W - Wayfair

[ScottHall]

For those of you out there who aren't turned off by companies that exhibit a lack of profitability, I think Wayfair is a pretty interesting fast-grower. I purchased some shares pretty recently, as mentioned on my Twitter account.

 

Wayfair is an internet-based furniture retailer. If you wach television, you've probably seen an ad or two of theirs, and the company is expanding very quickly. The ecommerce edge over traditional retailers has been discussed pretty thoroughly, so I won't go into it again here as I'm about to run.

 

I will focus more on Wayfair in particular. One of the more interesting things about the business model is that Wayfair holds almost no inventory, which allows it to have a very broad selection of products; the company sells >7,000,000 products, and has over 7,000 suppliers.

 

As with Amazon, which has been discussed here in pretty great detail, Wayfair benefits from a negative working capital model. When a customer purchases something from the website, Wayfair typically doesn't pay the supplier until something like a month later. So long as the company continues to grow, this provides a form of float for the business and allows it to grow at a rate it otherwise couldn't.

 

So far, it's growing very quickly. TTM sales are north of $1.4 billion, and the company is currently growing the top line at >50%. The company is spending pretty heavily on advertising to accomplish that, having spent about $205 million in the LTM as of Q1.

 

The advertising is pretty effective; the company is currently paying about a $60 CAC after partner ad spend, and customers spend about $340 on average with the company annually at a ~20% contribution margin, so the advertising pays for itself pretty quickly.

 

Once Wayfair has the customer's information and has identified them as a mark, it becomes much easier to sell to the same customer again in the future; right now about 54% of orders are from repeat customers. On an LTV basis, quite a bit of value is being created here.

 

This is one that could be a multibagger or flame out; although I think the company has a shot at creating a moat, it's still pretty early along in the process. What's particularly interesting is the relationship the company has with suppliers; Wayfair integrates itself pretty deeply into its supplier network - for example, it keeps track of supplier inventory on a real-time basis so customers usually won't be shown items that are out-of-stock. Because Wayfair relies pretty much exclusively on its suppliers - remember, it holds minimal inventory - having these relationships is pretty important.

 

If the company continues to gain traction at the rate it has been, I suspect Amazon will buy it out eventually, as it does with all of these sites that make major inroads into interesting niches. That is, if they can't kill it first. This is a riskier investment than many discussed here, but the company could become multiples of its current size pretty easily.

 

I like the odds, so I bought some shares, but there's definitely a good deal of risk here.

 

Best wishes.

 

 

 

 

 

[Liberty]

Interesting idea, Scott, thanks for writing. I don't like retailers in general (QVC is an exception), but this seems to mitigate many of the things I don't like about retailers. It's still probably not for me, but it's interesting to learn and think about.

 

Cheers!

[DCG]

Why are they not making any profit on $1.2 billion in sales when they don't carry inventory?

[Liberty]

Why are they not making any profit on $1.2 billion in sales when they don't carry inventory?

 

They spend a lot on advertising to further fuel growth.

[DCG]

Are any of the products they sell exclusive to Wayfair? I've followed the company from a while from afar, as I worked in eCommerce for a while. They basically started as a lot of niche sites (like hammocks.com, barstools.com, etc.), and had companies dropship products for them. They still seem to use the same dropshipping model, but combined all their sites into one large site a few years ago. Usually with dropshipping arrangements, products are not exclusive, so they're essentially more of a marketplace for furniture and home products than a retailer.

[saltybit]

Wayfair is also pretty active on Amazon and eBay.

[rohitc99]

havent looked at the company, but i bought some furniture from them via amazon and directly from their website. so did a few of my friends. the price is very reasonable (or even cheaper by 10-15%) and the quality is quite good. overall service and experience was pretty good too.

 

finally, free shipping made a lot of difference too :)

[ScottHall]

Interesting idea, Scott, thanks for writing. I don't like retailers in general (QVC is an exception), but this seems to mitigate many of the things I don't like about retailers. It's still probably not for me, but it's interesting to learn and think about.

 

Cheers!

 

Happy to. It's definitely a bit riskier than most companies.

 

Are any of the products they sell exclusive to Wayfair? I've followed the company from a while from afar, as I worked in eCommerce for a while. They basically started as a lot of niche sites (like hammocks.com, barstools.com, etc.), and had companies dropship products for them. They still seem to use the same dropshipping model, but combined all their sites into one large site a few years ago. Usually with dropshipping arrangements, products are not exclusive, so they're essentially more of a marketplace for furniture and home products than a retailer.

 

You're correct that they still largely use that model, having the suppliers ship directly to customers. They're a little more hands-on than just that, though; they have about 15 (as mentioned at the Goldman event recently) centers across the country that larger packages are shipped to where the company or its partners overpack the items to minimize the risk of damage in transit. The company apparently employs people to determine the optimal level of packing for different sorts of items.

 

The company makes no major mention of having exclusive products anywhere that I've found, so as far as I know, you're correct about that. You could call it a marketplace, I suppose, in the same sense that many retailers are. Which is to say, Wal-Mart sells Coke products but Coke isn't exclusive to Wal-Mart. But it's mostly a semantic difference; call it a retailer, a marketplace, whatever you want.

 

The one major point of contention with that is that Wayfair is buying these products from it suppliers; they're not just listing the products on the website. That also seems semantic until you think through the benefits of economies of scale when it comes to negotiating pricing; that, as Wayfair grows, it can probably demand somewhat lower prices from it suppliers to give back to consumers, spend on advertising, or whatever else.

 

Bargaining power is a pretty big thing, and I think a lot of people (myself included) don't consider it nearly as much as we should when evaluating businesses. As the company scales and starts developing something of a network effect, I wouldn't be shocked if we see Wayfair start to use some muscle on that front.

[ScottHall]

http://finance.yahoo.com/news/wayfair-announces-second-quarter-2015-110000467.html

 

A great quarter for Wayfair.

 

Highlights:

 

Repeat orders from 53.9% of biz last quarter to 56.6% today. Was 51.6% a year ago.

 

Overall revenue up 66.4% YOY to $491.8 million.

 

Direct retail revenue up 80.8% YOY to $440.3 million. Growth is accelerating; only up 63.4% in Q1.

 

LTM revenue per customer up 7.5% to $357, was at $346 in Q1.

 

Loss per share of $0.23, improved from $0.69 last year. Personally this metric is irrelevant to me right now.

 

Still holding, will continue to hold as long as this company continues down this road.

[DCG]

Why is the fact that they are losing money irrelevant to you (and most other shareholders apparently based on the 27% stock gain after posting a loss)?

[ScottHall]

Why is the fact that they are losing money irrelevant to you (and most other shareholders apparently based on the 27% stock gain after posting a loss)?

 

Reinvestment in advertising. Profitability is irrelevant for the business at this point; in fact, I wish they'd lose more money. Company mentioned on the call it will intentionally be giving up margin this quarter. <3 it.

[DCG]

But if they cut back on advertising, their sales will likely drop. spending more on advertising than they're making can only be sustained for so long.Is their goal to spend heavily now to build brand awareness, with the goal of cutting back on advertising in down the road?

[ScottHall]

But if they cut back on advertising, their sales will likely drop. spending more on advertising than they're making can only be sustained for so long.Is their goal to spend heavily now to build brand awareness, with the goal of cutting back on advertising in down the road?

 

You have to focus on customer lifetime value, right. Advertising is mostly to gain new customers. Once you've made a purchase on Wayfair and the company has your e-mail address, it costs much much less to get you to buy from them again. It is almost free to send another promotional e-mail, so sales to repeat customers are much more profitable than sales to new customers are.

 

That's why you advertise, to get more people on your list that you can then sell to again in the future. With a negative working capital business, this can persist for a very long time because OCF will fund a lot of it. Look at how Amazon became so large; companies that benefit from negative working capital cycles can become perpetual motion machines so long as they have a place to put the money.

 

Making this very simple, let's say I run a business where it costs $100 to acquire a customer from advertising and He'll bring me in $90 per year for three years. Advertising is expensed immediately, with rare exceptions, so that puts me $10 in the red each time I acquire a new customer. But that customer is going to give me $270 in total over the next three years, so it's actually obscenely profitable to advertise and get these customers. It just doesn't look like it so long as you're growing.

 

Year one: -$10, year 2 +$90, year 3 +$90. I'd take that deal all day.

 

That's a very dumbed down version of what Wayfair is doing here, but it's the same basic theory. Same as Netflix, too, or any business where you can pretty safely determine what your recurring sales per customer are going to be.

 

Sometimes the best way to make money is to set it on fire.

[Liberty]

Nice pick so far, Scott. Outside of my circle, so I'm only watching with popcorn, but doing very well so far. :)

[rpadebet]

But if they cut back on advertising, their sales will likely drop. spending more on advertising than they're making can only be sustained for so long.Is their goal to spend heavily now to build brand awareness, with the goal of cutting back on advertising in down the road?

 

Year one: -$10, year 2 +$90, year 3 +$90. I'd take that deal all day.

 

That's a very dumbed down version of what Wayfair is doing here, but it's the same basic theory. Same as Netflix, too, or any business where you can pretty safely determine what your recurring sales per customer are going to be.

 

Sometimes the best way to make money is to set it on fire.

 

+1

 

I think this is very important for value investors to understand with " new tech".

GARP investors like to get in at year 2 usually

Value investors get in at year 3 when growth is done, but they think they are getting growth for free looking at historical growth.

 

Mr. Market is getting very efficient at year 2 and year 3 these days

[rpadebet]

Thanks for the idea Scott .

 

It's 5 bill company roughly. Amazon is 250bill.

How do you handicap whether Amazon buys it or kills it?

 

Is there a specific size at which Amazon would rather buy it if price is reasonable? Does this management appear as practical and reasonable? Would they fight Amazon if they came knocking or would they prefer to sell?

 

The risk is binary as you have pointed out with a competitor like Amazon. I usually don't like such bets unless there is some thing pointing to very low probability of the downside materializing.

 

 

[ScottHall]

Thanks for the idea Scott .

 

It's 5 bill company roughly. Amazon is 250bill.

How do you handicap whether Amazon buys it or kills it?

 

Is there a specific size at which Amazon would rather buy it if price is reasonable? Does this management appear as practical and reasonable? Would they fight Amazon if they came knocking or would they prefer to sell?

 

The risk is binary as you have pointed out with a competitor like Amazon. I usually don't like such bets unless there is some thing pointing to very low probability of the downside materializing.

 

I don't know what someone else would do. The cofounders own a huge percentage of the company and have shown a pretty good focus on value creation, so I imagine they'd decide to sell if they thought it was the best path forward, but I don't know that for a fact.

 

The risk-reward is sufficiently skewed, in my view, for me to have a position in the company - upside is multiples, downside is 100% loss. Have talked with folks about this recently... you don't own Wayfair for a 50% gain, like I've had over the past few months. You hold it for the multibagger potential, because if it works, it will likely work out very well. I can't speak for you; everyone has their own risk tolerance and objectives in investing and nothing is right for everybody.

 

I have shared my thoughts on the Amazon risk on my Twitter profile, if you care to read. Was talking to Gio about it. Just click on "Tweets and replies," and it shouldn't be too far down. Thanks for the interest and I appreciate your thoughts on my simplification of what Wayfair is doing here; I mostly agree with that sentiment.

 

 

[LowIQinvestor]

All Longs should read this article:

 

http://seekingalpha.com/article/3443236-dont-get-zulilyd-by-wayfairs-overstocked-valuation

 

 

[Jurgis]

Anecdotal news: got Wayfair coupon/ad in one of these coupon pack books that you get in the mail. First time I saw one.

 

Disclosure: no position, no opinion. :)

[ScottHall]

All Longs should read this article:

 

http://seekingalpha.com/article/3443236-dont-get-zulilyd-by-wayfairs-overstocked-valuation

 

Thanks for sharing.

 

Most of that analysis was irrelevant to me - I don't care about quarterly beats or if the stock goes down 16% or whatever because the market wasn't happy with the quarter, so long as the company continues to perform well.

 

The valuation vs. Overstock was very ham-handed; Wayfair is growing at multiples of Overstock, and if it continues to do so, Wayfair will eventually end up proving it was worth a substantial multiple premium over Overstock.

 

The primary concern seems to be how the company calculates the value of its customers. The author seems offput by the fact that most of Wayfair's customers don't come back, and takes from that that using any sort of lifetime value approach doesn't work. That's a good line to dissect, but the numbers Wayfair reports are aggregate numbers, right, so it includes the customers who order once and don't come back.

 

By breaking it down like that, you're not really adding anything; you're just distorting the economic picture by not counting the people who order two, three, four or five times. It should be no surprise to anyone that some customers are worth far more than others. The alcohol companies make far more from alcoholics than casual drinkers, after all.

 

For example, the author says that he thinks customer acquisition cost should be calculated as ad spend / net new customers as opposed to gross customers. I guess gross customers are free. That's fine, you can allocate it that way if you want to. But what you're implying then is that the rest of the customers are free. You can't count the same ad spend twice, or you'd be double counting.

 

So, taking his numbers, now you're losing $53 on the "net new" customers and making $42 on the others. It's just attribution; you can slice it any way you want but unless you think Wayfair is lying about its numbers it doesn't mean much.

 

The other thing is his point that 76% of customers (as of Q3 2013) didn't buy anything again. That's not a real shock to me; in many businesses, a select few customers are much more valuable than the others are and by a lot. This is sort of like the Pareto principle. So 76% of these people never reorder, and, according to the author, Wayfair loses $53 on them because they're only spending $210 on average.

 

To illustrate the point about how attribution is really a non-issue, I'll go ahead and break it down, using the author's own assumptions. Remember, s/he wants to determine customer acquisition cost by dividing ad spend just by net new customers. Author's estimate is $125 per customer under that scenario. Let's say that number is right.

 

Using the author's own numbers, we can see that 76% of customers order once at an average order size of $210 and never come back. If we use the same source as the author for a contribution margin of 20%, we can see confirm author's numbers that each one adds $42 of contribution margin to the company.

 

Now we'll break out the customers by type - the author's one-and-doners, who order once and never return, and the 26% (probably higher now) that stick around and buy more from Wayfair later. We'll use the most recent quarter's customer information to make the point.

 

1,959,000 orders delivered in Q1

 

56.6% of orders were from repeat customers.

 

So, the number of gross new customers was 850,206 or so, which was calculated as orders delivered * (1-% of repeat customers).

 

The company announced that net new customers came in at roughly 447,000 on the conference call. Remember, we're applying the author's numbers here - $125 per new customer - exclusively to the net new customers in order to avoid double counting.

 

Let''s break it down.

 

447,000 net new customers * 76% = 339,720 one-and-doners

 

339,720 one-and-doners * $210 order size = $71,341,200 revenue from one-and-doners

 

$210 order size * 20% contribution margin = $42 contribution per one-and-doner

 

$42 contribution margin - $125 customer acquisition cost = $83 loss per one-and-doner.

 

$83 loss per one-and-doner * 339,720 one-and-doners = $28,196,760 loss from one-and-doners.

 

Of course, that leaves the 24% of the "net new" customers who do reorder. From the author's source (company presentation), we know that the average customer spends $342 per year at Wayfair (it's actually higher now). With that, we can calculate how much the people who stick around contribute to Wayfair.

 

447,000 net new members * $342 = $152,874,000 revenue from this quarter's net new customers over the course of a year.

 

$152,874,000 total revenue - $71,341,200 revenue from one-and-doners = $81,532,800 from customers that will later reorder.

 

447,000 - 339,720 one-and-doners = 107,280 customers who will later reorder

 

$81,532,800 from reorderers / 107,280 reorderers = $760 in revenue per reordering customer.

 

$760 order size * 20% contribution margin = $152 contribution margin per reorderer

 

$152 contribution margin - $125 customer acquisition cost = $27 year-one profit per reorderer.

 

$27 * 107,280 = $2,896,560 year one profit for reorderers.

 

$2,896,560 year one profit for reorderers - $28,196,760 loss from one-and-doners = $25,300,200 loss from net new customers.

 

 

So, that looks bad right? A $25.3 million loss from net new customers? It does, but that's when we allocated literally the entire advertising budget to those people. Don't forget the company acquired 850,206 customers with its ad spend this quarter.

 

850,206 - 447,000 = 403,206 customers acquired with no advertising expense allocated to them.

 

I'm not going through that whole process again, so we'll make this simple.

 

403,206 "free" customers * $342 average order size = $137,896,452 revenue from "free" customers.

 

$342 * 20% contribution margin = $68.40 contribution margin per customer.

 

$68.40 contribution margin * 403,206 free customers = $27,579,290.40 profit from free customers.

 

$27,579,290.40 profit from "free acquired customers" - $25,300,200 loss from paid acquired customers = $2,279,090.40 overall profit.

 

And some of both the re-orderers and one-and-doners will come back next year with next to no incremental ad spend to get them to do so, so the longer they stick around, the greater the profits are.

 

It doesn't matter if you allocate $125 just for net new customers or use the lower number when counting both net new customers and gross customers. Each of these customers has their own P&L attached to them; you're just shifting where the profits and losses get allocated.

 

The one point that has some merit in this article, in my view, is that ad spend may not scale far enough to allow Wayfair to grow into the behemoth it wants to be. If that happens, the stock will probably look expensive here. Zulily isn't really a good comparison, neither is the valuation vs. Overstock. And, as an investor who thinks in years instead of quarters, it doesn't really matter to me if Wall Street gets upset at Wayfair not consistently beating its numbers by 10% so long as the business remains sound.

 

I am looking forward to Citron's research on the matter. If Citron makes a convincing case, I'm not above changing my mind on this one. So far, though, that article didn't really do anything to change my thoughts here.

 

 

 

 

 

 

[Ross812]

Are the 403k customers really free though? My wife and I ordered a bench of wayfare. I googled orange bench and clicked wayfare's add. If I was going to buy a metal stool, I'd Google it. I'm not going to wayfare to search their site. They sell the exact furniture on amazon and o.co. I'll find the piece I like and compare prices on Google shopping. Wayfare didn't aquire me... I'd say most repeat customers are  the same way. I would be very interested to see the amount of direct site traffic vs add/Google traffic their site gets.

 

Is their revenue proportional to their total add spend? The other problem is their margin.

 

What is the upside? I think the SA article makes a good case for 2% margins. Heck even at 3% (best in the industry) and 7 years later at 45% you growth you are looking at .81b in net income. Slap a 20x multiple on that and you have a 4 bagger? Sounds good but you have to solve the customer aquisition cost problem. When do costumers use wayfare as their go to?

 

Amazon accomplishes this by selling everything. Wayfares business is selling a good that is bought at most 3 times a year...

 

I don't see a clear way for this to work out well...

 

Edit: I do realize it's wayfair not wayfare but my phone keeps changing it to warrior so you get what you get!

[ScottHall]

Sorry, I guess I didn't make my point clear enough. No, of course those customers aren't free. I was pointing out what I view as a problem with the author's article, namely that he wants to allocate the entire ad spend to net new customers as opposed to gross new customers.

 

That implies that the remainder > net new customers were free, because you can't allocate the same ad expense twice. That's clearly insane, so it makes more sense to allocate ad expense across all acquired customers, not just net new. So the author's numbers of a $50 or whatever loss per customer is not really sensible, at least in my view. Just to be clear, that's because if you allocate ad expense evenly, the cost for the remainder above net new customer goes up while the cost for the net new members heads down.

 

It's just taking money out of one pocket and putting it in another.

[KCLarkin]

Not familiar with Wayfair, but my guess is that the shorts are right. E-commerce is a tough business.

 

But one flaw in his analysis. He suggests that W will need to "reacquire" customers who don't repeat in the first year. If they are any good at marketing, they will have a strong email campaign, which is almost free.

 

Be careful Scott.

[rpadebet]

Scott,

Do you mind elaborating on why the downside (Amazon killing it) is not quite as plausible as upside (amazon acquiring it).

 

I get the 100% downside to multiple upside logic, but we don't know when or under what circumstance Amazon would acquire. If they acquire, how much premium they would pay. As you probably know, they typically try to kill the business through replication first, thus depressing the target valuation even if can't kill it completely and then swoop in to acquire if necessary.

 

To others, totally agree retail is tough business and e-commerce the hardest in retail as barriers to entry are not that high as B&M stores. Wayfair itself is a good example of that. Eventually scale is necessary to survive though. There is still money to be made during the initial stages if you can capture the value add cycle and growth cycle. It is risky to get this timing right, hence  small exposures to individual names and basket approach like venture capital seems like an appropriate strategy.

 

[eclecticvalue]

Scott,

 

Citron's thesis on wayfair has been released. Thoughts?

 

http://www.citronresearch.com/wp-content/uploads/2015/08/wayfair-pre-final-d.pdf