Value Investors Club / Qliro Group (QLRO:SS)

Description

Opportunity

Qliro Group presents an interesting long investment opportunity that offers ca. 60% upside from the current share

price of SEK 18.

At the core of the investment we have a CEO change story. Marcus Lindqvist joined as CEO of Qliro in August 2016

from Dustin AB. Marcus has a clear agenda:

a) Streamline the portfolio of business. When he joined Qliro had 5 e-tailers in various product categories

and a financial services business. He quickly divested the weakest ones (Lekmer in toys and Tretti in major

domestic appliances). The next one up for sale is Health Sports and Nutrition Group (sells products for the

gym like protein powder) as he sees (and clearly says in his communications) that this business is not core.

b) Secondly he wants to restructure all the business. Before Marcus joined Qliro was an under-managed

totally de-centralized conglomerate of e-tailers still run by their founders. These run their companies still as

start-ups: i.e. growth at all costs, with no attention to profits. Most of the businesses in the group have never

made a profit in their history. To give you a sense of the inefficiencies, posting (a substantial cost for an e-

tailer) was negotiated by each company independently – thus forgoing the purchasing scale benefits. Marcus

has a clear agenda for cash flow generation.

c) Thirdly Marcus wants to turn Cdon into a marketplace – sort a mini-Amazon of the Nordics.

d) Finally Marcus wants to grow significantly the financial services business which consists of merchandise

credit (thus tagging along the customer base who buy at Qliro e-sites) and as online consumer bank in the

Nordics.

Background

This is a brief description for how we got here.

a) The beginnings of Qliro go back to 1999 when Modern Times Group (a Swedish media company owned by

Kinnevik) founded CDON, an e-tailer to sell CDs, DVDs, PC games and books online in Sweden. The

company grew by adding consumer electronics to Cdon, acquiring e-tailers in other product categories (toys,

fashion, gym food, appliances) and expanding into the rest of the Nordic countries.

The important thing is that acquisitions were never integrated, still run by their founders (start-up mentality)

and not running for making money but just for growth. Thus many of the businesses never made money.

Moreover many of the businesses under-invested in marketing for many years, which led to market share

losses in some busineses.

b) In 2014 2 significant events happen: Qliro launched the marketplace for Cdon (in which 3

party merchants

could sell their products into Cdon site) and Qliro Financial Services (to provide financing for people buying

at Qliro sites). The latter business is still going through strong growth phase, and the benefits of operational

gearing have not kicked in fully.

c) Then in August 2016 the company appointed Marcus as new CEO.

Management Discussion – CEO Marcus Lindqvist

1. Management Assessment

Before joining Qliro Marcus spent 4 years at Dustin where he was initially the Head of Dustin Sweden and then also

added Head of Group Product Management to his responsibilities. Dustin is a Swedish company which supplies IT

equipment to businesses.

It is difficult to get financials for Dustin Sweden as the private accounts of the Dustin AB (Swedish subsidiary) include

central overheads and other central costs. To assess his track record we had relied on reference checks on Marcus

from people that worked with him at Dustin – the feedback was consistent and positive. These are his main traits:

- Marcus gets under the skin of the organization to assess its potential and opportunities. This in turn means

that he attacks both the cost base as well as draw strategies in-line with the company’s assets.

- He is a high-performer and likes to get surrounded of like-minded people.

- Finally he delivers on what he promises, he is not a bla-bla guy.

2. Actions Taken at Qliro

These are the main actions and results achieved at Qliro:

- 2 of the businesses (Tretti and Lekmer) were divested

- He has replaced 25 out 70 of the first and second management team. When you see the profiles of the first

layer of the management team you would see experience from well-established businesses (H&M, P&G, GE

Capital, Kinnevik).

- Finally he has cut significant costs out of the organization. For example in Nelly (the fashion retailer) TTM

EBIT increased from - SEK 4m (in Q3’16) to SEK 95m (in Q3’17).

Business Overview

Qliro is comprised of 4 businesses:

- Nelly: is an online fashion retailer for women 18-25 years old in the Nordics.

- Cdon market place: is like a mini Amazon

- Qliro Financial Services (“QFS”): provides merchandise credit to online buyers (e.g. if you want to purchase

something online on credit) and since September 2017 it gives consumer loans

- Health Sports and Nutrition Group (“HSNG”) is a mix of an online and brick and mortar retailer which sells

fitness products. This is non-core so I will not talk about it.

Below I discuss the essence of each business in more detail.

1. Nelly

Nelly is a strongly sharply positioned online fashion retailer. Its positioning is: female, 18-24 years old and with a

“party” twist (clothes women wear when they go out).

In this niche Nelly is the market leader in the Nordics with ca. 16% of the online market. Its brand is very strong. We

made a survey among 26 women in the target group and 17 of them (nearly 65%!) said responded Nelly to the

question “What online store would you go to if you needed party clothing?”

In the Nelly.com site ca. 42% of the net sales come from their own brand NLY. Consumers told us that they associate

NLY with “trendy”, “cheap”, “low quality”. In that price-point (“entry price”) the NLY is very strongly positioned among

consumers.

Its main competitor is Zalando who got 8 responses (or 30% of the women interviewed). Zalando is a much more

diversified retailer in terms of gender, style and price-points. We see the niche positioning of Nelly and its brand as a

competitive advantage.

The key risk for Nelly is Zalando. In Jan. 2017 Zalando announced that they will open a warehouse in Stockholm

sometime during 2018 with the goal to reduce the delivery times (from 2-4 days to 0-2 days) and to carry more

Swedish brands.

Zalando has been a competitor of Nelly since it launched the site Zalando.se (.se for Sweden) in 2012. Zalando is

also better than Nelly at delivery: 3-5 days vs. Zalando 2-4 days, and Zalando is better at the return policy.

Nevertheless Nelly, in the 2012 – 2016, was able to grow revenues at 14% per year – and more importantly increase

its market share from 14,5% to 16,0% in its target group.

Marcus’s strategy is to remain in its niche – its focus is on profitability and cash flows. He targets a revenue growth of

8% per year an EBITDA margin of 6% (implying and EBIT margin of 4%). If he was to achieve the targets then Nelly

would look as follows in 2019:

TTM Q2’2017 2019

- Revenues 1227 1567

- EBITDA 104 94

- EBITDA margin 8,1% 6,0%

- EBIT 78 63

- EBIT margin 6,3% 4,0%

Although Nelly will see some pressure on margins from Zalando (marketing expenses for example) I think the targets

as conservative. At the end of Q3 2017 TTM revenues grew by 7,6% (close to expectation) but EBITDA margin was

close to 9% - well above estimates. In the Q3 call Marcus commented that “they have achieved the cost savings faster

than expected but he is no ready to upgrade the revenue growth or EBITDA margins target yet.

2. Cdon Marketplace

Cdon is a mini Amazon in the Nordics. It has a presence in all Nordic countries, but Sweden is the strongest with ca.

60% of the Gross Merchandise Value (GMV). It sells all sorts of products, although consumer electronics, media,

books and domestic appliances will make > 70%.

It has 2 revenue streams: product sales of product whole on own-inventory and the kick-back or commission on the

product sales external merchants pay Qliro for selling their products in Cdon websites.

This is a tough business with very few/no competitive advantages and tons of competition and total price

transparency. To make some money in this business the company has to be a large player in the market: size gives

purchasing scale in your own inventory, size leads to brand recognition so more organic (i.e. non-paid) traffic comes

to your website and size finally gives bargaining power vs. the external merchants to drive up the kick-back or

commissions charge for being a marketplace.

Marcus’ objective is to grow GMV by 10% per year and the marketplace (or revenues from external merchants) being

the primary driver for growth. To grow the marketplace fast an e-tailer two things needs to happen:

a) The company needs a good market place “engine” which integrates and price the products of the merchants

into Cdon site automatically and efficiently. The current marketplace engine of Cdon is not efficient, there is

tons of manual input going on, which adds as lot of costs to Cdon. To resolve this problem Marcus has hired

IT people to upgrade such market place engine. Qliro expects to have completed the development of this

market place in H1 2018.

Thus Cdon will have an inefficient cost structure until the new marketplace engine comes live. This explains

why profitability has been declining since Marcus joined.

b) Secondly Qliro has increased its marketing spend.

In terms of competition one needs to look it from two angles: first by country and then by own-inventory vs.

marketplace.

a) Country wise Cdon is the number 1 player in Sweden in online in their core product categories with ca. 4,5%

share. Komplette (a Norwegian company) is number 2 with 4% share. The industry remains fragmented and

thus it offers opportunities to the larger players to gain market share from small players.

Outside Sweden Cdon is sub-scale. There are very strong competitors such as Komplett (in Norway) and

Verkkokauppa (in Finland). Both very profitable with EBIT margin in the 3-5% range. Marcus has no plans to

close the operations in Norway or Finland as he benefits from purchasing scale: shipments of goods are

made from a warehouse in Stockholm. The good news is that Verkkokauppa has no plans to expand into

Finland.

b) In terms of marketplace competition only Komplett offers a marketplace. It was launched very recently (June

2017) and for now it is only in the Nordics. The external merchants I spoke to told me that they are agnostic

with regards to marketplaces. If they believe marketplaces make sense for their business then they will sell

their products in all the marketplaces available.

c) The name you are missing in this list is Amazon. Amazon is indirectly present as it ships goods into the

Nordics at an affordable cost. However it does not have a Nordic site in the local language. E.g. when you

type Amazon.fi you get redirected to Amazon.de (Germany) with no option to translate the website into

Finnish. In terms of competition intensity this form of Amazon presence would be the least intense – the

highest level of competition from Amazon comes when Amazon sets a warehouse in the respective country.

About 3 weeks ago magazine Breakit.se announced that Amazon would be launching an e-commerce site in

Sweden soon. As a caveat Amazon bought the .se in April this year.

My understanding of Amazon international expansion strategy is that they only pursue the full-model (e.g.

warehouse in the country) in very large markets – the latest have been Middle East and Australia. Sweden is

a small country with ca. 10m people so it does not make sense for Amazon to do a full-launch.

Thus Amazon in Sweden will have the following forms: (i) a website in Swedish selling kindle and prime

video - like Amazon Netherlands, (ii) a website in Swedish selling products and shipping them from

Germany. (ii) will take some time 6 – 12 months, and even though it would increase competition (e.g. bidding

for keywords) the impact will not be catastrophic for Cdon. To start with Amazon will not carry Swedish

products as it will make no sense shipping out of Germany. This will lead to relatively lower consumer

engagement in the Amazon.se.

Marcus has set the following targets for 2019: growth of gross merchandise value by 10% per year and an EBITDA

(as % of GMV) 1-2%. This translates into an EBIT margin of 2-3%. If he was to achieve his targets then Cdon in 2019

would look as follows:

TTM Q2’17 2019

- GMV 2174 2759

- EBIT -24 69

- EBIT as % of GMV -1,1% 2,5%

3. Qliro Financial Services (“QFS”)

QFS does 2 things:

Merchandise credit:

In this business Qliro allows online buyers to pay on credit, either on invoice (paying within 14 days) or over a longer

period (3 – 36 months). The income stream is the commissions Qliro charges the buyer for setting up the loan and

lending the money (interest income).

The average loan amount is ca. SEK 1000 and duration is 1 year. The market leader in Europe is Klarna.

Qliro provides this service in its websites (captive) and in third party websites (non-captive). For 3

rd party websites 2 things matter:

- Conversion defined as the number of people who put an item into the basket and complete the purchase as

% of people who put the item into the basket. We have gone through the payment process both using Qliro

and Klarna, and they are similar. Finance managers of some e-tailers I have spoken to told me that the

conversion rate is similar.

- Economics of the transaction: Qliro does a revenue sharing with the merchant of the fee for processing the

payment for setting up the loan. Qliro will keep 100% of the interest income for itself. Klarna use to keep

100% of the processing fees and the interest for themselves in the past. Now they have started to offer some

revenue sharing, but still not as attractive as Qliro.

Consumer loans:

This business started in September 2017 when Qliro got the license to give loans. The loan size will range from SEK

20.000 to SEK 350.000 with a repayment period of 2- 15 years without collateral. Other peers in the sector include

Resurs Bank, Komplett Bank, Collector, TF Bank. They are all listed so you can get a sense of their returns (ROE

18% - 35%) and the growth in the loan book they have achieved.

The key to money in this business over the long-term is to have a sound credit process and risk-averse credit policies.

Qliro has no experience in this business – but it has a very good board (independent of the board of directors of Qliro

Group) with relevant experience in consumer banking. I would highlight Lennart Francke for example who worked as

Chief Credit Officer for Handelsbanken for ca. 15 years. Handelsbanken is known to be a risk-averse bank in the

Nordics. This provides comfort that QFS will not grow by being risky on the loans they give.

In addition Marcus has mentioned that they have started the consumer loan business just in Sweden slowly and

carefully.

To grow this business Qliro will nurture from the 3,5m customers they have on their other sites. This customer

database has 2 positives: first Qliro will know the customers better than it a cold/new customer were to come to the

website (this reduces the risk of loan defaults) and secondly customer acquisitions costs will also be lower.

Komplett launched the consumer bank business in March 2014. In Norway alone delivered an EBT (after interest

expenses and credit losses) of NOK 174m up from nil in March 2014. Komplett is a good benchmark to what QFS

could achieve as Komplett also benefited from the customers coming to their sites.

Marcus has set a target of EBTDA (i.e. after interest expenses and credit losses) of SEK 150m by the end of 2019. At

the end of Q3 2017, TTM EBTDA was SEK 30m. I see this target as achievable given the operational gearing and the

incremental volume of loans coming from the consume loan businesses.

Valuation

With the share price of SEK 18,0 the company has a market cap of SEK 2,7bn. And net financial cash (excluding all

the net financial cash of QFS) of SEK 240m

If Marcus was to achieve all the targets then Net Income on 2019 would be SEK 230m (tax rate of 25%) - see tables below for details.

his would imply a P/EPS of 10,7x in 2019.

Qliro TTM as of Q2 2017
	E-Commerce + MarketPlace
	Onw-inventory
	Nelly	HSNG	CDON	Sub-Total E-Commerce	Marketplace	CDON + Marketplace	Sub-total E-Commerce	Qliro Financial Services	Eliminations	Qliro Group
Gross Merchandise Value	1277	783	1727	3786	447	2174	4233	269	-1	4501
Net Sales	1277	783	1727		40	1768	3827	269	-1	4095
EBIT	78	38				-24	93
EBIT Margin	6.1%	4.9%				-1.1%	2.2%
Interest cost							0.1
PBT							92.7	3	-3.5	92.2
as % of GMV							2.2%	1.1%		2.0%

Qliro FY 2019
	E-Commerce + MarketPlace
	Onw-inventory
	Nelly	HSNG	CDON	Sub-Total E-Commerce	Marketplace	CDON + Marketplace	Sub-total E-Commerce	Qliro Financial Services	Eliminations	Qliro Group
Gross Merchandise Value	1,547	783	1,727	4,057	1,032	2,759	5,089	483	-1	5,571
Net Sales	1,547	783	1,727	4,057	93	1,819	4,150	483	-1	4,632
EBIT	61.9	38.2				69.0	169.1
as % of GMV	4.0%	4.9%				2.5%	3.3%
Interest cost	0	0				0
PBT	61.9	38.2				69.0	169.1	138	-3.5	303.6
as % of GMV	4.0%	4.9%					3.3%	28.6%		5.4%

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

No catalyst

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			2017	2018
Price:	18.00	EPS	0	0
Shares Out. (in M):	149	P/E	0	0
Market Cap (in $M):	320	P/FCF	0	0
Net Debt (in $M):	-29	EBIT	0	0
TEV (in $M):	291	TEV/EBIT	0	0