Description

BHG Group (BHG.SS), formerly known as Bygghemma Group meaning “building at home” is the “Wayfair of the Nordics”.

Despite only a ~$1.2bn market cap, BHG is one the largest and most successful e-commerce companies in Nordics (~90% of sales) and in all of Europe. BHG was a recent IPO in March 2018 at $45, and the stock has since more than doubled, but it remains relatively unknown, partly because of its limited liquidity (~$5mn ADV), as well as its limited sell side coverage. However, FSN, its previous PE sponsor, just placed its last shares so liquidity and coverage are likely to improve so I don’t believe shares will stay depressed for very long.

BHG is benefitting from the same secular retail brick and mortar (“B&M”) to online shifts that we are seeing globally as well as covid related tailwinds which has just accelerated ecommerce adoption by several years. In Q2 2020, BHG’s results were very strong as they posted +54% revenue growth and +39% comps. Most impressive was EBIT +119% y/y as EBIT margins reached 8.9% (+250 bps y/y). Moreover, mgmt explained that bookings exceeded revenue growth and that trends remained similar in early Q3 2020, so Q3 consensus is likely still too low. While the stock rallied to ~$115 post earnings, the stock has now pulled back to ~$105 on misplaced Amazon concerns and FSN’s secondary placement overhang which provides an attractive entry point.

While current growth is not sustainable, pre-covid BHG consistently exceeded its ~25% revenue growth target as its ~35% CAGR revenue growth over the last five years came from 15-20% organic growth augmented by ~10% growth from highly accretive tuck-in M&A. BHG Group now consists of ~36 brands and websites which are run in a decentralized manner although each brand is accessible from each site which provides unmatched scale benefits in the region. Moreover, BHG continues to strengthen its position as the market leader as its SKUs online have grown from ~500k to ~1 million over the last year.

However, I believe it is still early innings for an attractive investment which checks several of my favorite boxes: strong organic growth and not capital intensive with a solid track record of highly accretive capital allocation at a company that is led by heavily invested owner/operators.

During BHG’s 2018 IPO roadshow, mgmt disclosed a ~5-year revenue target of $10bn SEK (~$1bn USD) and I believe they will achieve this in 2021 (2 yrs early). BHG also disclosed a ~5-year EBIT margin target of 7% and they already achieved this in Q2 2020 (~3 years early). BHG’s management is of the opinion that these changes in consumer behavior could to some extent be permanent and I’m a believer as well. 

Target Price & Upside

Yet BHG, which has similar growth and higher margins than Wayfair, only trades at ~10x 2021 EV/EBITDA and ~20x ’21 EPS while Wayfair (“W”) trades at ~65x consensus 2021 EV/EBITDA and >100x ’21 P/E.

Nevertheless, this set up is not unique as it reminds me a lot of Sinch SS, or commonly known as the “Twilio of the Nordics”. Despite having a similar business model to Twilio with high growth and even higher margins, Sinch traded at ~20x forward P/E towards the end of 2019 while TWLO’s boasted a >100x P/E valuation. However once Sinch surpassed $1 billion market cap and it maintained its strong performance institutional interest started to pick up in the Fall 2019 and shares skyrocketed as its P/E multiple went from ~20x to >50x. Sinch shares are now +175% YTD and I think we are nearing a similar inflection point in BHG shares.

My base case for BHG over the next 12-18 months is >$207 (+97% upside) based on $5.91 ’22 EPS at 35x P/E. My bull case is ~$310 (+194% upside) based on $6.18 ’22 EPS at 50x P/E, while my bear case is $90 (~25% downside) based on $4.00 ’22 EPS at 20x P/E. This is a favorable >4/1 upside/downside. Also, my EPS estimates are >20% higher than consensus, which only assume modest EPS growth even though BHG organic growth has consistently been >15%.

Solid Drivers of Sustainable Growth

BHG was originally founded as a DIY brand (think LOW’s) and was a subscale retailer until 2012. That is when Mikael Olander, Martin Edblad and Peter Rosvall, all of whom had all successfully worked together for ~10 years building one of the first e-commerce websites (CDON Group), left the media conglomerate MTG Group to take over BHG and execute on their vision of what a preeminent online retailer would look like. Since then the three Partners have accelerated the company’s growth while beginning to penetrate the home furnishing market as well. Now the business is ~100% e-commerce with ~60% of revenues coming from DIY and 40% from home furnishing.

However, BHG is not merely just a transient covid winner, but a structural market leader and a share gainer in its early innings. BHG dominates the Nordic online home furnishing market, much like Wayfair in the US, and now has >30% market share of online furniture market in the Nordics, which is 4-5x the #2 player. While the home furnishing market pre-covid only had ~2-3% growth, the online category had been growing 10-15% and BHG continued to take share. In addition, this is a large market with Nordic home improvement spend at ~$266bn SEK/yr (~$26bn USD). This implies that BHG currently only has a 3-4% market share.

Still online penetration in the region remains low at ~10% (vs. ~15% in the US and ~20% in the UK) and this is despite the fact that the Nordic region has a relatively high GDP per capita and has been at the forefront of broadband access, online migration and advanced online payment systems. Also, there still is tremendous upside as online penetration for apparel is >30%, while consumer electronics are ~45%. In all, I see online penetration more than doubling over the next few years as consumers become more comfortable purchasing home goods online and BHG should continue to garner increasing market share.

Market Leader w/ Strong First Mover Advantages

BHG is the market leader with strong first mover and competitive advantages. Moreover, as BHG grows they become increasingly structurally advantaged in what is likely a “winner take most industry”. As BHG scales the company can in turn negotiate better prices from both its current and future suppliers. This in turn drives improved pricing and unit economics and the ability to further invest in the acquiring more loyal, repeat customers. The company’s key competitors are B&M retailers where they are not built to profitably compete with an online-only business model and they are playing catch up as their stores, which are losing volume, sap cash flow and resources. While these legacy players are slowly shifting online, BHG is galloping ahead.

BHG business has been fully optimized to be an online-only market leader from the start and it now offers the deepest and broadest range in the region at very affordable prices. As BHG continues to aggressively invest in customer acquisition and as they become the “one stop shop” for all things home goods they continue to build upon their moat.

BHG Group now consists of ~35 decentralized, yet unified brands, and as Nordic consumers search for home furnishing items on Google they oftentimes find that BHG owned websites populate several of the websites listed on page one effectively taking up all of the best online real estate. This once again creates another virtuous cycle as more people end up shopping on BHG’s sites and BHG has more money to invest in online advertising and/or GOOG placement. These dynamics create a powerful self-reinforcing scale advantage for leading online players and BHG is sure to benefit from this as well.

On top of this, BHG is leaning into its first mover and scale advantages and is further strengthening its moat by rolling out last mile delivery in major cities, installation and other value-added services which just serve to strengthen its customer loyalty and lifetime values.

Attractive Business Model and Cash Flows

On top of this, BHG is an attractive capital light business with solid margins. While many online retailers struggle to achieve profitability, EBIT margins have risen from ~4% in 2018 to ~7% in 2020 while capex/sales is ~1.5% and cash from operations is oftentimes >2x adjusted net income due to high amortization and negative NWC.

BHG only has a few showroom-like stores while most of its business is conducted online. Also, the majority of BHG’s products are delivered using a dropship model whereby suppliers are responsible for manufacturing the product, holding the inventory in their own warehouses and ensuring the product is delivered directly to BHG’s customers. This business model also allows BHG to scale using other people’s money as they benefit from a negative working capital model

Remarkably, BHG has been able to drive this sustainable >15% organic growth while only spending ~5% of sales on marketing, which is significantly lower than other ecommerce market leaders. In addition, BHG has done a great job of increasing its private label business mix which is now ~45% of total sales and provide BHG ~500 bps higher EBIT margins than branded products. As of now, ~90% of home furnishing sales come from private label while DIY private label penetration has grown from ~10% to >20% over the last year. BHG will continue to increase its private label penetration via organic growth and M&A and its margins should continue to benefit from this tailwind.

Additional Upside from Capital Allocation

M&A is another key part of the story, which isn’t in sell-side estimates and serves as an additional driver to the upside. BHG drives additional EPS growth from highly accretive M&A and this management team has already integrated >30 companies since 2012. Over the years, like most successful Platform Build Ups, BHG has developed a detailed and repeatable M&A playbook.

BHG typically targets subscale mom and pop brands with $10-30mn in revenues which they can acquire for 5-7x EBIT. The ideal target brings complementary product offering, category expansion and/or new geographical scale leading to increased wallet share and/or TAM expansion.

Upon acquiring these companies BHG can grow revenue at these brands oftentimes by 2-3x in a short period of time. BHG looks to keep entrepreneurs in place and have them continue to run their own businesses in a decentralized manner, but the new brands are added to all BHG Group websites where the product can now be seen my millions more eyeballs. On the cost side, BHG is also able to drive procurement savings as they can offer their suppliers much larger orders. Most recently, BHG acquired a 50% stake in FurnitureOne, which is a market leader in Eastern Europe and the Baltics and early results have been stellar. This opens the door for yet another untapped market and a potentially larger TAM than rest the Nordics. In addition, BHG has some exposure to Continental Europe, which provides additional upside, but this opportunity doesn’t impact my 12-18-month target price.

In 2020 BHG has not been active in M&A and their ND/EBITDA multiple has now dipped to net cash vs. their 1.5-2.5x ND/EBITDA target and typical ~1.5x position. However, there are signposts that M&A is on the verge of meaningfully accelerating. First, in late 2019 BHG doubled the size of its credit facility. Next EQT, which is a preeminent private equity investor in the Nordics, acquired a ~19% stake from FSN. Based on my discussions with EQT, I believe they will look to help BHG accelerate and improve its M&A strategy. Also, EQT intends to be a long term ~5-year holder. On top of M&A expertise, EQT offers endless knowledge and resources to BHG’s management team as the private equity firm specializes in tech and e-commerce investments. 

Lastly, BHG continues to be led by best in class owner/operators which are flat out winners, including the current COO and former CEO, Mikael Olander, who competed for Sweden in the 1988 Olympics as a decathlete. These three Partners still own ~7% of shares and EQT just recently subscribed to an additional ~3.5% stake at current prices which should put a new floor under shares. At the end of the day there are many ways to win as BHG continues to dominate this high growth industry and its valuation multiple has tremendous upside as the knowledge gap closes and people become more familiar with the story.

Thinking Backwards

Wayfair / Amazon Risk (of course)

As of right now it appears that W has its eyes set on growing in UK and Germany, which make sense as these are both very large markets. While I can’t rule out the Nordics, there are several other larger Continental European markets which are likely more attractive to W rather than moving into the Nordic in the next several years.

In regard to Amazon, for years Swedish consumers have been able to shop on Amazon’s website via Amazon’s Germany and/or Poland portal, but Amazon estimates that revenues are only ~1bn SEK, which suggests an online market share of <5%. However, years ago Amazon purchased a Swedish domain name and now in the last few months the rhetoric around Amazon’s entry has increased. On August 4^th, Amazon finally confirmed its plans to launch in Sweden. However, no exact date has been given and it appears that it will only be the online marketplace where third party vendors are able to sell on Amazon and Amazon will not be responsible for fulfillment. In fact, BHG themselves highlight that there is nothing that could keep them from listing some of their own SKUs on the website!

In addition, according to the Swedish tech news site Breakit, Amazon has established a warehouse ~50 miles west of Stockholm. However, the warehouse is ~15,000 sqm, which is way too small to function as a complete fulfilment center, suggesting it is more likely to serve as a cross-docking station for its Nordic fulfilment. Amazon’s avg Prime fulfillment warehouse in Europe is ~45,000 sqm (>3x the size). Therefore, initially Amazon will not have the infrastructure to offer Amazon Prime, which has been critical to their success in other markets. Eventually, in perhaps 3–5 years after its launch, I believe Amazon will likely establish local fulfilment centers which could enable next-day or even same-day deliveries and a full Prime experience.

Nevertheless, I think this is a moot point as Wayfair continues to dominate in the US, Amazon’s largest market, and Amazon has failed to gain traction in online fashion where they are trying to compete against online product specialists like Asos (UK) and Zalando (Germany) and this is despite the fact that Amazon represents >30% of online retail in Germany and the UK. In terms of pricing, BHG is already priced as a value priced retailer and ~50% of its product is private label which doesn’t provide a large price-related risk.

But What Happens When There’s A Vaccine?

Lastly, another key concern is the sustainability of this financial performance and potential risk to the share price. Here again, I think it’s a moot point because BHG’s valuation is ~50% lower than it should be based on its comparables. Therefore, I believe that any slowdown in business performance can be supported by closing its large valuation discount to peers. This tremendous valuation discount provides a large margin of safety as BHG remains a solid secular growth story which is still in its early innings despite the massive tailwind caused by covid.

Catalyst

·       Positive Q3/Q4 earnings releases driving higher consensus estimates

·       Additional research coverage driving a reduction in the knowledge gap

·       Improved transparency around customer level, cohort data

·       Potential new mid-term margin higher (>7%) EBIT margin targets

·       Accretive platform and/or tuck in M&A

·       Potential take out candidate by EQT and/or a strategic