Boohoo is a UK pure-play online retailer which focuses largely on women age 16-24. Since BOO’s founding, the Company has had a strong gross margin profile and positive working capital cash flow dynamics. BOO has been able to achieve such high gross margins, in spite of poor brand management[1], because they have been procuring inventory from related parties which give BOO product at close to cost. This has allowed BOO to target lower value unprofitable customers which has helped them triple their customer count since going public in 2013.
BOO is now changing their procurement from related party suppliers to third party suppliers; which will likely require very different terms. I think BOO’s gross margins are likely to fall to industry levels of ~40%-45% either because of procurement changes or pricing decreases. If this is the case, I believe their business model could break as the profits derived from each customer will not be enough to justify the current valuation.
In addition, I think the Company’s growth will be contingent on their brand succeeding in unproven geographies; due to the full penetration of their UK TAM. Despite these headwinds, the Company currently trades at 400x free cash flow and 5x revenue.
II. Brief History of Industry
The Online Apparel and Accessories market is a secular grower which is benefiting from continued online penetration of the $1.2 trillion consumer retail and accessory market. According to eMarketer, online apparel growth is expected to grow around 20% in 2017. This growth rate could be sustainable, if not accelerated, in the future as the online market has only penetrated 5-20% (depending on which geography you are in) of the total apparel market.
Amazon, eBay and Alibaba were first movers which were able to capture a large portion of the market due to their scale and brand recognition. However, because those brands are so large they have difficulty creating curated content that address a very specific target market. This “hole” in the apparel ecosystem has given rise to a number of pure-play online-first clothing brands (“Specific Target Brands”) such as Bonobos/NastyGal in the US and Boohoo/ASOS in the UK.
The attractive fast growing market has led to an extremely competitive market place for Specific Target Brands. According to CB insights, there was $1.5bn in US start-up funding to attack this large TAM on the back of 277 different deals. The business has fairly low barriers to entry aside from the capital to capture customers and build inventory.
Because of the extremely competitive marketplace, very few brands reach profitability. Even well-known brands like NastyGal (bankrupt), Gilt (downsizing) and Overstock (fraud) never reach the scale that investors initially expect. Many of these brands focus on building a following, rather than building a profitable business in the hopes that they can either sell the business or focus on profitability later. In the meantime they convince investors to fund their operations in the hopes that they are building the next mega brand.
III. Business Overview
Boohoo was created in 2006 in a joint venture between current Co-CEO’s Mahmud Kamani and Carol Kane. Kane and Kamani, had been working together at Pinstripe Clothing; a clothing manufacturer in London which was suppling fast-fashion styles for brick and mortar retailers in the UK. Boohoo was created to supply a branded product and go direct to the consumer.
The challenge with opening a pure-play online apparel brand is that it is usually extremely unprofitable due to the initial high cost of customer acquisition and an unfavorable cash profile. To combat this, BOO received product from Pinstripe Clothing (a Company owned by Kamani and Kane) at cost plus a very slim margin determined by Kamani and Kane. This allowed BOO to invest more in sales and marketing and build a large customer base of 1.5 million people by 2013.
Despite the favorable procurement relationship with Pinstripe Clothing, BOO was only barely profitable in 2013 producing £1m of free cash flow. The Company brought on retail veteran and current chairman Peter Williams; who had just abandoned ASOS’ board just before the stock busted. BOO took advantage of a strong equity capital market and IPO’d to a £600m valuation (implied multiple of 600x LTM FCF). The Company raised £300m with the intention of investing that money back into the business. However 3 years later the proceeds from the IPO still sit on the balance sheet.
Since IPO’ing, BOO has increased revenue by £220m and increased the stock price by over 300%. I believe this could be because BOO has been targeting an unprofitable customer and point to free cash flow up less than £3m in the same time frame. Despite little proof of scale and evidence of potential profitability, the market still rewards BOO with a 400x FCF multiple.
IV. Why BOO Could Fail
A. Gross Margin Likely to Fall
As mentioned before, BOO has a beneficial relationship with a few related party companies which have historically supplied a majority of their cost of goods sold. This has given them the appearance of high gross margin profile and a strong working capital dynamic.
When BOO went public they decided to begin cutting ties with their related companies as noted in the S-1:
“Historically, some products were sourced via a number of Associated Companies with common ownership to boohoo. Now all new products are sourced direct from third party suppliers.”
- S-1 BOO 2013
As new products begin to hit the shelves, BOO’s gross margins and trade payables are shifting closer to industry norms. I am doubtful that BOO’s gross margins will hold near their current levels and suspect that they could fall closer to industry norms of ~40%-45%. At that level of gross margin, BOO’s current sales per customer vs. cost of customer acquisition is likely to be unprofitable. As such, I am skeptical that BOO’s business should deserve its current frothy multiple.
Running out of TAM
Customer growth has decelerated from 50% in 2014 to 30% in 2016. While this is still impressive growth the total customer count now is 5.1m customers. BOO’s core customer are females age 16-24 and a quick look at the demographics of the UK show that they may already have penetrated 70% of their target TAM. If that is the case, then the bulls are betting that BOO will have success in unproven geographies.
Inferior Product
When your business model is “fast” fashion, you would think that it would extend to the company’s shipping. However, in BOO’s case, the delivery timing is typically longer or shipping costs are higher. Even worse, in several cases, BOO’s delivery takes longer and is more expensive than its competitors.
Questionable Management Team
Just google and youtube the CEO's name "Kamani". There are several instances of nefarious activity. Would rather not going into it online.
V. Conclussion
Fundamentally I think BOO’s business model could be broken. I think that in its current structure, the amount of profits that BOO can derive from its customer base are not enough to justify the £1.5bn valuation. BOO’s model will not work at the lower gross margin profile because their marketing spend is too high given how much each of their customer spends. As such I think BOO could have 100% downside in a bear scenario.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.