- 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.
- 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:
- 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.
- 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!
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;
2) Private equity investors value margins, while the listed market investors don’t seem to care that much;
3) There is a slight premium for scale in the listed markets, not in the private markets;
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?
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.
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…
Since Q3 2010 Amazon has been consistently growing headcount at a faster rate than net sales: while TTM net sales went from $30.8B in Q3 2010 to $66.8B in Q2 2013 (2.2x), headcount grew from 28k to almost 100k (3.1x) over the same period. What’s interesting is that this is a clear inversion of trend compared to the quarters leading up to Q3 2010: from 2001 to 2010 net sales grew by a factor of 10x while headcount ‘only’ trebled.
If one then looks at sales growth by segment (Amazon reports net sales by Media, Electronics & General Merchandise and Other), it all starts making sense: the bulk of the growth in absolute terms has come from the EGM segment, which grew from $15.6B TTM net sales in Q3 2010 to $43.1B TTM net sales in Q2 2013 and now accounts for close to two thirds of Amazon total net sales. EGM includes stuff like consumer electronics, DVDs, software, home & garden furniture, toys etc. which, unlike books, movies and video games (included in the Media segment) is heavy and bulky and requires both more warehouse employees AND more warehouse space. Also, as Amazon pushes aggressively towards same day delivery, more fulfillment centres are required to get closer and closer to the end customer, which is likely to further diminish Amazon efficiency at generating revenues.
Q3 2010 looks like an inflection point when the Media segment started being shadowed by the EGM segment in terms of net sales.
Benedict Evans, in a brilliant post on Amazon’s (lack of) profits, has recently speculated that the company could well be a cleverly orchestrated ‘Ponzi’ scheme where top line growth can only be sustained by suppressing profitability and constantly re-investing every cent of free cashflow back into the business (and particularly, in fulfillment centre staff).
“The other view is that this isn’t actually possible – that Amazon is a sort of Ponzi scheme. It can only grow by running at zero profit – as soon as it puts up prices or cuts capex the business will collapse, and as soon as the share price stops going up all the staff will leave. “
While the market does not seem yet to buy into this thesis (Amazon stock price trebled since Q3 2010, despite razor thin profits), I think it is interesting to draw a comparison between Amazon and other brick and mortar retailers that have historically suffered from Amazon stellar growth.
While Amazon pulls in c. $700k in annual sales per employee, the bricks & mortar retailers average just over $200k per employee. Again, that all still makes sense: the volume of online customers that can be serviced for every warehouse employee exceeds that of a physical retail store; and while Amazon’s servers don’t need that many dev ops to keep them up at night, other retailers need cleaners to mop the floors at each store location every night. That’s why on paper ecommerce beats brick & mortar retail on a unit economics basis. What’s interesting though is the trend in Amazon revenue per employee: while Amazon is still significantly more efficient than its offline competitors at generating revenues, the trend is now clearly showing a steady decline.
The acquisition of Kiva Systems, a warehouse automation company, in March 2012 (Amazon’s second largest ever after Zappos) was timely, although it is yet to make an impact on revenue / employee efficiency.
I will be monitoring this metric over the next few quarters.
[UPDATE TO Q3 2013: numbers are out. As expected Amazon continues to grow more inefficient. With total employees now at 110k, it’s average LTM revenue per employee is at a 10 year low of $730k]
I just read about Walgreens acquisition of Drugstore.com for over $400mm. Wow.Traditional retailers are really feeling left behind in the race to online…this is happening more and more often. Not too long ago Morrisons, the UK supermarket group, acquired Kiddicare and snapped up a minority stake in FreshDirect, the US online groceries retailer. While this is a natural move for companies that have traditionally operated in the offline world (and do not have a clue about online), it is also driving valuations of eCommerce businesses through the roof, literally.
These are some multiples I have calculated based on public info:
- Drugstore.com, at $409mm enterprise value, is being valued by Walgreens at 25x 2010 EBITDA and 22x 2011 projected EBITDA
- Kiddicare, at £70mm, was valued by Morrisons at well over 20x 2010 EBITDA
- ASOS trades at over 30x 2011 forecast EBITDA!
- Ocado trades at 30x 2011 forecast EBITDA
I would love to see a chart of eCommerce multiples pre dotcom crash..I bet they were not that far away from what we are seeing in the market these days (if you have a source, please send me the link!).
UPDATE: some useful data on Ben Horowitz‘s blog, which compares multiples now vs. the dotcom bubble. The answer is: we are not in a bubble! yet.