Description

Majestic Wines PLC (WINE) announced a strategic transformation to sell their retail business (Majestic) and focus on their online wine subscription club (Naked Wines) that I believe has been materially misunderstood by the market.  While this decision has been negatively received, I believe it will generate significant shareholder value because it will allow investors to more appropriately value Naked Wines (Naked) which I think is worth >GBp 500 per WINE share compared to a current share price of GBp 220.

What is Naked Wines

Naked (www.nakedwines.com) is an online wine subscription club that allows customers (called “angels”) to help fund up & coming winemakers by making deposits on a monthly basis.  These deposits provide the winemakers with capital to produce the wine.  Naked also provides bottling facilities, packaging, marketing support and distribution for the finished wine.

This model allows the winemaker to produce a better bottle of wine at a lower cost.  According to Naked, only $20 of the $100 cost of wine is spent on making the wine as the remaining $80 is spent on financing, marketing, paying for distribution, and profits for distributors and retailers.

Naked also has a social media aspect where customers can rate wines online and interact with other angels and winemakers via email and in chat forums.  This website provides Naked with significant data about customers purchases and preferences which allows them to better tailor future offerings.   The social media aspect also increases customer stickiness by creating a more personal relationship between the customer and a variety of winemakers and a sense of community among angels.

Naked has scale advantages in packaging, marketing and distribution compared to independent winemakers and can provide certainty of capital (in advance of production) and volume which can make it easier for the winemaker to produce the best wine possible.  These advantages have allowed Naked to attract top-tier winemaking talent.

What’s Naked Wines Worth?

Naked loses money on its initial customers due to its marketing costs and highly subsidized first order.  The goal of this spend is to attract highly profitable repeat customers with high retention.  Overall sales retention is currently 80% (repeat retention 85%) and the company expects sales retention to trend upwards to the high 80s as the customer base seasons, which has been supported by the performance of recent cohorts.  This level of retention compares very favorably to online retail peers.

As you can see from the chart above, in later years cohorts have very high retention.  For example, the 2013 cohort (darkest blue) has over ~90% retention from FY 17 vs 16 (10mln revs in 17 vs. 11mln in 16) and the 2012 cohort (lighter blue) has ~90% in FY 15 vs 14 and FY 16 vs. 15 and ~100% retention in  FY 17 vs. 16.  This retention creates customer curves with steeper initial declines and very flat long tails.

Naked invests CAC aiming for a minimum LTV Payback/CAC of 4x over a 10 year period and 5x over a 20 year period.  Thus, continued growth of Naked provides attractive returns.

One of the interesting things about Naked is that its already proved its ability to be profitable.   Unlike many subscription companies, Naked already generates positive EBIT with 5.6% EBIT margins in FY 18 and almost 8% EBIT margins in their more mature, but still growing UK market.  Thus, their profitability is not purely based on a pie-in-the-sky model but instead on actual results.

Given the upfront costs of acquiring new subscribers as well as their long tail, Naked is best valued by a DCF.  WINE has also provided the following example of how to model the business at the FY 18 results (happy to help more on this in the comments).

Below is my DCF using this analysis.  I believe it is conservative as I keep retention rate and repeat margin flat despite the fact that I expect both to increase as the company matures. I also believe my declines in new customer growth are conservative as Naked is still minimally penetrated in a large TAM and has the potential to export its model outside of its 3 current countries and should have a long runway for high growth.

Thus in this scenario, I think Naked is worth ~GBp 555 per WINE share or ~1.8x 2020 Naked Sales.  When you remove net debt of ~28p per share, you have a total price of ~GBp 530p for Naked.

For a downside scenario, I hit every one of these inputs significantly and derive a value of ~GBp 230 per WINE share or 0.8x sales.  Removing net debt generates a downside price of ~GBp 200 for Naked.

Obviously DCFs are very rough estimates and can move a lot depending on your inputs. which is why I am posting the model here.  I encourage people to use their own projections and see where they get.  I would also appreciate any pushback on my DCFs above.  Overall, I believe under most reasonable set of expectations, Naked is worth significantly more than what is implied by the current WINE share price.

Transformation

On March 25th, WINE announced a transformation plan which involved selling all/a portion of the Majestic Wine stores, refocusing the group on Naked and renaming it Naked Wines PLC.  This plan has been misunderstood to be the company closing the Majestic Wine brand and replacing it with Naked.  However, the most likely path of action is that a portion of the stores get sold along with the Majestic brand, some stores get closed, and some stores get rebranded as Naked showrooms.

UK investors have also not liked that the company is reviewing the dividend, increased the growth investment in Naked and will have restructuring costs in FY 19 and 20, lowering potential earnings.

However, I think this plan is the right one because Naked represents the vast majority of the long-term value for WINE and that value has been hidden as part of Majestic as investors have mainly been focused on the issues of UK retail and how they affect Majestic.  Once this transaction is complete, investor attention should be focused on the highly valuable Naked business.

CEO Gormley commented in the press release, “It is clear that Naked Wines has the potential for strong sustainable growth, and we will deliver the best results for our shareholders, customers, people, and supplies by focusing all our energies on delivering that potential.  We also believe that a transformed Majestic business does have the potential to be a long-term winner, but that we risk not maximizing the potential of Naked if we try to do both.”

It should be noted that the CEO owns 6% of the shares and takes a modest salary.  His personal wealth is highly tied to WINE equity (and therefore this transformation) and he has a strong reputation as a long-term thinker.  The CEO, CFO and CTO purchased shares at >GBp 300 in November 2018 but are currently restricted as they are running the sales process.

Downside from the transformation project is protected by the freehold land at Majestic.   As the CEO noted on the call, even in the worst-case scenario where they can’t find a buyer for any of the stores, cash restructuring charges should be largely offset by proceeds from the property portfolio.  Thus, while I expect some portion of Majestic to find a buyer for a large portion of its stores as it is still profitable with +LFLs, even in the worst-case scenario, I don’t believe it will be a material negative value for WINE.

Conclusion

Overall, I believe this transaction will be a material positive for the long-term value of WINE because it will force investors to more properly value Naked.  As a result, I believe the current share price is an extremely attractive risk-reward.

Catalyst

Majestic Sale

More explanation of Naked model