My thesis has long been that Wayfair (New York stock market :NYSE:W) was bubble stock, although I didn’t write about it publicly (instead, it was part of my Idea Generator service). My thesis, more than based solely on Wayfair’s outrageous review, was based on other facts:
- Wayfair pursues a 1P (first party) e-commerce business (hard for most, including Amazon.com).
- Wayfair’s consistently negative EBITDA margins and resulting cash burn.
- The negative book value of Wayfair, a big billion dollars at the time of my thesis.
- Wayfair tries to make the worst possible products – bulky, bulky items.
- Wayfair not only has negative book value and negative EBITDA, but also significant debt.
For a time, much of this thesis was challenged by the COVID-19 outbreak, which brought offline competitors to a standstill, at the same time as it confined much of the population to their homes and supplied them with stimulus checks. The result has been a rush to buy many furniture products online.
This passing trend was so powerful that it even allowed Wayfair to temporarily have decent EBITDA margins, largely due to the dilution of fixed costs (especially on advertising) due to the extreme demand served. by far fewer suppliers (physical competitors have been excluded). For a while, the short thesis was quite contested.
However, all of that is now over, and as demand for home furnishings (and e-commerce in general) normalizes, it might be time to revisit Wayfair. This is even truer today as Wayfair stock has already crashed – Wayfair has fallen more than 84% since its peak 1.5 years ago. It’s time to try to establish whether Wayfair might now be cheap or whether the outlook or my opinion of them would have improved. So let’s do this.
A new problem
An immediate observation is that Wayfair is now operating in a worse environment than existed before the pandemic. We have higher inflation, which has led to higher interest rates, which is now putting pressure on new and existing home sales.
Clearly, home sales are a tremendous driver of home furnishings sales, hence this sharp (and recent) decline in home sales which should put enormous additional pressure on Wayfair.
It’s rather unavoidable. In the short term, Wayfair is more or less forced to restructure given this factor alone (plus the lack of stimulus and COVID-19-induced demand).
By “restructuring” I mean laying off staff, reinventing operations, changing operations to increase profitability. Ultimately, “restructuring” could go as far as debt restructuring – but that’s NOT what I mean right now. I’m just saying this environment will force Wayfair to change its operations.
In the short term, it all looks really bad for Wayfair, and the stock reflects that.
This factor, once again, leads to the (past) bearish thesis. The fall in home sales will likely:
- Generate negative EBITDA.
- Train negative FCF.
- Generate losses and negative equity. Of note, Wayfair’s negative equity is now negative $2 billion, down from $1 billion pre-COVID, despite all the supportive environment Wayfair has been through.
It’s like going back to pre-COVID, only worse.
But is there no hope? This is where my other main observation comes from…
Is there hope?
The obvious need for change might lead Wayfair to try something new. And that, in my opinion, is the hope that I see for Wayfair. This hope also comes from my own reassessment of Wayfair’s business and outlook.
I think since Wayfair has, to some extent, the public eye, it also has a chance to turn into a 3P marketplace. That is to transform into a market place for 3P (third party) suppliers for home improvement and furnishings in general. Wayfair already does this to a small extent, in that it doesn’t manage supplier inventory or, at times, logistics. Generally, as Amazon’s 3P Marketplace, eBay (EBAY) or Alibaba (BABA) have shown, 3P marketplaces can be extremely profitable ventures.
Profitability comes from the fact that it is cheap, after having the public eye, to simply expose the public to third-party products and then take a (large) share of each sale without incurring most of the costs of commerce. In short, the 3P marketplace “just” runs a website displaying seller listings and handles payments. All remaining costs of serving the public (logistics, inventory, physical customer service, warranties, competition, etc.) are the responsibility of third-party sellers. For this reason, large 3P markets tend to be very profitable ventures.
It may not be possible
I see that perhaps Wayfair’s main opportunity will arise from this in a real 3P market. However, there are plenty of reasons to be wary of this potential transformation. For instance:
72% of Wayfair’s revenue in the United States comes from its own products. This immediately makes it more of a 1P online furniture retailer than anything else.
It is difficult to see how to avoid this 1P fixation, in the context of the change that must take place, so that Wayfair avoids competing in uninteresting businesses. It is true that this is how Wayfair earns sales and revenue, but not how it could earn profits.
The beauty of a 3P marketplace, from an economic perspective, comes from taking a big cut in price from a seller and then having them bear almost all of the costs of selling (supplying, keeping , presentation, customer service, logistics, etc.).
We could say that Amazon’s Marketplace (AMZN) handles the logistics (and sometimes the customer service). But it didn’t start like that. Instead, it first put all those costs on the backs of vendors and then slowly internalized certain functions while getting paid for them. This internalization was not the engine of profit – it simply functioned as another engine of growth for the already highly profitable market later on.
Here’s what to watch
eBay is a true pure 3P marketplace. eBay made $10 billion in Trailing Twelve Months (TTT) revenue, compared to $12.6 billion for Wayfair.
However, eBay’s revenue only counts the fees paid by sellers in its marketplace (including advertising), not the GMV (Gross Merchandise Value) moved in the marketplace. Wayfair, on the other hand, counts the actual GMV of its sellers, which is why its gross margin percentage is so much lower than eBay’s – 27% for Wayfair in the last 6 months, compared to 72% for eBay.
Therefore, to make Wayfair truly comparable to what eBay does, we would have compared eBay’s GMV to Wayfair’s revenue. eBay moved about $80 billion into TTM GMV. So, on a comparable basis, eBay handles 6 times more merchandise than Wayfair.
Now is where the real surprise hits: How many employees does eBay have? About 10,800. And how much for Wayfair, which should, in practice, be about 1/6e of the company? 18,000.
This is where the problem lies. As I explained, Wayfair’s greatest chance of becoming a viable and profitable business is to become a true 3P marketplace. And to do that, he has to let go of much of the work he currently does for his salespeople. Of course, what’s somewhat worrying is that customer experience may well suffer, and business size may suffer, unless pricing compensates.
What works would be abandoned? Things Wayfair is actually proud of:
- Curation. Wayfair selects its products carefully. eBay relies on vendors to categorize and organize products.
- Presentation. Wayfair uses its own workers to present the products in the context of collections etc. eBay relies on vendors to showcase products.
- Customer service. Wayfair prides itself on running customer service as if it were a 1P market – that means having our own customer service representatives, with knowledge of millions of products. eBay relies on sellers to provide customer service.
- And so on …
Although Wayfair does not behave entirely like a 1P seller, it does behave like a 1P seller to a large extent. It handles many functions that, in a true 3P marketplace, would be handled by third-party vendors, and therefore it bears all the costs associated with those functions. The only way to become a profitable 3P market is to stop managing these functions and incurring these costs.
That’s it. For Wayfair, creating a true 3P marketplace is the only real thing that I think can make their business valuable. It has the basics to transform into a true 3P marketplace (customer eyeballs), and it urgently needs to change its business model to a profitable one. But it also faces huge challenges in transforming into a 3P marketplace, as the destination is very different from what Wayfair is today.
Wayfair was a bubble, which was temporarily helped by the COVID-19 pandemic. Right now, Wayfair is facing a tougher environment than even before the pandemic, due to pressure on housing.
Wayfair has returned to a form where it might even struggle to survive. However, at this point, Wayfair will know that it will have to undergo a significant restructuring in my opinion.
This potential restructuring opens up the possibility of Wayfair unlocking the only possible value it has: transforming into a true 3P market, the type of which generates good margins. Wayfair has a chance of doing this because of the number of customers it already attracts to its websites.
Such change is possible, but it goes against a lot of what Wayfair does today, some of which appeals to customers (careful curation, first-party customer service, etc.). Either way, it’s the only way I see Wayfair unlocking value – otherwise its very existence might at some point be in doubt.
For now, in the absence of such a transformation, Wayfair still looks like a sellout to me. If such a transformation were attempted, then I think it would at least be a catch.