Description

ECOM

ChannelAdvisor Corporation (ticker: ECOM, $11.93) is a $340 million market cap software-as-as-service (SaaS) platform for e-commerce companies.  The company has been beaten down from over $40 to $12 in the last 18 months on what we believe are temporary issues. We see potential upside to $20+ as these concerns subside.

The business:

The Company’s software enables sellers to connect to online marketplaces such as Amazon, eBay, Google and Alibaba.  ChannelAdvisor takes retailers’ data and transforms it into something that can fit within the parameters of each of the marketplaces (each of which has different rules for sellers, different data presentation formats, etc).  That data is constantly changing as products sold through one channel need to be taken off other marketplaces and pricing is continually adjusted to match competition and inventory levels.  For a small to mid-size retailer with thousands of SKUs and ever-changing rules from eBay / Amazon, it can be an arduous process.  ChannelAdvisor has over 100 people in its R&D group keeping up with changes and pushing out software updates to clients.  For less than the cost of hiring two engineers to manage the process, one can connect to ChannelAdvisor’s solution.  The Company is the biggest player (and the only one with scale) in a niche-y space and, based on our conversations with various industry players, their offering is not easy to replicate. 

ChannelAdvisor offers an industry leading product that solves a pain-point for their customers and, in addition, benefits from multiple secular growth drivers.  The Company monetizes its software by charging clients a ~1.5% “take-rate” on their GMV (Gross Merchandise Value), which means ChannelAdvisor benefits from the natural secular growth of e-commerce.  E-commerce still only accounts for 10% of overall retail sales providing a multi-year runway for double-digit growth.  On top of that, we believe a proliferation in online marketplaces will help support both growth rates and the need for the product as it becomes increasingly complex to manage multiple channels.  We see three types of marketplaces sprouting up over the next few years: 1) social media and messaging platforms adding “Buy-buttons” (Pinterest, Facebook, Twitter, etc); 2) cross-border ecommerce platforms gaining traction (Alibaba); and 3) niche platforms such as “Jet” replicating off-line models, online.   With its cross-platform approach, ChannelAdvisor facilitates ~$5.7 billion of GMV annually which is ~1% penetration of their addressable market (and 2% penetration based on potential customers).

Recent History:

ChannelAdvisor’s stock, which IPO-ed in May of 2013 to much fanfare, has fallen from its mid-$40s high last year to ~$12 and recently has been sitting “in-the-penalty-box” after missing sales estimates multiple times.  Revenue growth decelerated from ~30% in the first half of 2014 to 26% in Q3, 16% in Q4 and falling further to ~14% in 2015.  We believe the deceleration in sales is explainable and primarily due to temporary issues. 

• First, part of ChannelAdvisor’s slowdown was self-inflicted with poorly designed sales incentives, causing associates to push Fixed GMV upgrades onto clients – even when uneconomical for the Company to do so.  Fixed contracts require retailers to pay a minimum fee to the Company in exchange for a lower take-rate.  Any amount of GMV over the fixed amount is charged a higher variable fee.  As a result of compensating sales associates solely on amount of the Fixed GMV a customer committed to at the time of signing or contract renewal, the Company saw a steep increase in customers trading up to higher fixed tier contracts during 2014.  While GMV growth remained stronger than revenue growth suggests, ChannelAdvisor caused a drop in its take-rate with its contract structure.  Management has now changed the incentive structure for sales associates to align their interests with those of the Company and has an opportunity to get back its share of GMV through changing the pricing structure to narrow the gap between fixed and variable tiers.

•  Second, the second largest sales channel for ChannelAdvisor’s customers is eBay (behind Amazon), and the deceleration in ChannelAdvisor’s sales growth coincides with the slowdown for eBay overall.  eBay saw a deceleration in its business last May stemming from a) a security breach which caused friction in the checkout process as all 150 million users were prompted to reset their passwords; b) policy changes for sellers (both Amazon and eBay implemented policy changes which caused increased small seller churn on ChannelAdvisor’s platform) and c) changes to the Google search algorithm that deemphasized eBay in search results.  ChannelAdvisor has historically over-indexed towards eBay, in part due to their close relationship with eBay Enterprise.  We expect eBay to return to growth, and as a result ChannelAdvisor growth on eBay, to reaccelerate after lapping the password reset and Google algorithm changes. 

• Finally, Management made the decision to focus on larger, higher LTV clients and proactively cut off some of the smaller SMBs they historically targeted. 

The Company recently reported, beat estimates for the first time in several quarters, and set what we believe to be conservative / beatable guidance for the rest of the year. 

Valuation:

With the stock currently at $12, we think investors are pricing in an overly bearish scenario.  The Company’s management team believes they can return to 20%+ revenue growth after lapping these headwinds.  If they are correct, we expect the stock to re-rate back towards peer levels of ~4x 2016 sales from 2.4x today (note: the peer group grows revenues high-teens), which would imply a ~$19 share price. (Note that we use sharecount including unvested RSUs and in the money options, adding option proceeds back to the EV.)

Hypothetical “no-growth” valuation: The Company will be investing in growth for years to come, so we ran some quick numbers to estimate valuation if those growth investments were curtailed. Note that included in the elevated ‘sales and marketing’ expense is the cost of the Company’s expansion into China where ChannelAdvisor is bearing a full load of expenses before any meaningful revenue contribution.  After diligencing the cost structure and walking through scenarios with the Company, we believe that ChannelAdvisor could cut out roughly half of ‘sales and marketing’ expense while keeping revenues flat (the remaining salesforce offsets revenue churn).  We believe the hypothetical reduction in SG&A would expand EBITDA margins to ~20%+.  Using this very rough analysis we are buying the stock at ~12x our estimated 2016 “no-growth” EBITDA, and closer to 9x “no-growth” 2017 EBITDA (including their NOLs). Although the above framework is obviously purely theoretical, and we expect the company to continue to invest in growth, it highlights the valuation potential of ChannelAdvisor’s deep-moated growth engine.

Upside scenario: One of the other reasons we are attracted to the name is that we believe there would be substantial M&A interest should the Company put itself up for sale.  ChannelAdvisor’s gross margins are currently in the low-70%s with the vast majority of costs coming from ‘sales and marketing’ expense.  Sales expense and G&A (estimated to be $80 million in 2016) would be highly duplicative with a number of potential buyers, and ChannelAdvisor’s uptake would likely benefit substantially from the cross-sell opportunity arising from a larger, established sales force.  Potential logical buyers include Oracle, NetSuite, Demandware, Liberty Media (which bought the Company’s main competitor Mercent), or even eBay Enterprise (which partners with ChannelAdvisor to implement the service with their clients).  We think an acquisition would be attractive to a scale strategic buyer such as Oracle, for example, at $21/share (a 75% premium to the current price) which would be ~8x Pro Forma EBITDA (after SG&A, but prior to any revenue synergies). 

Disclaimer: This report is neither a recommendation to purchase or sell any securities mentioned. The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. Please do your own work.

Catalyst

Growth re-acceleration