailer on its own platform to generate larger margin + take a FBA fee/sponsored products for third-party sales, begin its own delivery network, and create a profitable + scalable technology solution the likes of AWS), profitability will remain elusive. Wayfair may eventually implement these drivers, but again, in the near-term, this won’t move the needle much.

(In a macro sense, the We-Work debacle has gotten VCs and investors questioning the theory of growth-at-all-costs...great article in WSJ highlighting this https://www.wsj.com/articles/after-wework-real-estate-startups-rethink-pursuit-of-fast-growth-11580207402?mod=hp_featst_pos2
”In recent years more Silicon Valley startups chose to burn through cash to grow. The rationale: Online marketplaces and social networks can more easily and cheaply add customers once they reach a certain size.”

Analysis:

Wayfair has grown a tremendous amount since its founding in 2002 (rebranded in 2011), and still generates Y/Y revenue growth of 30-40+% (albeit slowing). 

However, that growth:
- is not scalable considering the fierce online marketplace and ease of price checking
- arguably not considered investment in future growth that can be turned off immediately
- web traffic data, including Q4 which the company has not released yet, shows slowing visits and significantly increased marketing expensive for Wayfair, in contrast to management's guidance. The company will suffer in the near-term, and presents a solid short opportunity as we inch closer to Q4 earnings.

Here is a snapshot of the company's recent financials released at the end of Oct:

 

A quick vertical analysis tells us that Gross Margin ranges in the 23-24% ballpark, advertising expense has ticked up slightly from 11% to 12% of revenues, and 49% to 50% of gross margin.

A horizontal analysis tells us revenue has grown YTD Y/Y 38%, gross margin has grown 43%, and advertising expense has grown 45%. 

Let’s put aside all concerns about slowing growth, repeat customers/LTV economics (full transparency, break-even does not occur on the first interaction with the customer), increased tariffs, infrastructure build-out, increased headcount and protests, and positive vibes about management...all that has been extensively discussed on previous discussion boards. While that represents a lot of moving parts, I believe more focus has to be given to marketing costs which eat 50% of the gross margin, and is crucial to online platform. So instead, let’s focus on the company’s marketing efforts, and whether this is creating loyalty, an expanding customer base, and potential leverage. 

To quote management during Q3 earnings call:

 “Advertising spend was $282 million, or 12.2% of net revenue in Q3. This is approximately 35 basis points higher year-over-year.  Advertising is up 44% YTD. This is due to continued negative mix shifts as our International business which operates at higher levels of advertising as a percent of sales outpaces U.S. growth rates, and continued ad spend to add new customers in the U.S. within our ROI payback threshold”

“The average cost of customer acquisition or CAC has risen modestly in the quarter…Fundamentally, we expect advertising costs to drop as a percent of net revenue, as the repeat customer base grows faster…and runs at a 7% ad cost as a percent of net revenue”

2 take-aways: 1) Advertising expense is going towards international domains (growing 40+% Y/Y), and that is more expensive than US advertising 2) Management has a fundamental belief that advertising costs should decelerate as loyalty and customer awareness builds. In other words, Wayfair will have more people coming directly to their sites, or at least not price checking against other sites = better conversion + cheaper ad spend.

2 realities: 

  1. Visits to the US site have not dramatically increased as 2019 has progressed (in line with slowing Y/Y revenue numbers), and worse- the balance between direct vs paid visits has swung to the paid side significantly throughout the year, marking a shift to a more expensive customer acquisition process (Orange represents 2018, blue represents 2019)

 


 

  1. International expansion has grown (albeit at a slower pace), but also in a more expensive fashion (paid search has grown from 19% to 31%, and direct has gone from 34% to 30%). Here is a trailing 24 months of visits. Below that we can see the shift for Q4 Y/Y, and then the shift from Q4 18, Q3 19, and Q4 19 (Disclaimer: Sample size over the individual quarters is desktop only, and international visits are more skewed to the mobile side) 

Data also shows that visitors go consistently between Wayfair and Overstock, and are increasingly going to Amazon (how surprising!) Granted, for bulky items Wayfair has a logistical advantage in delivery, but...well, we all know what Amazon could do.

Two other data points that are worth mentioning:

--Target released some numbers for Q4 in the middle of January. 

Home sales dropped about 1% during November and December, stating weakness across “portions” of the segment, not its entirety. Overall for retailers this holiday season, the home furniture and furnishings category grew 1.3%, according to Mastercard SpendingPulse. 

--Pier 1 imports is closing half its stores, which might bring some shoppers online, and into Wayfair’s net. Though for the time being, promotions and liquidations might squeeze competitions margins.

Risks:
Investors might become hyper-focused on revenue growth, and somehow justify increased cash burn and advertising costs. Though the acknowledged slowing rate of growth (CFO mentioned seeing mid 20% Y/Y growth in the beginning of Q4, significantly lower than previous years) should alleviate these concerns.

Web traffic data is off, and/or paid search becomes extremely profitable, without the regular 12+ month payback target.

Wayfair becomes an acquisition target. At its current size, cash reserve, and considering management/founders stock holdings, the pool of acquirers is pretty limited. Additionally, this likely won’t occur in the near-term.

Large short-interest out there (~30%), which could create a short squeeze

 

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

Increased customer acquisition costs

Continued cash burn

Poor Q4 results

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