Takeaway: W announcing its first B&M store highlights the flaws in the current biz model. Much more capital needed to make W profitable. 50% Downside.

We’ve said from the beginning that for Wayfair to become a sustainably growing and profitable retail operation and that it would need stores over the long term.  The company has been dabbling in popup stores, has built an outlet store, and now is going to open its first full service brick and mortar store in Natick, MA later this year (looks like it will take the place of the old Sears/Sears Auto anchor spot at the Natick Mall).  Perhaps the change in the business model means it can actually make money someday, but it also means that there is considerable capital to be deployed building (or buying) the asset base and funding the inventory needed to execute a brick and mortar strategy.  Without stores, the addressable market is compressed based on consumer shopping behavior (see slide below). That’s why Wayfair is opening stores before the online TAM starts to look tapped.

In our Black Book on March 11th we highlighted how the business model is changing (slide below), and those changes (more logistics/fulfillment and stores) will require more capital to be put into the model. Wayfair however has a negative 3% EBITDA margin, is burning cash, and already has convertible debt.  That means equity will likely have to be tapped to fund this new strategy over time.

If you believe in the massive TAM and management’s ambitious margin targets on a high return online platform model, Wayfair might be fairly valued.  However if this becomes a 50% B&M retailer, with much higher working capital requirements, with more entrenched competitors and a more realistic TAM, then we’re looking at a stock at least 50% overvalued.

For the full Wayfair Short Black Book replay: CLICK HERE

W | Management’s Thesis Morph - W note capital evolve

W | Management’s Thesis Morph - W Stores are Critical