Description

Opportunity Overview

I believe a series of recent sell-side upgrades on the basis of no news / changes to business outlook have provided an opportunity to short Casper (“CSPR”) with 35% downside in a base case.  Given the relatively small market cap, the idea may only be appropriate for PAs / smaller funds.  

The short thesis can be summarized in a few points:

1.      The Company’s core / legacy e-commerce business is unprofitable and not growing; CSPR’s plan to shift focus from e-commerce to wholesale presents significant risks that are not appreciated by the market

2.      Sell-side consensus is overly optimistic on revenue growth and is likely mismodeling gross margins associated with such a channel shift

3.      There are significant questions about management focus and competence, and the Board is unmotivated to hold management accountable

4.      The company is burning cash, so valuation on an EV basis will get more expensive over the next 12 months if the stock does not decline

Signpost tracking / how the short thesis is likely to play out:

1.      Wholesale channel:

a.      Deterioration of revenue per retail partner

b.      Churn of existing retail partners / slowing cadence of new adds

c.       More retail partners rolling out private label bed-in-box brands

2.      E-commerce

a.      Continued deceleration of e-commerce revenue and order count; negative YoY growth

3.      Disappointment vs management’s stated goal of Adj. EBITDA profitability by 2H 2021

4.      Continued cash burn and capital raise in 2H 2021 / 2022

Background

Casper was founded in 2014 and is based in Soho NYC.  If you’ve been in NYC, you likely have also seen the Company’s catchy ads on the subway or on billboards.  The Company was founded as e-commerce-only mattress brand but has since expanded into other channels (DTC – physical retail and most recently wholesale) and now offers other sleep-related products such as pillows and sheets.  CSPR’s average order value is ~$800, and as such they’re mostly competing at the <$1k price point, which does not put them in direct competition with Tempur Pedic, Purple or Sleep Number mattresses.  In 2019, DTC e-commerce made up ~2/3 of sales but this will likely come down to ~50% in 2021.           

The Company is geographically focused on the coasts and over-indexes to young singles living in cities, high income families and affluent suburban families.  In 2016, the Company expanded into Europe (UK, Germany, Austria, Switzerland, France), but in Feb. 2021 it shut down its European operations due to profitability and supply chain issues (its relies on all third part contract manufacturing).     

Casper – and the many bed-in-a-box peers – originally disrupted the mattress industry by offering consumers a better, more convenient way to purchase a mattress.  Like many other consumer product categories, mattress buying process was largely unchanged for many years before Casper and others came along.  Casper realized that the process of buying a mattress at a traditional retailer was not enjoyable – this often required walking into a dilapidated retail store and interacting with salespeople working solely on commission and viewing mattresses without any brand resonance.    

Instead of this sales motion, Casper envisioned acquiring customers online (search or social media primarily) or via its catchy out-of-home advertising and funneling customers to its e-commerce platform to complete the sale.  This business model seemed to work quite well, at least from a topline growth perspective, for the first few years after Casper was founded in 2014.  However, like many other DTC brands that came of age over the last few years, the unit economics of Casper’s e-commerce business were challenging.  The fundamental issue for Casper is that CAC is high and has continued to climb.  Casper faces a “race to the bottom” on marketing CAC, as it bids against 175+ DTC competitors on the same Google / Facebook keywords.  Worse still, mattresses have 7 – 8 year replacement cycles, which significantly decreases customer LTV and is not conducive to a habit-forming or recurring purchase behavior / brand interaction that is important for DTC brands with high CACs.                

Casper’s e-commerce unit economics (as of 2019 per its S-1) are:

1.      It costs Casper ~$256 to acquire an e-commerce customer

2.      E-commerce AOV is $715 at a 50% gross margin = $358 of gross profit and ~$100 of contribution profit per order

3.      Casper had $113m of G&A in 2019, which means they would have to process ~1.1m orders ($113m G&A / $100 contribution margin per order) just to breakeven on an Adj. EBITDA basis (excluding SBC)

4.      Casper did 393k orders in 2019, so assuming constant AOV, orders would have to increase 180% vs. 2019 levels just to breakeven on Adj. EBITDA; this is a particularly long putt given Casper’s e-commerce revenue grew ~0% in 2019       

Casper has been significantly unprofitable since its founding due to this, and in an effort to show profitability, Company is leaning heavily on its DTC retail and more recently wholesale channels. 

The other key insight into Casper is that it has not positioned itself as a “product” company.  As one industry expert put it: “At the end of the day, Casper is not really a mattress company. It's a marketing company.”  Casper, unlike peers PRPL and TPX, is not vertically integrated and thus relies on third-party contract manufacturing to produce its mattresses.  Its largest manufacturing partner is Leggett and Platt who also produce mattresses for its direct competitors.

While the Company touts the benefits of this “asset-light” footprint, it also means Casper’s product is undifferentiated from its many bed-in-a-box peers from a look and feel perspective.  An industry expert described the product as follows:

“You're selling a product that doesn't have planned obsolescence and real tech built into it, it's essentially a slab of foam on the Internet, and there's not a lot of differentiation, right? I mean Casper could say we're going to 10 layers and the competitors could say we're going to 11 layers. And so it's very small changes, I don't think consumers really see a big enough difference in the feel of our mattress to justify paying all these different prices.”

Several quotes from risk section of S-1 also highlight these dynamics that arise from lack of vertical integration / owned IP:

“Competitors have attempted and will likely continue to attempt to imitate our products and technology. We may not be able to prevent competitors from developing similar products or from marketing in a manner that capitalizes on our intellectual property.”

 “Further, we license certain intellectual property from third parties. For example, while most of our product design is developed in-house, certain foam formulations are currently licensed from certain of our contract manufacturers pursuant to our manufacturing agreements with them, some of which include varying degrees of exclusivity”

 “We depend on a limited number of third-party contract manufacturers for the sourcing of our products. For our mattresses, our two largest manufacturers comprised over 70% of our production volume during the nine months ended September 30, 2019. Further, consolidation among foam suppliers, which is a key component for our mattresses, and mattress fabricators has resulted in a decrease in the number of possible domestic suppliers from which we can source foam and mattress fabrication, as well as an increase in the threat of increased prices and less favorable commercial terms.”

 “Although many of our patents, trademarks, copyrights, and other intellectual property rights are not material to our business individually, we believe that, in the aggregate, our intellectual property rights have significant value and are important to the marketing of our brand and the favorable perception of our products.”

Short Thesis

Key Points

1.      The Company’s core / legacy e-commerce business is unprofitable and not growing; CSPR’s plan to shift focus from e-commerce to wholesale presents significant risks that are not appreciated by the market

a.      As discussed above, CSPR’s core e-commerce business is challenged due to large / growing CAC and questionable LTV.  While the Company no longer breaks out DTC – E-commerce from DTC – retail, it’s fairly easy to triangulate.  Core e-commerce revenue growth decelerated significantly in 2019, growing ~0% YoY, but the pandemic provided a growth lifeline for the e-commerce business, and the segment showed ~10% YoY growth in 2020.  Further evidence of the deceleration of the e-commerce biz came in Q1 2021.  In Q1 CSPR’s total DTC biz grew 11% YoY (excl. discontinued European ops), compared to SNBR (all DTC) at 20% and TPX’s DTC business at 62%.  This is despite the fact that CSPR increased its number of DTC retail doors by 11 between Q1 2020 and Q1 2021.  Another data point is that SNBR posted 12% SSS growth in Q1 on its retail stores.  Based on this, it’s hard to imagine e-commerce revenue grew much at all in the Q.  By contrast, SNBR / TPX both disclosed triple-digit e-commerce revenue growth in Q1. 

b.      Casper’s pivot to wholesale is not an exciting new growth avenue as the Company claims but a last resort in an effort to show profitability to the public markets

                       i.     Casper is not profitable today and has not been profitable on a full-year basis since inception.  Despite this, the Company’s growth (i.e. mostly customer acquisition costs) was readily funded by a stream of eager VC backers.  Between 2014 and Jan 2020, the Company raised $338m and another $100m in its IPO.  In leaked projections related to its Series D funding in Q1 2019, Casper indicated that it would be EBITDA profitable in 2019 and expected to do $556m of revenue in 2019 – in reality, the company printed revenue of $439m and Adj. EBITDA of -$70m.  Now in the public markets with no easy VC money to fund e-commerce customer acquisition and with e-commerce growth decelerating, Casper has realized that it needs to very quickly show profitability in order to survive.  Casper’s chosen strategy to reach profitability is twofold: expand its owned retail store footprint (“DTC – retail”) and expand its wholesale business.   For the purposes of this writeup, I am focused on Casper’s push into wholesale, which I view as a strategic blunder and contrary to Casper’s raison d'etre of improving the mattress buying experience.   

                     ii.     Casper originally eschewed the wholesale channel – according to industry players, Casper originally neglected wholesale because they felt their brand was “bigger than everybody else's.”  And as a result, they turned down a lot of partnerships that they’re now trying to chase today.  The Company has also moved the goalpost on target mix – in November 2020, Casper mentioned that “in the past, you've really heard us talk about our business being 1/3, 1/3, 1/3 in each of our channels … I think you could see in the future up to 50% of our business in retail partners and 50% of our business in direct to consumer.”

c.       The strategy comes with numerous risks including, substitution by private label, pricing / margin pressure and cannibalization of higher margin DTC revenue and general brand dilution

                       i.     Private label threat: There is a significant risk that wholesale partners will accelerate their push into private label bed-in-a-box.  Ashley Furniture, one of Casper’s recent retail partner additions as of Q3 2020, now has their own bed-in-the-box brand, and it's their top seller.  Feedback from industry players indicates that Casper is quite vulnerable to private label substitution given its lack of differentiating technology and outsourced manufacturing, meaning Casper’s mattresses don’t “feel” different than any of its bed-in-the-box peers, many of whom utilize the same third-party contract manufacturers. There are plenty of case studies for retailers going after the margins of brands / categories that it views as vulnerable - including CPG / grocery stores comes to mind, as well as Costco / Kirkland, Amazon / Amazon Basics.  It’s easy to imagine retailers using Casper as a marketing ploy to get customers in the door then pushing their own private label mattresses. 

                     ii.     “Race to the bottom” on pricing / commoditization:  Even if retailers are not favoring their own bed-in-the-box products at the expense of Casper, there is still significant incentive to pit bed-in-the box brand against each other in retail, especially at the <$1000 price point, which is where Casper players, particularly in the wholesale channel.  PRPL even recently ran an April fools promotion aimed at “highlighting the race to the bottom price war we continue to see among the sub-$1,000 bed-in-a-box companies.”

                    iii.     Cannibalization of higher margin DTC revenue: The most common channel shift among consumer brands today is from a predominantly wholesale model to a more DTC model (a la Nike).  The reason is simple – wholesale is a lower margin channel in which you don’t own your brand marketing and customer relationships.  Mattress wholesale gross margins are ~40% vs. DTC gross margins anywhere from 55% - 60%.  Thus shifting revenue from e-commerce / Casper’s own retail stores to wholesale has a significant impact on profitability.  Industry feedback indicates that large retailers have pretty wide latitude to price mattresses (Casper or otherwise) in-store below the equivalent product online when they’re sitting on excess inventory, citing “unforeseen circumstances” and that smaller brands do not have the ability to throw their weight around or threaten to pull products from shelves to prevent this behavior.  Thus channel cannibalization is a real risk as Casper leans into its wholesale strategy.    

                    iv.     General brand dilution: This one is hard to express in a model but it bears mentioning.  As discussed above, it’s uncommon for brands to begin as DTC-focused and shift focus to wholesale – this is because of margin dilution but also because it’s very easy to lose control of brand messaging when you’re not controlling how salespeople position the products / how advertising dollars are spent.

2.      Sell-side consensus modeling does not reflect the risks posed by the wholesale strategy; instead, consensus reflects a “blue-sky” revenue and gross margin forecasts

a.      Below is a spread of what consensus is assuming for 2021 through 2023; I believe that by using very conservative assumptions (from the perspective of the short) on revenue and gross margin, we can underwrite to significant misses vs. consensus expectations

b.      Topline:

                       i.     Wholesale: assume Casper adds 9-10 wholesale partners 2021 – 2023, consistent with guidance.  For competitive and product positioning reasons discussed earlier, assume sales per partner reverts to 2019 level in 2021 and declines LSD in 2022 – 2023.  This is a key point of difference vs. consensus, which I believe is assuming sales per retail partner continues to grow either on the inflated 2020 base or on the 2019 base. 

                     ii.     DTC – e-commerce: assume AOV and order count remain flat to 2020 in 2021 due to changes in consumer behavior and continued strong demand mattress / home goods, especially in 1H 2021; assumes declines in order count are offset by increased AOV (adding more higher priced SKUs) in 2022 / 2023, implying no growth in either year vs 2021. These assumptions should be conservative given e-commerce revenue already decelerated significantly pre-COVID and very likely did not grow in 2019 vs. 2018 and in Q1 2021.  This is a second point of difference vs. consensus, which I believe is assuming LSD / MSD e-commerce revenue growth. 

                    iii.     DTC – retail: assume 10 stores added in 2021, accelerating to 15 in both 2022 and 2023.  Assume sales per store recover to 2019 baseline in 2021 then grow 5% PA in 2022 and 2023 

c.       Gross Margin: consensus is perplexingly assuming that gross margins will increase almost 200bps over the next three years, despite the Company’s stated goal to significantly increase mix of lower margin wholesale revenue.  Even giving Casper credit for further maturation of its supply chain and thus increasing e-commerce gross margins to 60%, I believe gross margins will come in well below consensus expectations by 2023.  It’s notable that any underperformance on e-commerce revenue would have the double effect of decreasing revenue and gross margins.  This is also natural hedge on my assumptions regarding wholesale revenue underperformance – if wholesale revenue grows faster than I am forecasting, gross margins would also be diluted by the increased mix shift.

d.      Putting it all together:  On opex, I assume the Company gets operating leverage on the S&M line, as there’s little incremental ad spend associated with growing the wholesale channel (outside of co-op advertising, which is usually 2% - 5% of sales).  Casper has struggled to keep other G&A in check over the past several years, but I’m conservatively assuming some operating leverage on that line as well.  All in, using the revenue / GP assumptions laid out above, I arrive at an estimate of 2023 Adj. EBITDA that differs materially from consensus. It’s worth noting that my variant view is primarily on revenue and gross margins rather than opex / operating leverage – I’m conservatively assuming lower opex than consensus, so there may also be downside risk on the S&M line that I’m not contemplating in my forecast.

 3.      There are significant questions about management focus and competence, and the Board is unmotivated to hold management accountable

a.      While CEO of Casper, Phil Krim has been preoccupied raising and serving as Chairman of 3 different SPACs.  Most SPAC sponsors are former industry executives, board members or investor groups, and it’s rare to see a current public CEO personally raising a SPAC, let alone three.  Most recently in March, one of Krim’s SPACs took a risk analytics firm public.  This obviously raises questions about where Krim’s focus / attention lie, especially when his SPAC economics are likely much more significant than his remaining ownership in Casper.  Krim owns ~$23m of common shares in Casper, whereas his economics in his recent $300m SPAC IPO alone almost certainly more significant, given he is the primary sponsor.

b.      Channel checks generally have not come back favorably on Krim, with feedback that he is not capable of making the difficult decisions on how teams should be structured, how to assess priorities, determine which projects have the best ROIs, etc.  There is supporting evidence of this feedback in the significant amount of executive turnover that has taken place at Casper over the past two years.  Channel checks indicated that just as troublingly, the Company’s Board (which Krim chairs) is unmotivated to hold the executive team accountable for execution / strategy errors.  The VC firm New Enterprise Associates (“NEA”) remains Casper’s top shareholder (with number 2 and 3 also being pre-IPO VC investors) and owns 15% of the Company, has a Board seat and was responsible for placing all of the other Board members, except for Krim and another Casper founder.  I believe this is a classic case of overstretched VC investors / board members caring more about appearing “founder-friendly” than what is right for all pubic shareholders.  Simply put, there are serious questions about corporate governance and I believe little incentive for the existing Board / largest shareholders to hold the executive’s feet to the fire.    

4.      The company is burning cash, so valuation on an EV basis will get more expensive over the next 12 months if the stock does not decline

a.      Over the past 4 years, Casper’s FCF (CFO less Capex) has averaged -$84m.  While the Company’s cash burn should improve over the next 3 years, I still expect it to be FCF-negative.  The company spends around $600k per new store and its growing store base requires ongoing MCX.  The Company is 70% drawn on its revolver and average cost of debt is 12%+, both of which increase the likelihood of an equity raise, which would be constructive for the short.  Casper currently has net debt of ~$0m after generating -$28m of FCF in Q1 2021.  I expect the Company to generate ~-$55m of FCF in FY 2021 resulting in net debt by FYE 2021 of ~$30m.  The Company’s cash burn over the next 12 months should create some margin of safety for the equity from a short perspective.

Valuation / PT

I’ve adopted a fairly simple valuation framework based on what I see as two potential outcomes for the Company’s earnings trajectory over the next 12 months.  The Company is at in inflection point between being valued on a revenue basis and an EBITDA / earnings basis given its (consensus) forecasted pivot to full-year profitability in 2022.  My price targets are based on February 2022, when the Company will be reporting FY 2021 results and providing guidance for FY 2022.  Note I’m assuming continued cash burn throughout 2021 and some dilution from RSUs vesting.     

 CSPR is currently valued on a fwd. revenue multiple and trades at forward revenue multiple is ~0.6x vs. average multiple since IPO of ~0.4x.  If I am right and the Company makes much slower progress against its goal of achieving meaningful profitability on an Adj. EBITDA basis than consensus expects, I believe the Company will continue to be valued off forward revenue, as it is today.  In this case, if Casper’s current fwd revenue multiple reverts to its average since IPO of 0.4x, there’s 35% downside to the stock.  It’s worth noting that CSPR’s average multiple since IPO is likely conservative if the market begins to question Casper’s deteriorating core e-commerce business and treats the wholesale strategy with more skepticism, and we can easily envision a scenario with 50%+ downside.   

If I am wrong about earnings trajectory, CSPR is likely to be valued off of fwd EBITDA rather than revenue.  At a peer average (TPX / SNBR @ ~10x and PRPL @ ~19x) average fwd. EBITDA multiple of 14x, there is ~30% upside to the stock using consensus EBITDA.  If CSPR continues to be valued on a revenue basis and the current elevated multiple holds, there’s ~6% upside to the stock on consensus numbers.           

Bull Points and Rebuttals

Bull point: “Isn’t CSPR a take-out candidate?”

Rebuttal: There is a relatively small potential buyer universe for CSPR, and I believe none are interested.  PRPL’s CEO when discussing the M&A universe in February:

“We are looking at a number of M&A opportunities as we should be. We have very little interest in the bed-in-the-box players as we're a product-focused company focused on innovative technologies. And nearly all of the bed-in-the-box players are contract manufactured mattresses from existing manufacturers we could work directly with. So you're really just buying a brand or buying a customer base, neither of which is what we feel the best use of our capital.”

Serta Simmons purchased Tuft and Needle, a Casper competitor, in 2018, and they’re focused on expanding that brand.

TPX has expressed similar sentiments to PRPL regarding the value of the bed-in-a-box brands.  Also, TPX has their own bed-in-a-box called Tempur-Cloud which looks very similar to a CSPR mattress. 

SNBR is very focused on their own technology-enabled mattresses and they already have a robust DTC footprint. 

Bull point: “Why can’t CSPR trade at PRPL’s 19x fwd EBITDA multiple if it achieves profitability?”

Rebuttal:  For one, PRPL and CSPR have fundamentally different value propositions and business models.  PRPL is a vertically integrated product-focused company with significant IP associated with its mattresses.  Its typical price-point is ~$2,000 vs. CSPR at ~800. Casper, as discussed above, controls relatively little IP as its mattresses are made by the same contract manufacturers as its competitors.  PRPL also continues to grow much faster than CSPR, growing ~50% in both 2019 2019 and est. to grow 30%+ in 2021, compared to CSPR at 23%, 13% and 23% for the same periods.  Finally, I view management quality at PRPL as superior to CSPR.              

Tactical Considerations

·        SI is 8% of the Company’s float and represents only 0.8 ADTV, so it should be easy to secure a borrow.  

·        Could be a good inflation hedge given significant exposure to foam, steel, other commodities

·        Could be a nice pair trade with TPX or other mattress industry names

Catalyst

- Continued e-commerce decel

- Issues in wholesale channel

- Capital raise