Description

Gigacloud Technology (“GCT” $13.35 NASDAQ) is a Business to Business (“B2B”) ecommerce company focused on connecting furniture, exercise equipment and appliance manufacturers, mostly located in Southeast Asia, with retailers in the United States, Japan, and Western Europe.  It trades at a trailing EV/EBITDA multiple of 3.7 times due to a recent short attack by Culper Research that was poorly researched and was debunked by an independent Board review, and because US investors are often skeptical of Chinese operated companies.  I believe that GCT is at a very positive inflection point as it is becoming a fully US based public company as of its year-end 2023 audit. It has also just closed on the acquisition of Noble House LLC (“NH”), a bankrupt furniture sales company obtained at a very attractive price.  Once the dust settles from the short attack and the acquisition, GCT’s common stock can appreciate by about 78% to $23.72 by the end of calendar 2025.  If investors can become comfortable with GCT’s financials post its 2023 audit, then this price target should prove to be very conservative.

History

Gigacloud was founded by Chairman and CEO Larry Wu in 2006.  Its ecommerce business was started in 2010 in Japan, expanded to the UK in 2013 and entered the US through its acquisition of Comptree in 2014. GCT operates a large parcel B2B ecommerce website where it connects sellers to manufacturers that sell furniture, home appliances and exercise equipment and related items.  GCT performs this operation on either a 3rd party (“3P”) or a 1st party (“1P”) basis.  3P distribution is when GCT stores inventory for manufacturers in its warehouses and distributes the products to sellers.  GCT works on a lower margin in this business as it takes no inventory risk.  1P distribution is when GCT takes ownership risk on inventory and sells the items to non-affiliated sales partners.  

The Company refers to its B2B ecommerce platform as the “GigaCloud Marketplace” which it says “integrates everything from product discovery to payments to logistics tools into one easy-to-use platform”.  This allows buyers and sellers to transact globally with confidence, speed, and efficiency.  Effectively, it allows all sized manufacturers to reach a wider audiences by removing barriers to cross border sales and marketing.  

The business model allows buyers and sellers to eliminate steps and roadblocks to sell these large parcel items across the targeted markets.  GCT’s solution allows inventory from the supplier to reach the end customer without the seller ever touching the items (1P) or by pooling the inventory with other sellers across GCT’s warehouses (3P).  These approaches allow sellers to reduce inventory cost and risk and provide better use of the sellers’ balance sheets.  

GCT operates 21 warehouses across the US (14), UK (2), Germany (1) and Japan (4).  These warehouses encompass over 3 million square feet in the US and 500,000 square feet abroad.  These facilities cover 11 ports of destination receiving over 10,000 annual containers.  GCT utilizes artificial intelligence (“AI”) and data analytics to determine optimal distribution of inventory among its warehouses under a unified warehouse management system and provides a virtual warehousing solution for sellers and buyers in its marketplace. GCT’s AI-powered warehousing management system solves the many practical problems faced by sellers and buyers in connection with complex, cross-border transactions involving large parcel goods.

GCT has experienced consistent growth in the number of buyers that utilize its ecommerce site.  This bodes well as the Company has built an early mover advantage in this category of items.  This is demonstrated by the slide below from GCT’s 2nd quarter earnings call.

GCT is organized under the laws of the Cayman Islands.  On July 3, 2023, GCT announced that it had moved its headquarters from Hong Kong to California and thus ceased to be qualified as a Foreign Issuer.  Starting on January 1, 2024, the Company will be subject to the same reporting and disclosure requirements applicable to domestic U.S. companies, and the Company will be required to file periodic reports and financial statements prepared in accordance with United States generally accepted accounting principles with the SEC on Form 10-K and Form 10-Q, as applicable, as well as filing current reports on Form 8-K.  GCT currently has much of its back office and finance functions in Hong Kong, including the CFO who resides in Hong Kong.  

Gigacloud came public in August of 2022 through Aegis Capital after scrapping an earlier IPO filing with B of A (Merrill Lynch) and Wells Fargo, after the Form F-1 had been filed and accepted by the SEC.  That earlier IPO filing was derailed by China’s clampdown on public companies (DIDI was the main example) in July of 2021.  GCT scaled down the latter successful offering to $36MM from a much larger deal as the Company was already operating with significant free cash flow.  Even though GCT ended up going public through Aegis, it is comforting to know that B of A and Wells Fargo’s due diligence gave them comfort to try and bring the Company public.

Financials

GCT has grown revenues, gross profits, and EBITDA rapidly over the last few years and was able to handle the boom/bust cycle of the covid pandemic that sank many companies in the furniture space.  Using the analysts’ estimates for calendar 2023, GCT will have compounded revenues at 49%, gross profits at 60% and EBITDA at 105% over the last 4 years.  It operates with a gross margin in the low to mid 20% range and has been free cash flow positive since 2020.  

The Company utilized some of the cash it has built up on its balance sheet to purchase Noble House Home Furnishings LLC (“Noble House” or “NH”) out of Chapter 11 bankruptcy at the end of October.  All financials and projections shown below come from Bloomberg.  There are three analysts that follow the Company, and all projections are an average of their estimates.

Noble House Home Furnishings LLC Acquisition

GCT was the stalking horse bidder for Noble House with an $85MM cash bid for the assets of this company.  This deal closed November 1, 2023.  GCT did not assume any historical liabilities and got to pick which leases it retained upon closing.  NH was an ecommerce furniture distributor selling furniture and bulky items manufactured in southeast Asia to Amazon, Wayfair and other large ecommerce retailers.  NH owns and licences a number of successful brands including Christopher Knight that have very high ratings on Amazon (https://www.amazon.com/s?k=christopher+knight+furniture&i=garden&crid=1977LTF4ORV76&sprefix=christo%2Cgarden%2C220&ref=nb_sb_ss_ts-doa-p_2_7 ).  

NH greatly benefitted from the shop from home bonanza that the pandemic caused.  However, I believe it got caught with too much inventory as the effect of home shopping and free government handouts faded.  NH generated revenues of $703MM in 2021 which fell to $516MM in 2022 and to $283MM through the first 9 months of 2023 (Source: bankruptcy docket chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://document.epiq11.com/document/getdocumentbycode?docId=4236036&projectCode=NHH&source=DM).  This document is filed as part of the overall bankruptcy case is one of many documents available here (https://dm.epiq11.com/case/noblehousehomefurnishings/dockets) .  

I would expect NH to add annual revenues of $250MM in the worst case and $400MM in the best case to GCT starting in 2024.  To be conservative I would give this business an EBITDA margin (once integrated) of between 8% and 10% which is lower than GCT’s expected margin of 14%+ estimated by Wall Steet for calendar years 2023 and 2024.  This would generate EBITDA of between $20MM on the low end and $40MM on the high end on GCT’s purchase.  Assuming $5MM of costs to close NH, GCT’s total purchase price of $90MM will generate EBITDA returns of between 22% and 44% on this investment.

I believe that there will be some initial additional use of cash as GCT will have to offer customer friendly payment terms to the manufacturers who were selling to NH and were hurt by its bankruptcy.  These manufacturers should continue to sell through GCT as the Company’s relationships with large ecommerce and Bricks and Mortar retailers has significant value to them. This transaction should bring GCT’s annual revenues to between $800 million and $1 billion in 2024 assuming no growth in GCT’s business.  I wouldn’t expect the transaction to be accretive in 2024 as GCT spends money to fix NH’s business model and vendor relationships.  To be conservative I would expect $20MM to $40MM of EBITDA to be generated in calendar 2025.  This should be reasonable as GCT will add thousands of SKU’s to its B2B ecommerce portal and become more dominant in distributing large parcel merchandise across the developed world.  For ecommerce retailers like Amazon and Wayfair, GCT provides a way to access thousands of manufacturers across the world without having to create individual relationships.  This brings value to both sides of the transaction and has real world applications as companies such as Target and Walmart already heavily restrict the number of vendors that can sell to them.

Short Report Retort

On September 28, 2023, Culper Research published a report saying GCT with the title “If it’s too good to be true…”.  The report claims that GCT is doing the “China Hustle” and that its business is a fraction of what it purports to be.  I will list the claims in order and then I will refute them in my due diligence section below.  

1. Culper states “GigaCloud claims to run 14 U.S. warehouses yet the Company discloses just 73 employees in the entire U.S., implying just 5 employees per warehouse.1 Simply put, we don’t think it’s at all possible to profitably run 14 warehouses with over 3.7 million square feet which supposedly distribute hundreds of millions of dollars of furniture with this few people. “

2. Culper states “GigaCloud’s marketing materials utilize photoshopped stock photos to portray itself as a highly efficient, growing operation. However, our September 2023 visits to the Company’s actual warehouses revealed a much different picture: we staked out GigaCloud’s 9 warehouses in its two main east coast (New Jersey) and west coast (California) regions and saw laughably sparse activity. For example, at one warehouse in New Jersey, our investigator sat for 3 hours – during weekday business hours – and saw only a single GigaCloud delivery truck. At another location in California, our investigators did see a handful of overseas shipping containers being unloaded, but the unloaded cardboard boxes then sat strewn in the loading bay for hours without being sorted. “

3. Culper states that the last mile delivery operation of GCT is a meager business with little revenues.

4. Culper states GCT has no linkedin.com employees who have claimed to developed any AI for the Company.

5. Culper states GigaCloud exhibits multiple hallmarks of previous “China Hustle” stocks. The Company’s auditor is based in China, despite its US listing and dollar-denominated financial statements. 67% of the Company’s cash is held offshore, despite again claiming that it operates primarily in the US, to US-based customers. Finally, the Company generates very little interest income in comparison to its cash balances, which is even more concerning given that the Company has also claimed to run a financing business.

6. Culper has other complaints that are numerous and not worth mentioning as the 5 above are the key points.

Answers to Culper and on-site Due Diligence

I had begun my due diligence prior to the Culper write up by visiting some of the California warehouses and the corporate headquarters.  Post the short report, I visited three of the NJ warehouse locations.  Here are my observations:

1. GCT runs its warehouses mostly with workers provided by 3rd party staffing companies.  These outsourced workers move the large boxes from ocean containers (“OC’s”) to shelves that are anywhere from 3 to 5 levels high.  Another set of outside staffed workers pick the boxes and pallets to be distributed, and load them into outgoing Fedex, UPS and other trucking company trailers that are lined up in loading bays.  The use of 3rd party staffed workers to perform jobs in its warehouses provides GCT great flexibility to scale up or down depending on workflow and seasonality.  The few direct hire GCT employees who work in the warehouses are all bilingual with Mandarin and English to facilitate communication with manufacturers in Southeast Asia and the Company’s operations center in Suzhou, China who utilize Mandarin as their main business language.  

2. Ocean containers are unloaded throughout the day as the containers arrive at the warehouses.  Seen below are a number of OC’s being unloaded in preparation for Cyber Monday and Black Friday at one of the NJ warehouses.

Outgoing shipments are grouped by carrier (Fedex, UPS, etc.) and go out at different times from different bays so that there are not cross mingling errors.  Seen below are Fedex trailers that were in the process of being loaded for delivery from one of the NJ warehouses.

3. The three warehouses that I saw in NJ were filled.  It is to hard to know exactly how much merchandise was there, but I would estimate that it had to be over 90% filled.  Activity inside the warehouse was frantic across all three that I visited in NJ and much the same with the California ones that I visited in the late summer.  I don’t know why Culper didn’t ask to go inside the warehouses as the Company was very open to my visits even prior to the short report.  Here are some photos of what the inside of a GCT warehouse looks like.

4. 

As you can see from the photos, these are not pick and pack items as you would see in an Amazon warehouse.  Everything is moved by forklift with very little loading into trailers being done by hand.

4. Last mile delivery is not a big part of GCT’s business.  I saw only one GCT truck in the 3 NJ warehouses that I visited, and it was being loaded with large boxes of what I assume were living room furniture.  In my conversations with GCT senior management they have never claimed that this last mile delivery was important to the Company’s operations, nor is it a focus of their go-forward strategy.

5. Historically, GCT has utilized KPMG’s Shanghai branch as their auditor. GCT will be switching to KPMG’s US audit staff as the Company changed its headquarters to the US as of July 3, 2023.  The recent agreement (Holding Foreign Companies Accountable Act) between China (“PRC”) and the United States now allows US auditors to see Chinese auditors work product.  As of December 15, 2022, China and Hong Kong were removed from the PCAOB’s list of jurisdictions where it was unable to inspect or investigate registered CPA firms like KPMG.  Therefore, the questions raised about the reliability of GCT’s audit and cash become a moot point post the year-end audit.  GCT publicly disclosed where its cash resides in its 20-F 2022 year-end filing with the SEC.  At that time, GCT listed 29% of the cash as being in the PRC.  The acquisition of NH for $89MM in cash implies that the Company has generated significant cash flow outside of the PRC to be able to pay for this transaction.

6. The lack of Linkedin.com listed employees who do AI for GCT would be explained by the fact that they all reside and work in Suzhou, China.  It seems unlikely that they would show up in a search on the US Linkedin website.

7. GCT went public through Aegis Capital which Culper calls a “bucket shop”.  I cannot argue that Aegis is a high-quality underwriter, but I have been around a long time and have seen good companies come public through lesser investment banks.  GCT was originally going public through two premier investment banks (BofA and Wells Fargo) only to have the PRC’s attack on Didi submarine that deal.  It gives me comfort that GCT passed the smell test from both of those institutions who would have done extensive due diligence prior to the downsized deal done through Aegis.  

8. Finally, an independent Board of Directors review conducted by White & Case on the legal side and FTI Consulting’s Forensic Accounting unit found that Culper’s allegations were not correct.  This came out on November 16, 2023, and should put investor’s minds to rest about malfeasance at GCT.

Valuation

GCT operates in a niche part of the warehousing and logistics industry.  There are quite a large number of public companies that do logistics and/or warehousing across the globe but none that I can find that focus on shipping, warehousing and performing logistics on large items.  According to Bloomberg, Companies in these two sectors tend to be quite large and trade at training twelve months EV/EBITDA multiples that range from 5X for smaller companies like Hub Group (“HUBG”), Sankyu Inc (“”9065 JP”) and Forward Air Corp (“FWRD”) to 15X for XPO Inc (“XPO”) and 17X for CH Robinson (“CHRW”).   

B2B ecommerce companies like Wix (“WIX”), Shofify (“SHOP”) and others are typically more software based and trade at revenue multiples of between 4X and 13X as most of these businesses are not producing earnings.  GCT is making significant free cash flow, but its software is used to facilitate transactions that require physical touching of products unlike most ecommerce businesses.

Companies that distribute industrial, farming and manufacturing items like WW Grainger (“GWW”), Fastenal (“FAST”) and Wesco International (“WCC”) trade at an average EV/EBITDA multiple of 12X this year’s projected numbers.  GCT does distribute some items that fall in this category, but it is not a meaningful part of the business from what I could visually see during my site visit.

GCT does not neatly fit into any of these categories and as Culper correctly pointed out has the taint of being Hong Kong headquartered and audited by a Chinese affiliate of KPMG.  For these reasons I will take a very conservative view of valuation in coming up with a target price.  GCT’s headquarters move to the US will make them a fully compliant US listed company upon completion of the year-end 2023 audit.  I believe this coupled with the Board of Director’s independent 3rd party review which concluded the allegations by Culper were not founded and the continuing positive momentum in GCT’s business will be the inflection points needed to bring GCT’s trading value to reflect the value of the services it provides to customers.

GCT currently trades at a 3.7 trailing 12 months (“TTM”) EV/EBITDA which is just below the lowest valuation multiple from warehousing and logistics companies.  It is less than ½ the EV/EBITDA multiple for distribution companies listed above.  However, GCT is growing rapidly and has acquired an asset that should contribute to earnings and free cash flow once it is run by the Company.  In the table below I show Revenues and EBITDA as projected by the sell-side analysts on the Bloomberg platform.  GCT’s Enterprise Value is trading at 3x the average 2024 and 2.2x the average 2025 estimates of EBITDA.  I did not adjust the September 30, 2023 cash for the approximate $85MM spent for NH as it should be fully covered by the $80MM and $105MM of free cash flow that GCT should generate in 2024 and 2025, respectively.  On a free cash flow yield basis an investor is receiving a mid-teens return for a high growth company that does not require much capital expenditure to support its growth.  The valuation table below reflects this information.

Valuing GCT at 5 times EV/EBITDA would produce a share price of between $16.17 today and $24.18 at year end 2025 as shown below.  

If I value GCT as a B2B Ecommerce Company it is trading at about .5 times LTM revenues which is a huge discount to publicly traded peers as mentioned above.  If I used the bottom end of three times revenues, then GCT would trade at about $62 per share.  This scenario could occur if investors become comfortable with the quality and accuracy of GCT’s publicly reported sales and earnings.  I believe that this is possible once GCT is a fully compliant US audited company in early 2024.

Finally, I am using a target price of $23.72 which should provide upside if the market starts to value GCT as a clean US listed company as opposed to a PRC company with possible financial issues.

Risks

1. China – Whether it be the PRC government cracking down on companies or having strained relations with other countries this is a risk that will always remain if the Company and many of the manufacturers it deals with have operations over there.

2. Recession – An economic recession in the US and Western Europe could decrease demand for items that GCT sells and distributes.

3. Noble House Acquisition – This transaction could not go well and could distract GCT from its everyday business.

4. The US auditors find differences of opinion with how the Chinese audits were conducted.

Catalyst

1. US reviewed and audited financial statements starting in 2023.

2. Continued earnings growth and increasing free cash flow.

3. Increased investor comfort now that Board review of short seller ("SS") accusations proved the SS was wrong.