Borderfree is a low tech consulting and logistics business masquerading as an e-commerce cloud solutions provider with shares that trade on a multiple of sales that is grossly inflated and misunderstood.  Its sales recording method is unique against the hundreds of companies we study and follow.  Regardless, over time, BRDR shares should rerate to reflect the underlying reality of the business’ poor economics.  This write-up will highlight six key reasons as to why we think BRDR is a compelling short (including a timely IPO lock-up expiration).  But first, lets go over some background on the Company.

What does Borderfree do?

In the Company’s own words, “Borderfree, Inc. provides cross-border ecommerce solutions. The company operates a technology and services platform that enables retailers in the United States to transact with consumers in approximately 100 countries and territories worldwide. Its customers include retailers, department stores, apparel brands, and lifestyle brands that sell a range of physical goods online, including apparel, handbags, jewelry, sporting goods, home décor, and toys.”

In layman’s terms, Borderfree provides a web platform/interface that allows its customers (large US retailers like Williams Sonoma and Macy’s) to offer their products in different countries to end consumers.  Borderfree handles the currency translation, duties, shipping and fulfillment responsibility on behalf of the retailer.  At the same time, they are also on the hook for fraud, chargebacks and payment processing mishaps, if any.  Keep in mind that BRDR holds no inventory.  Once a product is ordered, it is shipped to a domestic hub that is run by a third party logistic provider that has contracted with Borderfree.  It is then sent to an overseas hub before being shipped to the ‘last mile’ by (usually) DHL.  In some cases, if there are high moving SKUs, Borderfree will preemptively place certain inventory in country at third party overseas hubs.  BRDR calls the total value of goods passing through their platform as GMV or Gross Merchandise Volume.  In 2013, GMV amounted to $447.8m

See for yourself.

Go to Macy’s.com and click on the little flag at the top right hand corner of the page.  Select ‘United Kingdom’ as your shipping destination.  You are now in the world of Borderfree.  What you will notice, if you place something into your shopping cart and try to buy it, is the exorbitant cost of shipping and duty.

Example: Borderfree shopping experience on Macys.com

Our analyst goes to Macys.com from our London UK office and sees this popup:

 He then selects this handsome Izod golf polo.  A steal at only 14.62 GBP!

 He adds the polo to his cart and proceeds to pay.  Much to his dismay, the item’s shipping charge costs more than the item! (note the Borderfree fulfillment service disclaimer at the bottom)

Ready to short Borderfree yet?  Hold up.  First, some more background on the business.

How did Borderfree start?

Borderfree’s roots can be traced back to established serial entrepreneur Yuval Tal’s early company E4X.  According to the “Geektime” blog:

“[E4X was] a business that developed a solution that allowed for electronic trading around the world to view prices in local currency of the user and get the transaction in exchange for dollars, without dealing with the hassle of converting different currencies.  Along with the development of e-commerce, the developers understood that the various trading sites have difficulty with other aspects of the new digital business reality with regards to handling international customers so they decided to expand the company’s product portfolio to offer handling international shipments, accurate price calculations; and to include additional costs such as customs clearance of credit, risk management and even the allocation of personnel customer service.

As part of this development, the company changed its name in 2007 from E4X to FiftyOne, bringing in a new outside CEO named Michael deSimone, a former senior executive at Citibank, to further develop the activity.”

In March of 2012, FiftyOne bought Canadian competitor Borderfree, and changed the name of the Company to Borderfree in April of 2013.  Since its inception and before coming public in 2014, Borderfree has raised $41.5 million from Israeli venture capital funds:  Delta Ventures, Pitango, Vintage and Loyola Credit; and from American foundations Adam Street Partners, Online Ventures and Ventures Strategy Group. 

Initial Public Offering

On March 21, 2014, Borderfree sold 5,750,000 shares of common stock, which included 750,000 shares sold pursuant to the underwriters' option to purchase additional shares, in its initial public offering, at an offering price of $16.00 per share, valuing the Company at $500m.  Note that in 2012, bankers were tossing around the idea of a $700-$800m valuation. 

Post IPO, Borderfree received approximately $85.6 million, net of underwriting discounts and commissions.  Credit Suisse and RBC Capital Markets were the lead underwriters.  The company ended its first trading day up 25% (after having reached a peak of 33%).  It closed the day at $20 and has never seen that price again, hitting an intraday low of $10.82 on May 9^th 2014, two days after their first earnings report as a public company. 

Currently, there are 31.5m shares out, with the top five shareholders holding 55% of the stock (see below).

***The lockup expiration is on 9.17.2014 making this a somewhat timely idea.***

Top 5 Shareholders:

Pitango 8.6m shares (26.5%)

Adams St 5.5m shares (17.5%)

Delta Ventures 3.1m shares (10%)

VSP Capital 1.5m shares (4.7%)

Mass Fin Services Co 1.1m shares (3.66%)

1.  Borderfree is a “Bridge to Nowhere”

The more success that a merchant may having using BRDR, the higher the likelihood that BRDR will, in the long run, fail.  What does this mean?  It means that if Macy’s, Williams Sonoma, Marc Jacobs, etc.  were ever able to generate any meaningful international sales, they would simply recut their contracts with Borderfree the first time they came up for renewal or they would just bring the business in-house.  Why would a multimillion dollar brand with global aspirations give away a meaningful percentage of their sales to what is, at the end of the day, a “skin” on a web site with a currency converter attached to it?  BRDR is a terrific testing ground/end-to-end solution for a company to begin selling their wares into dozens of countries fast.  But that is where it ends.  Any brand that can achieve size or scale in a foreign land is likely to take up operations there so as not to give up any of their economics and/or cut a new deal with Borderfree.  

Borderfree also competes against well established behemoths like Amazon and eBay Enterprise where merchants have the benefit of the latest technology, local sales, distribution centers, currency and fulfilment capabilities simply by hitching a ride on the Amazon/eBay platform.  Amazon has also demonstrated that it has no need to ever really turn a profit.  BRDR would refute this statement by saying that once a brand is on Amazon, it loses some of its identity, ie any real brand would prefer to have its own web site.  While this may be true in some cases, say for Brooks Brothers (a BRDR customer), it is hardly true for the thousands of products sold by say Macy’s, a company that is just an aggregator of other merchant’s products.  Services such as PayPal already allow consumers to pay in their own currency as well.  Borderlinx, among other startups, offer a service whereby customers receive a US shipping address (Borderlinx’s warehouse) and thus the ability to buy US items as a US customer, deliver to your storage space in their warehouse, and then Borderlinx ships it to you.

Borderfree walks a delicate line where customers need to grow in order to BRDR to enjoy higher sales and profits, but not grow too much or too fast where they will cut a new deal with BRDR or leave the platform.  Contracts don’t last forever.  Our discussions with large third party e-commerce facilitators indicate that no deal is ever more than 3-5 years and that once a customer (at least domestically) reaches $250m in sales, they usually leave and handle their e-commerce platform on their own.  BRDR talks often about its competitive advantage and tries to paint itself as being in a great niche where they ‘preserve brand value’ but their competitive position is actually very weak.

2.  Borderfree has no real technology

Borderfree has no real technology.  Less than $42m in venture capital has been invested in the company since inception.  By way of comparison, everybody’s favorite SaaS company to hate, Workday (ticker: WDAY) spent $62m in product development in 2012 alone, when its sales were comparable to BRDR ($134m for WDAY vs $116m ttm for BRDR).

The Company has touted the following, none of which we can find any evidence of (paraphrased from conference calls, presentations).  Note that our rebuttal is in bold:

-          “Borderfree’s platform gives its merchants the ability to shape prices in real time.”  A random walk through several of BRDR’s customer sites shows no evidence of this whatsoever.  In fact, pricing looked uniform across all of the jurisdictions that we tested the site and was based on nothing more than the exchange rate plus shipping and duty.  If a sweater was $40.00 in the U.S. it was $40 multiplied by whatever country factor of price/shipping/duty was unique to that country.  Not one merchant seemed to be contouring anything based on local tastes or preferences.

-          “Shoppers abandon 50% of all domestic transactions online, and almost 75% of all international transactions online.  As we drive down the cost of shipping international transactions, we will see an uptake in the order rate and be able to drive volumes through our platform.”  This is a chicken/egg argument.  We tend to think that higher sales drive lower shipping prices, and not the other way around.  See Amazon.com for proof of this.

-          “Our platform gives valuable data insights to merchants with respect to what items are selling where.”  Fair.  But this data is no more valuable than the data that those merchants would gather if they ran the platform on their own.  If on the other hand BRDR is showing Macys what people at Williams Sonoma are buying, this could be very valuable.  However, we doubt that this is going on, as customers would be reluctant to have their data shared in this way.

-          BRDR does not break out the gross merchandise value (GMV) of products across platforms ie desktop versus mobile, tablet etc.  Mobile commerce (or mcommerce) sales are growing much faster than traditional ecommerce sales and are becoming an increasingly larger slice of the web commerce pie (see the chart below).  BRDR will clearly have to bring on (or acquire) additional resources to accommodate this trend.  The fact that this is not discussed or broken out today, leads us to believe that it is an inconsequential portion of sales. 

3.  BRDR’s revenue model is opaque and the business suffers from heavy customer and geographic concentration

Ten BRDR customers represent over 60% of sales.  In addition, almost a third of sales are from Canada.  This is non-trivial.  Canada is the easiest natural extension for growing US brands.  An expansion into Canada both logistically and commercially would not be hard to facilitate and is further proof that most merchants on the platform are simply testing the waters. 

Furthermore, with revenue concentration this high, the typical customer contract should be easy to articulate to investors.

Instead, we find the financial statements are opaque with respect to how their revenue is calculated and booked.  Consequently, we tried several times to reach the CFO in the NYC headquarters for clarity on the financials.

Conceptually, both from the Company’s public statements (conference calls, presentations, etc.) we think we understand how a customer contract works.  However, when your business is worth close to half a billion dollars, it is very rare to see so little disclosed with respect to the revenue model.  Perhaps this is because each contract is different and they have to keep terms private so as not to inform the next potential customer what kind of deals the previous customers received.

Borderfree books revenue in two segments:  1. fulfillment services and 2. ecommerce services. 

Fulfillment services are completely pass-through and Borderfree earns no margin at all.  These are the shipping and duty fees that BRDR charges to a customer that are then remitted to shipping carriers and government agencies.

Ecommerce service revenues are slightly harder to understand.  BRDR earns ecommerce revenues in two ways:  1.  From the online merchant and 2. From the end customer.

For the purposes of this point, we are only concerned with Ecommerce services, because this is the only segment that will produce a profit.

Straight from the public filings:

We derive ecommerce revenue from fees paid to us by our customers based on a percentage of their total gross international sales revenue processed through our technology and services platform. In 2013, this revenue driven by customers represented 42% of global ecommerce services revenue. Our customer contracts typically have multi-year initial terms ranging from one to four years, followed by one-year renewal periods. Revenue derived from our customers is recognized upon the delivery of the agreed upon service to the customer.

We generate additional ecommerce revenue from foreign exchange services and fees related to parcel protection and other transaction based fees from consumers who transact on our customers’ websites and mobile applications. In 2013, this revenue driven by consumers represented 58% of our global ecommerce services revenue.

So what have we learned? 

Actual ecommerce revenue is 12% of GMV.  Out of this 12%, 42% comes from the merchant.  This is the 5 of sales that BRDR is taking on each transaction.  For the model to be sustainable, and sales to go higher over time, either volumes have to improve, or merchants have to pay BRDR more.  We already covered why we do not see the latter happening.

58% of the 12% comes from the consumer.  This opaque amount is buried in handling fees and FX fees.  Think of the currency management and exposure issues that could cause a strange "surprise” from time to time.  That aside, again we find that BRDR’s sales are linked to items that either must go up on their own (unlikely as the Company has stated that they want to drive sales by reducing fees) or must improve via volumes.  BRDR has no control over the volumes that end up moving through their site and rely on the local brand awareness, advertising and interest of their merchants.

It simply isn't enough in our estimation to say that you earn your revenue from forex and 'other' fees.  The mechanics of this should be clear and right in the financials for investors to see and understand.

4.  The $103.32 Pepper Mill for the Pakistani consumer

Ask yourself the following…

Why would somebody in Canada need to order a Ralph Lauren shirt from Macys.com?

Why would somebody in Japan need to order a pair of Adidas from Shoes.com?

Why would somebody in Pakistan need a Pepper Mill from Williams Sonoma..and for $103.32 !?!

The case analysis we show below is key to understanding the ridiculous premise of Borderfree, as it relates to most of the business.  While even us skeptics can see why an impossible to find Under Armour training shirt may be ordered by a Peruvian soccer star (that is until Under Armour sets up shop in South America and/or does this themselves), most of the products offered through the Borderfree platform are not only unnecessary at their retail price given the slow speed of delivery and hassle alone, but even more absurd when you factor in the fully burdened cost.  Take a look at the data below, which we pulled by going to Williams Sonoma and adding dozens of items to our currency matrix.  This snapshot highlighs both an All Clad Cookware Set and a Trudeau Pepper Mill, which we added to our cart as we pretended to be in the following countries (note not all items are even available everywhere - a sad state of affairs for those interested in the Le Creuset Cookware set or Vitamix Blender):

Would BRDR contend that as more Pepper Mills are ordered in Pakistan, shipping costs will plummet, causing prices to fall, causing pepper mill sales to rise?  We think not.  This exercise proves that BRDR is a snazzy bell and whistle for customers such as Williams and Sonoma, who can now say that they ship to dozens of countries around the world.  Whether any traction happens with respect to sales growth does not really matter.  The bar graphs above are staggering.  They display the all-in premium one must pay (over the USD price) in a few select countries, to obtain these products.

5.  BRDR’s sales are vastly overstated and extremely misleading.  Shares should trade at a multiple of true revenues, not pass through revenues

Let’s recap BRDR’s revenue segments once more for it is worth repeating.

Borderfree books revenue in two segments:  1. fulfillment services and 2. ecommerce services.

Fulfillment services are completely pass-through and Borderfree earns no margin at all.  These are the shipping and duty fees that BRDR charges to a customer that are then remitted to shipping carriers and government agencies.  The Company's own public filing basically articulate that this revenue has no commensurate profit, nor will it ever.  That having been said, it remains a staggering 47% of BRDR’s revenues.   While our research indicates that it is completely within the accounting guidelines for BRDR to recognize revenue as such, the end result paints a picture of a much larger enterprise where Wall Street’s hefty multiple on sales makes an enormous difference to the share price.

Ecommerce service revenues are slightly harder to understand.  BRDR earns ecommerce revenues in two ways:  1.  From the online merchant and 2. From the end customer.The company claims that its pricing model works out to roughly 50/50 ie 50% of their ecommerce revenue is from the merchant, and 50% is from the end customer.

BRDR Sales by year (in millions):

Current BRDR share price: $14.16

Shares out:  33.5 (fully diluted)

Market Cap: $474m

Price to sales multiples:

As you can see, BRDR trades at 8.0x its true sales number.

What multiple of sales should it trade for?

We recently had the chance to see two leading e-commerce/fulfillment companies present, Speed Commerce (ticker: SPCD) and PFS Web (ticker: PFSW)

Speed Commerce (sample customers: Lowe's, Huawei, Yankee Candle, Ulta)

FY-14 Sales: $107m

Adjusted EBITDA: $12.3m

Market Cap: $210m

Price to Sales: 1.9x

PFS Web (sample customers: Lego, Asics, Gevalia, Starbucks)

FY-14e Sales: $129m-$135m

EBITDA: $12m - $14m

Market Cap: $145m

Price to Sales: 1.1x

YOOX S.p.A. (BIT:YOOX), the engine behind “Powered by Yoox” which operates the full-price online stores of fashion houses Marni, Emporio Armani, Dolce & Gabbana Moschino, Jil Sander, Bally Shoe and Ermenegildo Zegna, amongst dozens of others, enjoys the following valuation:

YOOX S.p.A.

Sales (ttm): 486m

EBITDA: 31.4m

Market Cap (EUR): 1.1b

Price to Sales: 2.26x

Only Demandware (ticker: DWRE) trades at a crazier multiple than Borderfee (14.8x sales) as its solution is truly cloud based.  Unlike BRDR, DWRE allows companies to use their cloud software to develop their own web sites.  Brooks Brothers is a BRDR client as well as a DWRE client.  Brooks Brothers would use DWRE to create and customize its digital commerce platform across multiple geographies and BRDR to facilitate sending a necktie to Turkey.  We are not trying to justify DWRE’s multiple, but the business spends more in a year on R&D than BRDR raised in its entire history and boasts 70% gross profit margins.

**Borderfree's market value approximates almost the entire gross market value of all merchandise passing through their platform.**  Even AMZN only trades at 1.75x sales.

We think that Borderfree should be given a multiple along the lines of a technology consulting outfit mixed with an e-commerce provider.  As such, 1.75-2.25x sales seems like a very reasonable range. 

However, we know how much the market loves tech.  So we will double that range to 3.5-4.5x just to be conservative.  However, what we won't do, is use a phony sales number that does not represent the true economic operations of the business.  We use ecommerce revenue only to arrive at true value:

CONSERVATIVE SCENARIO

Ecommerce revenue full year 2014: $75m

Multiple: 3.5-4.5x

Value: $262m - $337m

Fully diluted shares: 33.5

Value per share: $7.83 - $10.07

Upside: 29-45%

LESS CONSERVATIVE SCENARIO

Ecommerce revenue full year 2014: $75m

Multiple: 1.75-2.25x

Value: $131m - $168m

Fully diluted shares: 33.5

Value per share: $3.91 - $5.03

Upside: 64-72%

6.  The lock-up on BRDR shares held by insiders is set to expire on 9.17.14

BRDR’s shares are still held mostly by insiders.

Only 11.62m of the 31.5m shares are in the public float.

Average volume is around 100k shares per day or around $1.5m a day, which is low for a $471.5m market cap.  Insider selling pressure and the laws of supply and demand could help shares settle to a more reasonable level.

Borderfree shares trade at unsustainably high levels for a profit and technology-light middleman whose successes and fortunes are dependent on those of the customers that it serves.  A consulting company with a third party logistics back end does not deserve the multiple of a true SAAS engine.

BRDR trades for 37.7x the mid range of the Company’s stated full year 2014 adjusted EBITDA estimate and 88.5x the high end of their Non-GAAP earnings per diluted share estimate.

Risks

Cash:  The biggest risk to the BRDR short thesis is the Company’s $120m in cash.  This could be used to acquire a better business that would then be awarded a BRDR multiple.

Customer Traction:  The market could trade this name based solely on customer count.  If BRDR continues to sign up brand name customers, shares could go higher despite the lack of commensurate profits.

Notes

Full Year 2014 Projections (source: Borderfree)

• Ecommerce services revenue of $72.9 million to $73.8 million
• Revenue of $139.0 million to $141.0 million
• Adjusted EBITDA of $8.9 million to $9.7 million
• Non-GAAP net income of $4.6 million to $5.4 million or $0.15 to $0.18 per basic share and $0.14 to $0.16 per diluted share. Weighted average basic shares outstanding of 30.6 million and diluted shares outstanding of 33.3 million, on a pro forma basis, as if all preferred shares converted to common shares outstanding as of January 1, 2013
• Non-cash stock-based compensation expense of approximately $3.8 million