Description

Naked Wines (WINE.L) is a direct to consumer (DtC), two-sided wine platform headquartered in the United Kingdom. The company generates sales from the United States (47%), United Kingdom (39%), and Australia (13%) and is in the process of re-shaping the wine industry.

The company pairs wine drinkers with independent winemakers through online channels and has greatly benefited from changes in consumer behavior linked to COVID-19. Monthly user “contributions” provide a float-like dynamic giving Naked upfront working capital that can be used to fund winemaker operations and better predict future income. In the United States, Naked effectively bypasses the three-tier system providing higher quality wine at affordable prices for wine drinkers. Winemakers also experience benefits of scale and a great deal of burden reduction while selling wine DtC as opposed to going through the three-tier system.

At the core, the company is driven by its mission to add stakeholder value and annually discloses its carbon footprint and strategic initiatives. Over the last three years, Naked has assembled an outstanding leadership team. The company has made significant fixed cost investments and has begun to benefit from massive scale efficiencies brought by incremental growth. As a result, Naked has been quietly taking market share from competition. 

Looking to the future, the company has recently launched major initiatives around innovative product development and improved customer experience, two key drivers of “Lifetime Value.” 

Naked currently trades at a TEV/Sales of 1.47x, a TEV/Standstill EBIT of 12.73x, and a TEV/FCF of 16.17. As management continues to execute, we expect to see a price over £22 by the end of 2025, offering patient shareholders a potential cumulative return of 175% and an IRR of 25%. The company has a clean balance sheet with net cash of £85 million and generated Standstill EBIT of £39.3 million in FY2021. 

Business

Naked Wines was launched in the United Kingdom in 2008 and later purchased in 2015 by Majestic Wines, a brick and mortar wine seller. In 2019, the company underwent major restructuring and sold the Majestic brand along with 200 stores to a private equity firm. Today the company operates only as Naked Wines and has a mission to disrupt the wine industry.

Two-sided network

Since 2008, Naked Wines has been quietly building out a powerful two-sided marketplace that connects wine makers directly to wine drinkers. The company now has 886,000 users (Angels) and 235 winemakers on the Naked Wines platform.

Angels

To become a full member of the nakedwines.com community, Angels commit to saving $40 a month into a nakedwines.com “piggy bank.” There is no subscription cost to be an Angel and this money can be used toward future wine purchases. Angels may withdraw money from their nakedwines.com piggy bank at any time free of charge. In exchange for becoming an Angel, users receive significant cost savings on all of Naked’s wines. 

Winemakers

Being a winemaker on Naked Wines eliminates many of the requirements of running an operating business. Winemakers are able to focus almost completely on making the best possible wine. In partnership with Naked Wines, winemakers can better predict demand dynamics leading to better inventory control. Naked Wines is also able to pass savings on to winemakers in the form of input and distribution costs as well. The company uses a $60 bottle of Napa Cab for example, stating that there is approximately $10 of wine in the bottle, allowing the company to pass savings directly to customers by charging $25 and still achieving a +50% margin on the sale. Everybody wins.

One winemaker I spoke to elaborated on their story of breaking away from a former winery where they were the head winemaker. Naked offered them the support and autonomy to launch their dream business. The only thing Naked Wines asks for in return, is winemakers engage with their wine drinkers on the platform. 

Angel funds free float

The $40 per month Angles commit to saving, allows for amazing discounts on Naked’s wines. Unlike a subscription fee, the entire amount goes toward future purchases. Similar to insurance premiums, the aggregate monthly savings creates a free float for Naked Wines. The company is able to use the float as an interest free loan for working capital needs. Currently, the company has a deferred Angel funds balance of £65.83 million.

Bypassing the three-tiered system

Naked Wines in the United States is established as a “vineyard,” allowing the company to bypass the three-tier system which was established in the United States following Prohibition. The FY2021 annual report explains,

The US segment benefits from the US market’s 3-tier distribution system, which results in higher wine prices for consumers. Naked’s unique model means that it is able to deliver better value wine to customers and still maintain beneficial gross margins.

As the company has grown, Naked Wines has become the largest DTC wine producer in the United States. The company recently increased their total cases of wine sold in the United States by 72% to 1.4 million. Most of Naked Wine’s U.S. competition operates at a large disadvantage by participating in the three-tier system.

Addressable markets

One thing making Naked Wine’s an attractive investment is the massive addressable market of regular wine buyers. The company has identified the United States as its largest potential growth market with a TAM of $20 billion. 

In addition to a massive addressable market, Naked Wines also benefits from the tailwinds of a rapidly growing DtC consumer wine buying dynamics. In 2020, dollar value of DtC wine shipments in the United States grew by 14.9% to just under $4 billion and is expected to reach $5 billion by 2023. Naked is currently the largest single DtC wine seller in the United States. 

It should come as no surprise as Naked has been rapidly taking market share from competitors and climbing the ranks of total cases sold per year in the United States. 

https://www.winebusiness.com/wbm/index.cfm?go=getDigitalIssue&issueId=12555 

Sustainable growth and civics

Naked Wines is a stakeholder focused company. The company does interesting work as it pertains to carbon footprint and cost savings from a logistics and distribution standpoint. For instance, instead of bottling wine at a winemaker’s facility, the company ships wine in bulk to a central distribution site where the wine is then bottled. This alone saves fuel and reduces costs.

During COVID-19, Naked used cash from cumulative Angel funds to support winemakers experiencing financial troubles. The company even launched a COVID relief marketplace to support family wineries in crisis. This allowed the company to test drive the “featured wines” product on the platform. 

Content

As the winemaker and Angel communities grow on nakedwines.com, it will become more and more attractive for winemakers outside the Naked Wines network to begin exploring wine sales on the platform. Nick Devlin has mentioned his vision of having featured wines as rotating content with a somewhat Netflix like dynamic. We also believe there is an amazing opportunity to provide top of the line wines branded specifically for Naked (think Kirkland signature vodka or golf clubs).

Catalysts

Naked has recruited some incredibly talented operators into company management and while the company experienced explosive growth over the last two years, it has also faced complications. With the mission of increasing stakeholder value, management has shifted focus to scale economics, outlining strategic goals of long-term customer retention, increased brand value, and innovation.

Building out the “A” team

Nick Devlin, the company’s current CEO has a background in corporate strategy and was promoted to CEO of Naked Wines in 2020 after serving as Chief Operating Officer and President of the U.S. division. In the 2020 annual report, Chairman John C. Walden says,

Nick has led our business in the important US market, demonstrated his ability to trade well in difficult conditions and been instrumental in developing and delivering our growth strategy. Finally, Nick embodies the Company’s philosophy that the best way to deliver value for shareholders is to look after our customers, winemakers and employees better than anyone else.

At only 36 years old, Nick has proven to be an effective leader, carving a name for himself in the global wine industry. We look forward to watching him work.

Shawn Tabak joined Naked as CFO in 2020. Shawn brings with him experience from his most recent position as Vice President of Finance at Upwork Inc. Nick Devlin mentions,

Shawn’s deep understanding of driving growth through a focus on customer economics and cohorts makes him ideally suited to the role at Naked. Additionally, his understanding of the US market will be highly valuable and recruiting this role in the USA, our largest market, is another key step in our transition from British startup to a US-led global pureplay.

https://www.thedrinksbusiness.com/2020/11/naked-wines-appoints-new-napa-based-cfo/ 

Darryl Rawlings the CEO of Trupanion joined the Naked Wine’s board as an independent director in April of 2021. In August of this year, he will succeed Ian Harding as chairman of the board. He brings with him extensive experience in unit economics surrounding DtC subscription businesses in U.S. markets. He has said, 

Naked is disrupting the wine industry through its unique business model and superior offering to both customers and winemakers… Nick and the team have created a compelling consumer proposition with attractive economics and high retention… I’m excited to join the board as the business scales and leverages its position as a leader in the direct-to-consumer wine market.

https://www.retailgazette.co.uk/blog/2021/04/naked-wines-names-new-chairman/ 

Scale economics

Naked has put significant investment in place to build out its platform. We believe the company is at an inflection point where it can start to realize economies of scale. In the company’s latest annual report, Nick Devlin says,

While making exact predictions around the next 12 months is not much easier than it was last year, we are clear around the shape of our medium-term prospects. We expect Naked Wines to be growing sales at c.20% p.a, underpinned by continued strong unit economics. Equally, as the business scales, we see a clear path to an EBIT margin in excess of 10% at mature scale. Indeed, while undoubtedly flattered by some of the impact of the pandemic, our Standstill EBIT margin in FY21 gives an indication of the potential for this level of margin as we continue to scale the business.

At a 20% growth rate in sales, you can imagine how powerful scale economics will turn out for Naked at a 10% EBIT margin. While the company continues to invest in growth through the balance sheet, it might not be immediately apparent. Eventually the company will become too profitable to hide. 

Customer experience

On the company’s most recent conference call, Nick Devlin mentions that in order to have grown to £340 million in revenue, the company has almost exclusively used direct response advertising aimed at driving immediate response. Strategically, he mentions the company is at a point in its evolution where it will be moving more into brand advertising. This requires a longer-term measurement. On the call, Nick says, “before we deploy material sums of money behind new initiatives, we want to validate our test findings.”

Management is determined to create lower friction experiences, increasing product relevance early in the Angel journey and reducing customer churn.

Product development and innovation

As the company moves forward, management is testing innovation to enhance the customer experience. In the United Kingdom, Naked Wines recently launched tasting kits. This will allow wine drinkers to do live virtual tastings with winemakers, vastly decreasing customer discovery costs.

Subscriptions

Naked Wines has launched a strategic initiative to provide value adding subscription services to Angels. The company recently introduced the “Wine Genie” subscription service that will use the feedback a wine drinker provides on their wines to automatically select and send new wines to try on a periodic basis. In addition to this, Naked has launched the “Never miss out” subscription service that allows angels to reserve future vintages of their favorite wines, authorizing payment in advance. 

We believe layering subscription services on top of the already subscription-like angel contributions will prove to be a powerful value driver for the future of Naked Wines.

More than wine

On July 5th, Naked announced the launch of a Blended Scotch Whisky on the UK platform. We believe the TAM for spirits and beer is multiples larger than the current TAM for wine globally. Entering these markets significantly increases Naked’s growth runway.

Valuation

Naked offers investors with attractive asymmetric risk/reward dynamics. The company has gained competitive advantages that will be difficult for competitors to replicate.

Standstill EBIT and implied churn

In FY2021, the company generated repeat customer sales of £283.9 equating to a standstill EBIT of £39.3 and EBIT margin of 13.8%. This means the company’s trades at a current TEV/Standstill EBIT of 12.73x, an extremely attractive multiple for a company that expects to grow sales over the long term at 20%. Using the company’s published financials and assumptions we’ve made, Naked has reduced implied churn from 19% in FY2019 to 12% in FY2021.

As the company continues to improve customer experience and increase “Lifetime Value” of customers, we expect vastly improved unit and cohort based economics.

Unit economics

Triangulating sales and cases sold with contribution for repeat and new customers, we detect a reduction in price per case (passing savings to customers) while the company increases contribution margin. We suspect these are some of the early impacts of scale economics that the company will likely benefit from in the future. 

Cohort economics

Naked provides incredible transparency around cohort based economics. Using data from company segment reporting and a few assumptions, we are able to look at cohort based economics. While the average revenue per user (ARPU) isn’t exactly increasing in a straight line, it is directionally increasing. At the same time, customer acquisition cost is starting to come down. The company recently switched from providing twenty year “Lifetime Value” forecasts to five-year “Lifetime Value” forecasts. We think this makes logical sense and provides investors with better insight into cohort profitability.

While the company provides a growth expectation of 20% per year, we thought it would be interesting to model out an increase in sales from new customers at 10% using historical median retained contribution rates.

If the company is able to achieve forecasted 10% growth, we expect FY2025 Standstill EBIT of roughly £119.6. Using the current TEV, this equates to a multiple of 4.18x. At a multiple of 10x, we expect shares to trade at £17.51 offering a 119% cumulative and 19% IRR through the end of 2025. At a multiple of 15x, which we believe is completely reasonable for Naked, shares should trade at £25.68 offering shareholders a cumulative return of 221% and IRR of 30%.

Risks

Customer churn is a major concern and was addressed in the latest conference call. Nick Devlin mentioned the company is shifting strategic focus toward long-term customer experience and brand value in order to improve customer experience, increase “Lifetime Value,” and reduce churn.

The United States is host to several major wine producers. They could potentially launch platforms, similar to Naked Wines as a way to bypass the three-tiered system and reach consumers directly. This would increase competition and negatively impact Naked’s economics.

Inventory issues surfaced during COVID-19 as the company grew much faster than expected. These types of issues may arise in the future. Seasonality of winemaking may create issues. As Naked aims to be a global pure play, they will be able to use both hemispheres to their advantage while navigating seasons. 

Summary

Naked Wines is still a relatively small company but has created an incredibly strong flywheel on top of their DtC platform that connects wine buyers with winemakers. Every day that goes by, Naked’s moat is widening and the wine industry is further shaped in their image. The company offers investors a compelling opportunity to benefit from organic growth as management continues to execute on their strategic plan. After a strong FY2021, the company is stronger and more capable to capitalize on future growth opportunities than ever before.

Catalyst

Re-rating post restructuring, organic growth, exceptional leadership, scale economics, operating leverage, improved customer experience, potential re-listing to U.S. (Nasdaq)