The Investment Thesis Behind Opendesk

Over the summer of 2014 I personally invested in Opendesk, a three-sided online marketplace for locally made office furniture. The marketplace connects furniture designers (who can upload their designs to the platform and get paid in the form of royalties), with a network of local furniture workshops (who get commissioned work from the platform) and companies (who are in the market for office furniture).
The business is a spin-out of Project 00, a highly creative design-oriented studio.
Opendesk successfully raised an over-subscribed seed round on Crowdcube over the summer, with further participation for Telefonica incubator Wayra and a number of high profile angels. I was then asked to joined the board of the company as a non-executive director and we recently had our first board meeting.
I thought it would be a good time to share my investment thesis for future record:
  1. An underlying trend supporting the rise of digital fabrication
    • The downward spiral in entry costs for small-scale digital fabrication (i.e. 3D printing, CNC milling, laser cutting), coupled with the improved output quality and the widespread adoption of digital design softwares, have revolutionized the economics of batch manufacturing. As these machines become widely available at local small-scale workshops, it is now possible to leverage a network of makers that can manufacture high quality products, on demand and in small batches, while being close to the end customers and without having to rely on economies of scale to drive their economics.
    • We are still only at the dawn of this trend, and OD is well positioned to ride along it.
  2. A compelling user proposition for all 3 sides of the marketplace
    • For designers: OD aims to be a remunerative route-to-market for both up and coming and established product designers who normally struggle to bring commercially viable product designs to market via the traditional routes. Stuck in a vicious cycle of needing strong retail appetite in order to secure financing for the manufacturing, while not being able to test retailers’ appetite for their product designs unless they have resources to manufacture them, they can only hope that a brand discovers them and gives them access to their infrastructure. On OD furniture designers can upload their digital creations and connect directly with end customers: OD will act as the curator/moderator who ensures the designs are commercially viable and uploaded in the right format, ready to be manufactured by the local manufacturers that are plugged into OD. Designers will ultimately earn royalties, as well as gain visibility in a community of like-minded professionals.
    • For makers: OD aims to be a source of highly qualified, validated and paying customers for furniture workshops, who welcome a no-risk way to fill up surplus capacity (similarly to what Just-Eat does for takeaway restaurants) by accessing both quality designs and end customers on OD.
    • For customers:
      • Quality at affordable prices: on OD they can find real wood, customisable design furniture at only 2-3x the price of equivalent mass produced furniture (which, by the way, is often made of pulp rather than actual wood) and well below the more expensive alternatives of buying wooden designer branded furniture (generally 10-20x more expensive than anything on OD), or commissioning custom made furniture.
      • Short lead times: since OD furniture is manufactured locally by leveraging a network of furniture workshops, lead times from purchase to delivery tend to be significantly shorter than the alternatives offered by traditional design furniture distribution companies that often rely on sea shipping from the Far-East and are generally are not able to cope efficiently and economically with small order quantities.
      • Emotional appeal: I believe there is an increasingly evident demand among consumers and companies for unique products and experiences, handmade goods, craft and artisan-ship, locally made and sourced a products and a wider movement away from the mass-produced, the commodity shopping establishment, the Ikeas and Tescos of the world. Consumers ascribe an emotional premium to the experience of having a direct connection with the makers (think Esty), the hosts (think airbnb), the drivers (think Uber/Lyft) or whoever is crafting the experience for the end user. OD, by connecting the customers with the makers and the designers, provides a much more engaging, transparent and responsible way to buy furniture that the alternatives out there.
  3. An elegant “asset-light” business model
    • The OD marketplace is built on top of the pre-existing digital fabrication supply chain, and as such it does not require investment in the hard assets that a traditional retailer or brand would need in order to operate, such as warehouses, inventory, working capital, manufacturing equipment, raw materials, logistics network etc. OD simply enables the existing supply chain to function more efficiently by removing the frictions and the intermediaries that exist in the traditional retail or manufacturing value chains, and in doing that is able to capture (and defend in the long term) a large share of the incremental value it unlocks along the way.
  4. A big and compelling vision executed by a team with deep domain knowledge
    • Office furniture is clearly only the first step for OD, although it in itself represents a large opportunity to build a valuable business. Once the machine is well oiled though, there is nothing stopping OD from moving into home furniture and home decor more broadly and, eventually, into any product category that can be digitally fabricated. The idea of of ultimately taking on Ikea, a €30B revenue business, is not that far fetched.
    • I am confident that a team with deep domain knowledge in industrial design and crowd-sourcing, such as the one that Tim is leading up, is best placed to execute on this compelling vision.

I am excited to see the business grow and validate my investment thesis over the next few years!


Do Listed Markets Understand Ecommerce?

I have been keeping a close eye on the recent IPO activity of online retail businesses in the UK.

AO World is the most recent example, an online retail business selling a range of white good brands which listed on March 3rd 2014 and achieved a market capitalisation in excess of £1.5B (close to 6x historic revenues), joining ASOS and Ocado in what seems to be an uncontrollable euforia amongst retail investors for anything that involves selling and online.

Having looked at ecommerce businesses in the private market as an investor over the past four years, what caught my interest is that such valuations are nowhere to be seen in private equity land. Some of the most recent deals in the private markets (interestingly one has to go back to December 2011 to find the first relevant one), such as Wiggle, Moonpig or MyProtein, were done at 2-3x revenue and 10-13x EBITDA. This is a world apart from what the listed markets are valuing online retails businesses at the moment: Ocado (70x EBITDA), ASOS (80x EBITDA), AO (147x EBITDA).

So why are private equity investors not paying such high multiples for online retail businesses, while listed market investors pile in?

A few charts should help shed some light. Red dots represent listed online retail companies (including the ones rumoured to be listing in the next few months e.g. Boohoo, Photobox), blue dots represent privately owned online retail companies. Three things appear quite evident:

1) Listed market investors are happy to pay a premium for revenue growth, unlike private equity investors;

Valuation / revenue

2) Private equity investors value margins, while the listed market investors don’t seem to care that much;

Screen Shot 2014-03-10 at 20.01.35

3) There is a slight premium for scale in the listed markets, not in the private markets;

Screen Shot 2014-03-10 at 20.01.44

Three things could be explaining this data:

1 – The level of sophistication amongst private equity investors is higher than that of listed market investors (listed equity fund managers, pension funds, retail investors). This would explain private equity’s obsession with margin (a rough proxy for the quality of the business model) rather than topline growth (which could come at the expense of margins). In a nutshell this is Amazon’s equity story of how they won the heart of Wall Street: a business carefully run at zero margin to keep topline growing at >20% pa to win market share of all retail. More equity analysts covering UK ecommerce stocks could be a good thing as the market capitalisation of online retail businesses in the UK now tops £10B.

2- There is a scarcity of growth stocks for UK fund managers to take exposure to and the offline to online shift is still one of the few attractive growth stories remaining out there. So anything that simply smells ecommerce, regardless of the actual underlying business model, will attract a premium valuation. This is actually causing severe headaches amongst some of the best IPO candidates (and their bankers) that, despite operating at 30-40% margins, will inevitably be thrown in the “online retail” bucket by the listed markets and possibly get an Ocado (5% margin) or an AO.com (3% margin) multiple on their revenue (c. 4x). I am sure they won’t be un-happy about those multiples, but in theory they should trade at a premium to less attractive business models.

3 – Listed markets seem to believe that with size come economies of scale in ecommerce, and therefore they are happy to ascribe a premium for larger businesses. But is that actually the case? The same data set suggests the opposite, the larger the business the lower the margins (a proxy for its efficiency) i.e. it’s either growth/scale or margin in ecommerce. This brings us back to point 1: how sophisticated are the listed market investors?

Scale vs margin in ecommerce


Is Offline Undervalued?

Every year, 40 million people walk in and out of Piccadilly Circus underground station in London. That’s 770 thousand a week, 110 thousand a day, every day. That’s a lot of footfall, but also potential eyeballs.

You can actually rent a retail shop in Piccadilly Circus station for £1,500 / week. To keep it simple, you could just hang a large billboard in front of the shop unit, so you don’t have to bother about fitting it, staffing it, stocking it etc.

Now, assuming that all 770 thousand people walking in and out of the station on a weekly basis look at your billboard, that’s costing you just shy of £2.0 CPM (£2 for every 1,000 impressions).

Let’s say you wanted to buy 770 thousand impressions online from an audience that is similar to the people that pass through Piccadilly Circus every day (i.e. 50/50 men/women, ABC1, shoppers, tourists, 18-40,  professionals). That’s likely to cost you a lot more than £2.0 CPM. For example, the Mail Online, world’s largest online news site (with close to 200 million monthly UVs and an audience somewhat comparable to the Piccadilly crowd) charges anywhere between £20-50 CPM for ad space on its web property.

I’ve made the assumption that all people walking through the station would look at the billboard, which is obviously optimistic. However to achieve a CPM comparable to the online CPM only 4-10% of the people would have to look at the billboard, which feels quite conservative given people have to walk by it to get in an out (I for example always look at ads in the tube and at stations, I suspect I am not the only one).

I have also assumed for simplicity that one would just hang a billboard in front of the shop, which would not attract higher than average attention from the crowd. In reality, with a little investment, the unit can become an interactive billboard where potential customers can walk, touch and feel the products, talk to staff and buy.

Overall it feels like there is an opportunity for online businesses to leverage flexible offline retail presence to drive impressions at attractive CPM rates, with the upside of the human interaction.


8 Areas of Digital Media I Will Pay Closer Attention to in 2014

(1) Vertical integration in retail. I refer to the process of brands cutting out the intermediaries and selling own products directly to their end consumers, primarily via the web. The intermediary share of the value normally created along the value chain gets split between the end customers and the brands, as higher customer satisfaction (higher quality at lower price) also results in higher gross margins. The enablers have been the web channel at the front end, which allows for effective and scalable direct to consumer distribution without the need to add more brick & mortar stores, and the emergence of rapid designing, prototyping and manufacturing technologies at the back end, which have shortened production cycles significantly. Despite what Oliver Samwer thinks, I believe the offline channel will still play an important role, not necessarily as a sales channel though but more as part of a multi-channel approach to retail. Services such as Appear Here will provide online brands the ability to access the high street “on demand”, at the right time and location. I will watch particularly closely for businesses embracing scalable manufacturing technologies, such as 3D printing, in their processes and leveraging flexible offline presence at the front end.
Examples: Makie Lab, Align Tech, Shoesofprey, Rapha, Walker & Company, Harry’sBonobos, Warby Parker, Shapeways, Intelligent Beauty.
(2) Mobile as the main delivery platform. As obvious as it sounds in 2014, any business not putting mobile at its core is soon going to be obsolete. I believe in 2-3 years the large majority of our digital interactions will occur via mobile or tablets, including commerce (mobile commerce is still only 25% of ecommerce). Some of this shift will be just desktop-replacement, but a large portion will be incremental as mobile makes us all ubiquitously connected, always a click away from another purchase or booking. Some services are also just better delivered via the mobile (think Hailo, Uber, Instagram, Snapchat, Citymapper, Yplan etc). Marketplaces are an example of a business model that mobile has enhanced, since it makes it “vastly quicker and cheaper than ever before to ‘wire up’ both sides” as Matt Cohler noted recently. Opportunities will be plenty for businesses delivering beautifully simple mobile experiences.
Examples: Hailo*, Uber, Depop, Bizzby, Hotel Tonight, Citymapper, yplan, Osom.
(3) Image-led ecommerce: the trend of commerce and content converging has been in the headlines for a long time already, with publishers getting closer and closer to the transaction (e.g. Mail Online, Conde Naste) and online retailers investing heavily in curation and content (e.g. Asos, Farfetch, Net-a-Porter etc). I expect more companies attempting to bridge the gap between rich media (photos/videos) and commerce as users attention span gets lower and lower (as Biz Stone, co-founder of Twitter and Jelly puts it: “In a world where 140 characters is considered a maximum length, a picture really is worth a thousand words”) and mobile and tablets, with their constrained screen real estate, made the economic model of traditional advertising inefficient.
Examples: Houzz, Osom, Asap54Pinterest, Fancy, WireWAX, Olapic.
(4) C2C economies: it is about the emergence of online (often mobile-only) vertical marketplaces that allow any individual with excess capacity of an asset (e.g. skills, know-how, money, time, car, taxi, couch, bed, room, house etc) to efficiently monetise it. An interesting trend that has emerged from the resulting over-fragmentation (and thus expansion) of supply is that hard ownership has become redundant for certain asset classes that can be now available on demand: it’s happening to transportation, apparel, music and even server space. Watch this happen to other verticals.
Examples: Airbnbuber, lyft, blablacarboatboundStylebee, Vestiare Collective, Lending Club, Zopa*.
(5) Offline to online shift in large and ripe industries: while most industries and product/service categories have already transitioned online, there are still a few large industries that are resilient to moving online, but inevitably doomed to (e.g. commercial real estate, healthcare, education, law, financial services, automotive).
Examples: Zesty, zocdocAppear Here*, nutmeg, covestor, Shake, LawPivot, LawpalWealthFront, Carwow.
(6) Twitter ecosystem. I am long Twitter as an interest-based advertising AND ecommerce platform in the making. To the extent that “interest” is more strongly correlated to purchase intent than just “friendship”, I believe Twitter has the potential to become an effective platform for commerce, where Facebook effectively failed. I believe the userbase gap with Facebook will slim significantly in the next few years.
Examples: socialbro, Driftrock*, Buffer, Hootsuite.
(7) Online education. I think in 2014 we will start to see the pace of investing and consolidation accelerating in the space as the new learning/teaching formats become increasingly accepted and incumbents realise they have missed the boat and decide to up their digital exposure. Opportunities remain as an enormous industry is changing fast and new value chains become clearer. I continue to believe the value captured by the online educational content producer will diminish as competition intensifies (there are countless sites already where I can learn the basics of coding for example) and therefore businesses building tools and services that sit on top the content providers to create better online learning environments (ultimately improving outcomes) will thrive.
Examples: Clever, Blikbook*, TopHat, Piazza.
(8) Pervasive computing. I include in this area the entire ecosystem created around the ability of any device, from wearables to connected home appliances and drones, to capture, analyse and act upon data. The technology is now available for this to happen. As this is a new area for me, I will aim to learn as much as possible about it in 2014.
Examples: Cyberhawk, SkycatchStrava, Alert Me, 3D Robotics.
* Forward’s investments

How Important is the Off-Price Channel in Retail

I have been thinking at the off-price retail market recently, both offline and online. Businesses playing into this market rely on accessing surplus stock from brands, and then selling it down to the end customers at a markup (but still at heavy discounts to RRP). Surplus stock fundamentally exists because of structural inefficiencies in the retail industry which make it difficult for brands to accurately forecast demand (and therefore production): production cycles are long, so brands don’t know if it will be a good season until it’s too late to react. In categories like fashion, where trends are volatile and their lifespan difficult to predict, this factor is even more important: fear of missing out forces brands to deliberately over-produce.

One key question from the investor’s perspective is whether these structural imperfections will at some point go away, as brands become increasingly good at forecasting demand.  That would obviously reduce the economic need for off-price retailers, as in a perfect retail marketplace brands should be able to sell 100% of their inventory at full price.

So I looked at the US market, where more data is available on listed off-price retailers. I specifically looked for evidence of low / decreasing importance of off-price retailers in the retail value chain (in my mind low was <5% of the entire market, a completely arbitrary low number). I was therefore surprised to find that the basket of six off-price retailers I used in my analysis contributed to 16.3% of the US Clothing & Clothing Accessories market in 2012, up from 12.9% in 2005. I looked at the clothing and accessories market as off-price retailers tend to mainly sell that.

US Clothing & Clothing Accessories Market

Note: off-price include TJX, Ross Stores, Big Lots, Stein Mart, Overstock, Bluefly.

Source: companies accounts, US Census

This is even more impressive if one thinks that those off-price sales occurred at c. 50% discount to full retail price, so in terms of volumes the importance of off-price retailers in this category is enormous.

My analysis is deliberately conservative as it is excluding all privately-owned off-price retailers which I could not easily get revenue data for. These include large online off-price retailers such as Gilt, RueLaLa, HauteLook etc which experienced very high growth over the period I looked at and certainly would add % points to the 16.3% number I got to and steepness to the red curve.

What this is suggesting is that surplus stock is unlikely to go away from the industry any time soon and, if anything, brands should be feeling more comfortable in their over-production decision because of the efficiency of these channels in clearing up their unsold stock.

What this is not showing though is the impact on margins that this channel has for the brands…


The Investment Thesis Behind Appear Here

As I think it is a good practice for investors to make investment thesis publicly available, this post will be about the investment thesis that led Forward Investment Partners to invest in Appear Here back in November 2012.

As a backgrounder on the company, Appear Here aims to be THE online marketplace where commercial property is rented out, irrespective of lease length. The investment thesis can be summarised as backing a compelling entrepreneur to disrupt a large, ripe market via a proven and attractive business model.

Market

Commercial property is a large sector (between retail and office rentals, the UK market is worth well in excess of £30B a year), currently undergoing rapid and significant structural changes:

1) Landlords are under pressure as an ever larger portion of their portfolio becomes vacant and occupied lease lengths keep falling year after year.

  • Vacancy rates up. This is driven by the weak economy, and online sales growing as a portion of total retail sales. This has meant UK retail vacancy rate (i.e. readily available retail units as a % of total available retail units) has surpassed 16% towards the end of 2012. This is likely to grow even further, possibly double, driven by ongoing growth of e-commerce and the large number of long-term leases coming up for renewal in the next 2-3 years which are unlikely to be renewed. It is also worth noting that vacancies have a double-whammy impact on landlords: not only do they generate no rental income (opportunity cost), they still incur in business rates which the landlords have to front (actual cost). This cost UK landlords £1.1B in 2011/12;

commercial property vacancy rate

  • Lease lengths down: the average length of new signed leases continues to shorten, from over 20 years in 1991 to c. 9 years in 1999 to below 5 years now, with terms now often including long rent-free periods and short break clauses. There is no sign of this trend inverting any time soon;

commercial lease length

  • Conclusion: landlords know they need to adapt to a new environment where their inventory gets rented out on extremely flexible and standardized terms (e.g. rolling weekly/monthly leases). What they are looking for is a platform that will help them to optimize this inventory so the total net value of the yield is the same.

2) Secondly, on the demand side, brands are increasingly trying to build direct relationships with their customers, cutting the intermediaries out of the equation as Paul Fisher has elegantly illustrated in one of his recent blog post.

  • In the long-term the dis-intermediation of the retail world is inevitable and brands will establish more direct relationships with their customers;
  • Retailers, particularly online ones, are starting to value bricks & mortar as an extension of their brand: much more about the touchy-feely customer experience rather than product revenue. What companies like Rapha, Warby Parker, Moo, Etsy etc. have done offline are good examples;
  • As online cost of customer acquisition keeps increasing month on month and return from online marketing dollars is maxed out, offline becomes an attractive complement as another touch point in the customer purchase cycle. This requires a shift to viewing a square foot of space as media rather than as potential revenue generator;
  • Conclusion: brands need flexible and easily accessible physical retail.

3) Last, dis-intermediation in the property marketplace is inevitable: timing is not clear, but the web WILL disrupt as it has done already in other sectors:

  • the transparency brought by the internet makes it increasingly difficult for middle-men to justify their share of the value created along the entire value chain, leaving buyers and sellers to retain the margin that would otherwise go to the market intermediaries;
  • the compensation model under which commercial property agents are remunerated is still the same as it was when lease length averaged > 10 years, with short-term leases not generating enough commission to be worth their while;
  • Conclusion: the web will enable dis-intermediation in the commercial property market.

Business Model

An online transactional marketplace is a proven business model that is very attractive because of its economics and its defensibility, at scale.

  • Attractive economics: marketplaces generates a fee without taking the cost of inventory and incurring in the risk of not being able to shift it; in the case of Appear Here, the inventory is owned and held by the landlords, and Appear Here valuably facilitates the transaction via its website;
  • Defensibility: marketplaces also tend to be highly defensible, once they reach a certain level of liquidity; this is because buyers/sellers tend to naturally gravitate (and stick) to highly liquid marketplaces where they have the highest chance of being able to find a large number of seller/buyers.

Entrepreneur

Ross Bailey is a charismatic and energetic entrepreneur with a grand vision and the courage to go after it. We, at Forward Investment Partners, love backing entrepreneurs like Ross.


Yahoo! Sum of the Parts