Web Smith kicked off a discussion this week regarding valuation multiples for direct-to-consumer (DTC) commerce companies. The recent Casper IPO filing brought this debate into the zeitgeist (and my newsletter too). This week, I’d like to add a bit of data to frame the conversation around valuation multiples.
First, a big caveat: valuation is a bit of art and science. We seldom have enough information about the future in a fast growing company to do a proper discounted cash flow analysis. Multiples are quick and dirty benchmarks to get the job done, but are easy to misapply. Extraordinary companies can break free of the constraints of a set of comparable multiples. So, please don’t interpret the below as prescriptive for every company.
Multiples will vary by DTC category. I’ve discussed the business models and valuation comparables for each of the four major DTC categories below. The first three categories have fairly well-defined valuation ranges, based on several decades of comps. The last one, as we shall see, leaves the most open for debate.
(1) eRetail: These companies sell 3rd party goods to consumers. Some may also offer private label products, but generally these businesses rely on the brand equity and marketing dollars of the 3rd party products they sell. Most of these businesses also hold inventory and are consequently burdened with working capital. Recent IPOs in this category include Wayfair ($W), Stitch Fix* ($SFIX), Revolve Group ($RVLV), and Chewy ($CHWY). Amazon* ($AMZN), of course, is the dominant player in this category.
These public companies have gross profit margins ranging from 20-45%, with slim or negative EBTIDA margins. The standout exception is RVLV, with 53% gross margins and 9% EBITDA. Valuation multiples for these businesses over the last 5 years have been constrained to 1-3x LTM revenues, for the most part. The big exception is AMZN, but a big chunk of its valuation premium comes from its high margin cloud services segment. Its core e-commerce business would likely fall in the typical range.
Gross margin alone does not explain a company’s multiple in this category. Take W and CHWY, which have similar gross margins (low 20%’s) and growth rates (35-40% YoY). CHWY has more than double the multiple of W due to more frequent purchases and the sticky nature of its customer.
(2) Transactional marketplace: These companies connect buyers and sellers to transact products or services. They monetize primarily by extracting a cut of the of transaction (i.e. the “rake”). Often, paid placement will supplement transactional revenue to drive higher margins. Some are peer-to-peer, while others match different groups across the platform. Recent IPOs in this category include Eventbrite ($EB), Fiverr ($FVRR), Farfetch ($FTCH), Etsy ($ETSY), Uber ($UBER), and Lyft ($LYFT). Ebay ($EBAY), of course, was the original player in this category.
These companies trade between 3-7x LTM revenues today, with some upside to 10x+ in headier times. That wide range is driven by the degree of operational complexity and/or competition in a given market. UBER and LYFT, for example, have plenty of both and are at the bottom of the range with gross margins of 30-40%. ETSY and FVRR, which merely connect buyers and sellers online (with no offline component), have 70-80% gross margins and earn nearly double the multiple.
(3) Listings service: These companies also connect buyers and sellers, but importantly stay out of the flow of the transaction. They monetize predominately through advertising and listings fees, sometimes in a subscription format. This business model is more common in long lead time, high dollar value purchases like homes, cars, or personal services. Cargurus ($CARG) is a recent IPO in this category. The category also includes companies like Tripadvisor ($TRIP), Yelp ($YELP), and Zillow ($Z).
These companies trade across a wide range of valuations from 1-7x LTM revenues. Gross margins are very high in this category, usually in excess of 90%, due to the low cost of goods from ad products. The difference instead is driven by growth rate: TRIP is shrinking, and YELP is only growing at 7%. Z has accelerated growth from 20% to over 70% by shifting its business from high margin listings to low margin “iBuying” à la Opendoor. As such, Z’s multiple has fallen significantly due to business model risk and lower margins. CARG has 30-40% growth and healthy margins, and as such earns a 7x multiple, topping the range.
(4) Digitally native vertical brands (DNVBs): Bonobos* founder Andy Dunn coined this term years ago to describe a brand started on the internet that sells directly to its own customers. Vertically integrated brands have existed for decades at retail (e.g. Lululemon, Starbucks, Crate&Barrel, Patagonia, Trader Joe’s), but the DNVB model is only a decade old. The only DNVBs to IPO are Blue Apron ($ARPN), HelloFresh ($HLFFF), and most recently Smile Direct Club ($SDC).
From a valuation standpoint, we can draw few general conclusions from this comp set. APRN and HLFFF are in the same business, but have drastically different financials. The former is shrinking at 34% and is worth $120M of enterprise value. The latter is accelerating growth from 31% to 36%, wroth $3.8B of enterprise value, and is expected to post its first annual profit in 2019. On a multiple basis, HLFFF is worth ~2x revenues, but turning profitable could inflect that number upwards. SDC is also trading around 2x now, with high gross margins (74%), decent growth (50%), but accelerating Adjusted EBITDA losses (25% of revs).
No publicly traded DNVB comp has demonstrated a capital efficient business model to date. The trading range of 1-2x revenues reflects the market’s skepticism that these businesses will turn a significant profit in the future.
However, a crop of late stage, private DNVBs (e.g. Warby, Glossier, Away, Rothy’s*) may show a different path in the public markets. These companies exist in high margin categories, with minimal competition, and have been able to bootstrap growth on relatively little (or, in Rothy’s case, zero) cash burn.
A better metaphor for these businesses may be premium, vertically integrated consumer brands. Examples include recently public companies Yeti Holdings ($YETI) and Canada Goose ($GOOS.CA), with gross margins of 50-60%, EBITDA of 18-24%, and growth of 16-38%, respectively. These companies trade at 4-5x LTM revenues and 21-22x LTM EBITDA.
If we look at older companies with even greater scale like Lululemon ($LULU), Under Armor ($UAA), or even Nike ($NKE), we find periods of time when these stocks performed at least as well in the last decade. LULU peaked at over 10x LTM revenues in 2012, when it was growing nearly 40% YoY with 20% EBITDA margins with over $1 billion in revenues.
Given the strength of the offline comps, the question I’ve grown to ask myself with DNVBs is if the business can scale to $1 billion in revenues over time and produce 20% EBITDA margins at that scale. It also needs to do this on a reasonable amount of invested capital (<$50M) in order to demonstrate capital efficiency. If so, the median offline vertical brand multiples suggest such a company could be worth over $4 billion, with additional upside if you consider LULU to be the blue sky scenario.
Until DNVBs appear with these characteristics, they will likely trade at eRetail-like multiples (1-3x revenues) because the market has no other solid comp. I am optimistic because I have seen a renewed focus on capital efficiency in the recent crop of DNVBs, with a number of them at or close to profitability. One of these companies will be the first blockbuster DNVB company to go public and will hopefully redefine the conversation.