Zulily, Inc. (ZU) went public during the week of November 15th and currently sports an enterprise value of nearly $4 billion. This is based on a stock price near $35/share, and over 122 million shares outstanding. Some initial coverage of Zulily has expressed concerns of overvaluation. For a company with $570 million in trailing twelve-month, or TTM revenue, 120% Y/Y revenue growth, and improving free cash flow, the current stock price may offer a fair entry opportunity with significant upside potential over the course of the next 12-month period.
In order to provide context for this statement, there are fundamental comparisons about the company that should be highlighted. First and foremost, comparing Zulily to Amazon.com, Inc. (AMZN) during a similar growth stage will provide valuable transparency for investors seeking to consider Zulily's growth potential. Both companies utilize structures incorporating consumer and vendor dynamics; however, this is accomplished through distinct business models. It will also be valuable to gain perspective between Zulily and its peers who directly incorporate similar flash sales models.
Like most investments, there are important questions surrounding Zulily including: how do their margins compare against a company like Amazon? How does their growth rate compare against peers? What are some major risks that could inhibit the sustainability of the business model? Are there any advantages the company has over its peers based on recent developments?
In order to attempt to respond to these questions and highlighted comparisons, it makes sense to organize this assessment beginning with a comparison against Amazon and Zulily's peers, followed by a fundamental analysis of Zulily considering the company's risks, and a final conclusion.
Ultimately the goal is to put enough information out there for investors to have a concrete understanding of Zulily's business as it relates to growth, competition, and valuation. This will benefit those interested in gaining some exposure to the e-commerce industry. It will also set the stage for questions to be further explored and answered based upon investment objectives and risk tolerances.
ZULILY AND AMAZON
How Do These Companies Compare?
In order to get a sense of how to answer this question it is necessary to go back into the past when Amazon was in its early growth stage. However, since Amazon has been operating over a much longer time period than Zulily, it is equally valuable to compare Amazon's current business characteristics to the company. This will build Zulily's future growth potential into the picture.
Like Zulily, Amazon had a specific niche focus in the company's earlier days. As some may remember, Amazon's focus in the mid to late 1990s was as an Internet book, music, and video retailer. Zulily has emerged with a focus on offerings for moms which revolve around merchandise categories including children's apparel, women's apparel, children's merchandise, and other merchandise. The key initial takeaway here is that Amazon was attempting to develop its e-commerce model in the mid-90s with a more fragmented web-based market whereas Zulily is entering a fiercely competitive web and mobile market which is much more mature. As we all know, Amazon has scaled significantly and competes with Zulily on all of its merchandise category fronts. Additionally other major competitive e-commerce platforms include Target (TGT), Toys "R" Us, Wal-Mart Stores (WMT), and eBay (EBAY).
Another primary variable between the two companies is that Zulily has developed a more targeted demographic relationship with its active customers than Amazon. The company utilizes its merchandising team to search the market for new and unique brands. Once brands are identified, the company invests in photography and editorial content to tell each brand's story in a fun and engaging manner. Products are sold through a flash sales model, creating an impulse-driven shopping experience that delivers entertainment, value, and convenience for moms anytime and anywhere. This is orchestrated through customer messaging emails and alerts, or "push" communications. Amazon on the other hand, provides a more general broad-based approach to its customer messaging and focus. To date, this is most clearly represented by the number of active customers between the two companies; Zulily as of the third quarter of 2013 had 2.6 million active customers while Amazon at the end of 2012 had 182 million.
From a warehousing, fulfillment, and distribution perspective, Amazon during its early stages provided a focus on maximizing inventory supply to provide timely delivery of many of its products within a 24-hour period, with other products available within 2-3 days, and the remainder being available within 4-6 weeks. This strategy has grown tremendously with Amazon's current coverage for one-day delivery within the U.S. An article from 2012 details Amazon's recent initiatives to enhance its shipping and delivery capabilities to same day delivery; Sunday delivery has more recently been publicized by the company. In 1998 Amazon had approximately 293 thousand square feet of leased warehousing and fulfillment operations in North America. As of 2012, Amazon had 339 thousand and 35.3 million square feet of owned and leased fulfillment, data centers, and other facilities within North America, and close to double this amount for its international equivalents.
For Zulily, the company has taken a different approach towards inventory supply by ordering products from vendors only when active customers make an online or mobile purchase. This has translated to shipping times throughout the warehousing, fulfillment, and distribution process taking 11 days on average as of the third quarter for 2013. Compared to Amazon's 1998 warehousing and fulfillment, Zulily has 1.1 million square feet of fulfillment in the United States, and as of the third quarter 2013, regularly handled more than 125 thousand items per day. This is a critical component of the business model to consider. Zulily provides a risk factor related to their possible need to incur greater shipping costs to compete more effectively against e-commerce companies like Amazon who have better delivery times. Consumers may be willing to accept extended delivery times as long as the purchase price justifies a perceived value. This perceived value is based upon price, breadth of selection, and product reputability.
Another distinction between each company's inventory supply models relates to vendor dependency. For Amazon during its early stages, the company relied heavily upon Ingram Book Group (40% of inventory purchases in 1998) whereas Zulily has worked with over 12,000 vendors with none representing over 1.5% of revenues. At the end of fiscal year 2012, Amazon stated that no vendor represented over 10% of revenues. Both companies have recently disclosed that they do not maintain long-term contracts or arrangements with their vendors. It would appear that Zulily's risk for not having exclusive contracts with vendors is just part of the e-commerce environment. Zulily is much more leveraged based upon their diversified vendor arrangements than Amazon was during its earlier days; and from a current relative revenue per vendor standpoint, this remains so.
Financial Factors
When considering revenues at Amazon during a similar growth stage as Zulily, it is clear that Amazon grew revenues at a more robust rate. To illustrate this we can compare Amazon's 2-year average annual growth rate between 1996 and 1998, with Zulily's 2-year average annual growth rate between 2010 and 2012. During these respective time periods, Amazon revenue grew 522% per year (base revenue $15.7 million), while Zulily revenue grew 325% per year (base revenue $18.4 million). The table below provides additional comparative details from 1998 and 2012 for each company respectively (all numbers in millions except gross margin, loss/share, debt to equity, and days inventory outstanding, or DIO).
(click to enlarge)
To provide a little more context, despite similar DIO, Amazon had twice the inventory as Zulily in 1998 as compared to 2012. Additionally, Amazon was relying extensively on debt to fund its growth. In early 1999 an additional $1.25 billion was raised through convertible notes. In its early days, Amazon included fulfillment costs within the cost of sales line item similar to how Zulily accounts for fulfillment currently.
(click to enlarge)
The revenue line item utilized for Amazon in Table 2 includes the company's electronics and other general merchandise segment for North America as a more general comparison. All other information is from all of Amazon's business segments. Clearly Amazon has scaled significantly over the previous 17 years. However, it is interesting that the company has now broken out its fulfillment costs separately from its cost of sales (due to scale). It is widely publicized that Amazon's gross margins are higher due to the exclusion of fulfillment costs. To be consistent for comparison, the gross margin in Table 2 includes fulfillment costs for both companies.
Summary
Zulily has established a straight forward business model targeting the mom demographic. The company also has established an opportunity for small and medium boutique vendors looking to supply product brands for this target demographic. The company feels it has the potential to compete favorably based on estimates for online retail growth (14.5% CAGR to 2017); the number of moms and children represented by household data and the propensity for women to spend more online as a percentage of the online population; and mobile online shopping growth (over 29% CAGR to 2017).
Key strengths for the company include its large merchandising team which is responsible for sourcing a unique selection of curated merchandise from the company's thousands of vendors; the company's strong growing mobile orders as a percent of total orders (45% of U.S. orders were mobile as of the third quarter 2013); and the company's custom-built fulfillment centers which handle small to medium sized inventory lots, a large number of rapidly changing items, and high inventory turnover, all while maintaining minimal inventory levels. This is meant to support emerging brands and smaller boutique vendors that often need more help shipping and delivering their products.
It is quite interesting that Zulily has been able to scale as quickly as the company has despite a very intense and competitive market. Amazon has grown its net product sales over the same time period since Zulily's business began by roughly 29% per year. At Amazon's scale this is equally impressive. From a financial standpoint, Zulily is comprehensively in a better position compared to Amazon in its earlier days. The company is experiencing significant network effects, has better margins starting out, is closer to generating a profit, and has achieved all of this without taking on considerable debt. Whether or not Zulily will be generating revenues in the billions and how far the company can scale are what will ultimately drive the stock price.
OTHER FLASH SALES MODEL PEERS
The focus for this section will be explicitly on revenue growth amongst peers. Only one of Zulily's direct competitors is part of a publicly traded company and has revenues disclosed regularly. This company is HauteLook which is a subsidiary of Nordstrom, Inc. (JWN). It should be noted that while Nordstrom does break out a line item for HauteLook, this line item also includes Jeffrey. Remaining peers include Fab Inc., Gilt Groupe Holdings, Inc., MyHabit (owned by Amazon), One Kings Lane Inc., and RueLaLa.com (owned by Retail Convergence.com LP), formerly of GSI Commerce which was spun off privately after being acquired by eBay who owns a 30% stake. All numbers in the table below are expressed in millions.
(click to enlarge)
Fab began operating in June 2011. The company has been estimated to have generated around $20 million in revenue during its 5-month operating period during 2011. Other recent publications have written regarding the company's struggles and have questioned whether it will be able to get anywhere close to a target of $250 million in revenue for 2013. The company's expected 2012 revenue target for $140 million was not achieved. Gilt has recently been cited as potentially heading toward an IPO in 2014; revenues were derived from the linked publication. HauteLook numbers were taken from Nordstrom's 2012 10-K filing and the 2013 number has been estimated to grow 25% above 2012 revenue based on the first half for 2013 actual growth rate. Ideeli revenues were included from a July 2013 publication. The One Kings Lane website provided general revenue numbers. There were two separate publications used to generate the RueLaLa information; here and here.
Judging from the available information, which should be taken with a moderate grain of salt, Zulily clearly seems to be growing more robustly than all listed peers. The majority of companies are growing between 20 - 45% per year. Only Fab and One Kings Lane are potentially growing near the 100% level. With the amount of negative sentiment espoused by many of the articles sourced above, it would appear that Zulily has possibly provided a more successful model by focusing on the mom demographic, while creating a unique experience for its consumers and vendors. This differs from the majority of listed peers as many of them focus on high-end product brands sold at a discount to all consumers.
With the holiday season upon us, Zulily will most likely generate record revenue. The company grew revenue 120% Y/Y in the third quarter during 2013 exceeding the 115% Y/Y growth in the second quarter. If the company is able to grow revenue 110% or more Y/Y, it will exceed the $700 million revenue mark. It is also worth mentioning that some of the companies listed above have more disclosed customers, have been reducing their labor force, ditching the flash sales model entirely and converting to a pure e-commerce model, and branching out into other merchandise areas such as jewelry. These are all clear indications of significant struggles of late for the high-end discount flash sales focus.
FUNDAMENTAL PROSPECTS AND RISK ASSESSMENT
For the fundamental assessment of the company it is important to monitor the company's key operating metrics, factors affecting its performance, and valuation measurements. The company lists the following key financial and operating metrics:
- Adjusted EBITDA
- Free cash flow
- Active customers
- Revenue per active customer
- Total orders placed
- Average order value
Financial and Operating Metrics
Of the metrics listed above, we will expand upon Zulily's free cash flow, active customers, and total orders placed. Adjusted EBITDA is a metric which tends to cause a lot of controversy, and we can consider the company's free cash flow trends instead. Revenue per active customer and average order value both can be added to the active customers and total orders placed trends.
(click to enlarge)
The company generated over $20 million in free cash flow during the third quarter of 2013. This is a 280% increase Y/Y . During the first nine months of the year, the company has experienced significant improvements to line items reflected within its operating cash flows. The most notable has been the fact that the company was able to produce net income versus a $13.5 million loss last year during this same period.
Based on the company's improved net income, Zulily is trading at a very expensive P/E ratio near 1,000. The stock price/free cash flow per diluted share on the other hand is trading just over 125. For the upcoming fourth quarter, the company will possibly earn close to $0.10/share which should drive operating and free cash flows to record levels. Based on the November 22nd price, the company is potentially headed towards a P/E near 450 and price/free cash flow per diluted share near 80. On a more conservative basis, the company could remain at today's current P/E level at year-end, but will most likely still see improvements to operating and free cash flows.
(click to enlarge)
Zulily defines active customers as an individual customer who has made a purchase from the company at least once in the last year. This may seem like a low threshold to consider activity, however, as each quarter passes it really provides a good indication of growth for the company's customers driving revenue. Active customer growth trends are increasing comparatively Y/Y for each quarter during 2013. Zulily currently has 2.6 million active customers which represents a 96% Y/Y increase. This is an increase of 860 basis points from the first quarter of the year for comparative Y/Y growth. The company will most likely reach 3 million or more active customers if it can keep pace with current trends. Zulily's revenue per active customer has increased from $210 at year-end 2012, to $215 during the third quarter TTM period.
Total orders placed is defined as the total number of customer orders placed by the company's customers within any period. Total orders placed has consistently been higher than active customers based on recent trends. Total orders placed have also outpaced active customer Y/Y growth during the same time period of analysis. Zulily currently had 3.7 million orders placed during the third quarter of 2013 representing 98% Y/Y growth. This, however, represents a 610 basis point decrease from the first quarter of the year for comparative Y/Y growth. The company will most likely reach 4.5 million orders placed during the fourth quarter if it keeps pace with current trends. Zulily's average order value has increased from $52 to $55 over the past six quarters.
Factors Affecting Performance
The primary challenge that Zulily faces to successfully scale its business is the need to acquire email subscribers, users of the company's mobile applications, and customers at a reasonable costs. Paid and unpaid marketing channels used by the company to attract potential new customers to Zulily's sites include affiliate channels and partners, customer referrals, direct navigation, display advertising, key word search campaigns, search engine optimization, social media, and television ads. For the first nine months of 2013, 77% of the U.S. daily visitors to the company's sites came via email or mobile "push" communications, or other unpaid sources, such as direct navigation and search engine optimization. Attracting new visitors and converting them into customers on a cost-efficient basis is material to the company's future success.
In order to measure how the company's marketing channels are performing and to provide guidance for future marketing investments, the company utilizes a contribution margin which is compared against net sales. The contribution margin reflects added costs associated with merchant processing fees and general and administrative expenses for merchandising, customer service, order fulfillment, and studio.
(click to enlarge)
The company has highlighted a unique example reflecting the value of its active customers to its contribution margin. The company used a first quarter 2011 cohort which included 1.1 million email subscribers that we acquired in the first quarter of 2011 and which we have converted into 268 thousand customers as of September 29, 2013. Zulily initially spent $3.8 million in total marketing expenses to acquire the email subscribers in that quarter. The tables below provide the respective net sales and contribution margin amounts from this cohort.
(click to enlarge)
Other key areas the company has identified that will affect performance include product mix, growth of mobile commerce, and general investments in the company's growth.
Valuation
When comparing Zulily's valuation amongst other peers, it makes the most sense to use Amazon and eBay as comparisons. Zulily does not have significant scale outside of the U.S. so this analysis will not include other companies such as MercadoLibre, Inc. (MELI) or Vipshop Holdings Limited (VIPS), among others. All data reflected within the table below is as of the stock market close on November 22nd. All nominal values are expressed in millions.
(click to enlarge)
It is quite striking when seeing the significant scale of Amazon between the three companies. Amazon is valued roughly three times eBay's valuation and over 42 times Zulily's. When comparing Zulily to these two peers with much more history, Zulily competes fairly well. The company outperforms Amazon based on TTM P/E, TTM P/FCF, P/Cash and has no debt. As the company is in its very early growth stage, it is trading at a much higher valuation when compared to eBay for TTM P/E and TTM P/FCF, and P/B.
Based on comparative growth trends, Zulily's valuation is assuming continued robust revenue growth. From the third quarter revenue growth for the three companies was the following; Amazon grew North America electronics and other merchandise revenue 33% Y/Y; eBay grew U.S. revenue 14% Y/Y; and as stated earlier, Zulily grew revenue 120% Y/Y.
Zulily is on a trajectory to surpass $1 billion in revenue for 2014. Even if we assume a significant decline in revenue for 2014 to 50% Y/Y growth, the company would still generate around $1.1 billion in revenue. Depending on how the company's margins change during the next year, Zulily will potentially see improvements for all metrics listed in the table above. As long as the company is able to continue to scale its business robustly, the stock price should value the company similar to where it sits at today's level. This provides investors with an opportunity to capitalize on the company's growth prospects during the next 12-month period.
Risks
We have reviewed a couple of the company's disclosed risk factors above including the potential for increasing shipping costs and more comprehensively, competitors in the flash sales space. The company has effectively reduced its order-to-ship time from 14 to 11 days Y/Y during the third quarter for 2013. Zulily will need to expand upon its objectives to further reduce delivery times for its customers to continue to compete effectively. From a peer competitive standpoint, it is clear that Zulily is one of the fastest growing companies in the e-commerce market within the U.S. The company is experiencing Y/Y growth near 100% for active customers, total orders placed, and as result, net revenues. Competition should continue to be monitored closely, especially if Gilt goes public next year. But the company has proven that its targeted demographic focus is scaling successfully and competing quite well.
It should be noted that Zulily operates a highly complex system for its services to consumers and vendors. As the company pursues continued growth strategies, this will further complicate the existing system. For example, the company is responsible for providing products that connect with consumer preferences. This requires a high level of sophistication and coordination between merchandise teams, editorial and studio staff, fulfillment operations, and vendors and consumers. Any weaknesses within this work flow may materially impact the company over time, which also could potentially harm the company's brand recognition and reputation.
CONCLUSION
For investors, it is important to consider Zulily's potential. Analysts have not yet provided their estimates and the company itself has expressed that it faces challenges in accurately forecasting its future growth. However, the company's trends have displayed excellent growth and development of the business. Zulily's initial success can be attributed to the company's merchandise team and fulfillment operations which has yielded early brand acceptance and a growing network effect. Loyalty to the company is displayed by the company's contribution margin which accounts for costs to acquire new customers and respective net sales and contribution from these customers' activity.
The company has experienced strong growth in its U.S. mobile orders: 1,400 basis points to 45% of U.S. orders since December 2012. Zulily is investing in enhancing its data analytics and proprietary technology to improve targeting to meet active customer preferences. Ultimately, the company has a highly leveraged model which maintains minimum inventory and favorable payment terms with its thousands of vendors. The company has been cash flow positive on an annual basis since 2011, and the scale of growth will allow for significant flexibility to invest further into the business.
Zulily appears to be taking the lead amongst its direct peers and is in a more stable position than Amazon during its early stages. Obviously, Amazon has developed into an amazing business that recently generated over $70 billion in TTM revenue for the third quarter of 2013. Zulily is looking to generate its first TTM billion in revenue sometime next year. The growth story is intact with the company's highest performing season soon approaching.
Disclosure: I am long ZU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
This entry passed through the Full-Text RSS service — if this is your content and you're reading it on someone else's site, please read the FAQ at fivefilters.org/content-only/faq.php#publishers.
from SeekingAlpha.com: Home Page http://seekingalpha.com/article/1861111-zulily-a-compelling-buy-or-just-another-flash-sale-in-time?source=feed
Aucun commentaire:
Enregistrer un commentaire