THE HEDGEYE EDGE
Wayfair is one of those polarizing stocks in the investment community where there is plenty of love, plenty of hate, and not much in between. Use whatever emoji you want…we’ll stick to research, our investment process, and simple math. Those three things combined tell us that Wayfair is unlikely to earn money – ever.
With a market capitalization of $3.5bn (roughly on par with Restoration Hardware) we can be pretty certain that our view is not currently represented in the stock. While it might take a while, we think that Wayfair is ultimately headed to zero.
Let’s first respect the Bull case (it takes two to tango) and start with the positive. The speed at which W has achieved such strong brand equity in such a fragmented space (Home Furnishings) is incredibly impressive. It’s emerging as something of a ‘buyers agent’ for Home Goods the same way WMT and COST have done for their consumers. That buying power will be hard to compete with for anyone. Ad costs are coming down incrementally, and although we think they’re ultimately headed much higher, it should help margins over the near term (and the bulls know it).
To be clear – if this management team wants to, it could pull back on investment spending (bad long term move) and temporarily report a small profit. But when a company with 58x inventory turns flirts with profitability, the risk to the upside could be both dramatic and painful. There’s your short term risk. But to be clear, that’s the exact event we’d use to get even heavier on the short side.
This is a name where you keep selling Green.
Now for the Bear Case – the Hedgeye Bear Case. First off, Wayfair has considerably higher penetration in its TAM (total addressable market) than people believe. People – including Management, are using numbers like $200bn-$300bn as an addressable market. That’s just flat-out wrong.
We’ve done extensive research on this one, and when all is said and done, we think that the end market is no more than $30bn. To put that into context, it suggests that Wayfair has about 10% share of its market. That’s 2-3x the share of players like RH and IKEA. There’s absolutely no reason why this should be the case.
The primary reason is that Wayfair sells furniture and home goods. The purchasing process for a consumer durable like a set of bunk beds, for example, almost always includes in-store visits as well as online research. You get that at Williams-Sonoma, Restoration Hardware, and even Pier 1. But you can’t touch and feel the seven million items sold by Wayfair before you buy. In fact, our research suggests that W’s target consumer has a ‘blind buy’ threshold of around $750. That’s well below the prices listed for furniture sold on its websites.
Now…that only applies to furniture, but what about thinks like lamps, linens, and kitchen utensils? Yes, that’s where we think Wayfair will drive incremental volume. But how defendable is it when that product can also be bought online/in-store at Bed Bath & Beyond, Kohl’s and Target?
Overall, our work shows that the incremental customer is likely to be much more price sensitive, which not only challenges long term Gross Margin targets, but takes customer acquisition costs higher off a reprieve in 2015. We do think there’s 500bp upside in Order Margins over time, but we need to see 700bp to get Wayfair in the black.
Also, we previously thought an AMZN take-out was a safety net. That’s no longer the case. There’s little that Wayfair has that Amazon cannot build on its own. Heck, look at Etsy. That was also a rumored AMZN target. On October 8, AMZN announced a home-grown site that competes directly with ETSY. In this case, W is on its own to sink or swim.
Maybe Management realizes that with $11.2mm in insider sales since the stock hit all-time highs in mid-August, and $40mm since the lockup expiration at the end of March.