A pair of professors argues that shares of Wayfair, the Boston-based online furniture retailer, is 84% over-valued. Should you join the crowd betting on its decline? No.
Before getting into that question, let's look at Wayfair's recent financial and stock market performance. Wayfair revenues are growing -- to $4.3 billion in the last 12 months and it's burning through cash -- with negative free cash flow of $66 million in the last 12 months, according to Morningstar. But its stock has soared 115% in the last year -- valuing the company at $8 billion.
There are four reasons to bet against Wayfair. According to the Wall Street Journal, these include "new competition, high marketing costs, low customer retention and its need to keep raising cash." The Journal makes a good case -- competitors include Amazon, Walmart, Target, Restoration Hardware and Williams-Sonoma (the latter four are gaining a growing share of revenues online.
Wayfair does not seem to be getting the most bang for its marketing buck. Wayfair spent $500 million in the last four quarters on advertising and it got a relatively small 9% of traffic from consumers searching for the brand; whereas "Restoration Hardware and Williams-Sonoma get 60% to 70% of their traffic from brand-modified searches," according to the Journal.
Wayfair even spends more on marketing than it earns back -- making the stock 84% over-valued according to marketing professors Daniel McCarthy of Emory University and Peter Fader of the University of Pennsylvania’s Wharton School. They found that Wayfair loses $10 on every new customer it adds -- spending $69 to acquire a customer but only getting $59 from each one added.
Finally, Wayfair is burning through cash -- but investors have been willing to front the company more. In the nine months ending September 2017, Wayfair’s free cash flow was negative $114.7 million and it ended the quarter with $610 million in cash and short-term investments. This is thanks in part to its ability to raise cash from investors. According to the Journal, Wayfair issued "stock twice in the last two years, followed by a convertible-bond offering in September."
Should Walmart acquire Wayfair as the Journal suggests? Last May I argued there were four reasons that it should pass on that based on the four tests for successful acquisitions about which I wrote in my book Disciplined Growth Strategies. And in so doing, I conclude that this deal would not work.
Industry Attractive?
The online market for U.S. furniture and home goods is large and growing rapidly. It also appears to be quite unprofitable with no clear path to profitability.
According to Statista, Wayfair's industry generated $30.4 billion in 2016 revenue and was expected to grow at an 8.9% annual rate through 2019. Sadly, Wayfair's negative operating margin and its failure to earn a profit since it was started do not bode well for the industry's profit potential.
Better Off?
Wayfair's rapid growth suggests that Walmart -- which has been growing a 1.7% annual rate since 2014, according to Morningstar -- would impede Wayfair's upward momentum. Walmart has been trying for about 20 years to succeed in e-commerce -- its latest effort is a combination of acquisitions and creating an internal startup hatchery, according to the New York Times -- but has been singularly ineffective.
It is unclear why a merger with Walmart would do anything but mire Wayfair in an imponderably messy integration challenge that would distract it from what it already does well -- offering consumers big selection, competitive prices, and consistently great service.
Positive Net Present Value?
If Walmart were to pay a 30% premium for Wayfair -- or $10.4 billion, it is difficult to see where the positive cash flow would come from to offset that purchase price. After all, Wayfair has been steadily sucking free cash flow.
Should Walmart demonstrate considerable organic revenue growth from its e-commerce acquisitions, then I might conclude that it could digest Wayfair and boost its performance. But beyond putting the head of its $3.3 billion acquisition of Jet in charge of its e-commerce operation, there is not much evidence of that integration skill.
In short, a deal with Walmart would flunk all four tests of a successful acquisition. And with a decent cash cushion and its high valuation, Walmart might shy away from buying Wayfair.
Still, I think it's dangerous to bet that Wayfair stock will plunge without an obvious catalyst. And as long as investors are still willing to finance its losses, I do not see a great short opportunity here.
