Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.
Shares of Stitch Fix, a digitally-enabled “styling service,” are off sharply this morning after its earnings failed to excite public market investors. The firm, worth over $29 per share as recently as February, opened today worth just $14.75 per share. Stitch Fix equity shed nearly 7% of its value yesterday in the broad market selloff. Today it’s off another 30.48%.
The company is profitable and growing, making its declines seemingly out of the norm for a somewhat recent venture-backed IPO. Stitch Fix raised more than $79 million during its life as a private company from investors like Baseline Ventures, Lightspeed Venture Partners, and Bessemer, according to Crunchbase data
Stitch Fix, which went public in 2017, is a good example of a tech-enabled business. Its margins are slimmer than what we see from technology-first companies like software shops. It uses modern tech methods like data science to help power its consumer recommendations, boosting the value it offers its users, and growing its share of spend. But the company ultimately sells third-party physical goods intermediated by human choices. So it’s a business that may have attractive economics, but it won’t trade near software as a service (SaaS) multiples, as we’ll see.
We’ve recently covered the public market’s evolving views on the value of tech-enabled companies in contrast to pure-tech valuations; it’s a topic that matters as there are startups in the market today likely valued more like the latter whose economics are more like the former. We know that as Casper ran into that exact situation while going public earlier this year.
Let’s unpack Stitch Fix’s quarterly performance, its forecast, and how those figures failed to meet market expectations. We’ll tease out where things went wrong, and then consider the firm’s results in light of what’s happened to other tech-enabled businesses this year to see if there’s a lesson for startups whose gross margins are under 50%.
Results, expectations
On first examination, Stitch Fix had a good quarter. The company reported more customers than in the year-ago period, rising 17%. Those customers spent more than they did a year ago, with “net revenue per active client” growing 8% from the year-ago quarter to $501. The combination of the two led to a 22% revenue jump to $451.8 million. The company also made money, generating $30.1 million in adjusted EBITDA while discounting share-based compensation costs, and net income of $11.4 million when counting all expenses.
How did a company reporting that deck of data earn such a decline in share price? Expectations.
The company’s profit performance beat expectations, posting $0.11 per share against an expectation of either $0.07 or $0.06 per share, depending on how you count. But Stitch Fix’s revenue growth came up short. The company’s $451.8 million in top line during Q2 of its fiscal 2020 (the three-month period ending February 1, 2020) was under the market’s expectation of $452.5 million. That, in itself, might not have been so bad had the company not said three things:
First, that it is considering selling cheaper goods (transcript quotes via Motley Fool):
[D]ue, we think, to the heightened promotional activity across retail, those clients spent less with us in their Fixes in the quarter on average, resulting in lower order values than we anticipated. We think it’s responsible to reflect this trend in our second half forecast. Our strategy to continue to grow our assortment of lower price products to serve a broader universe of clients also impacts this guidance.
Second, that its customer acquisition costs are rising:
[W]hile we expect our customer acquisition cost in the second half of FY ’20 to be approximately flat year-over-year, we’ve seen costs rise in some key digital channels. We’re working on both product innovation, as well as experimenting into new and emerging channels to offset this. So we are applying more conservatism in the way we are thinking about our marketing spend in the second half of the year.
And third, the company lowered guidance:
As [our CEO Katrina Lake] mentioned, we are lowering our guidance for the full year. For fiscal 2020, we are now expecting net revenue in the range of $1.81 billion to $1.84 billion, representing growth of 15% to 17% year-over-year. Adjusting for the impact of the 53rd week in 2019, this range reflects growth of 17% to 19% year-over-year on a 52-week comparable basis.
With the flow-through from our revised guidance, we are updating our adjusted EBITDA to be between $0 million and $10 million with adjusted EBITDA excluding SBC in the range of $75 million to $85 million.
Moving to a lower-margin revenue mix with rising CAC, summing to slower growth and less profitability, is a tough deal to offer investors.
And as CNBC points out, analysts had anticipated “$506.2 million, or growth of nearly 24%” in the current quarter. Stitch Fix itself said that it expects “net revenue in the range of $465 million to $475 million” in the same three-month period.
What about startups?
It’s a tough market for non-software companies that lack recurring revenues and report slower-than-expected growth. While investors have bid software shares down in recent days, the most extreme punishment has been saved for companies like Stitch Fix that sport lower margins and recurring customer acquisition costs. Recall that Stitch Fix both indicated a move to lower-priced items while noting CAC concerns; that’s a double squeeze.
Update: A correction. Stitch Fix reached out, noting that I misread its words a little. Above I wrote that the company had “indicated a move to lower-priced items,” as that was my read of its report. However, the company told TechCrunch that, instead, it meant that it will expand its lower-priced inventory, as those goods are resonating with the market. So, instead of the company executing a strategic shift, it’s more answering a request from the market itself. I’m sorry for getting this point a bit twisted. The impacts are probably about the same, but it’s worth noting their intent all the same.
We can see somewhat similar issues at companies like Casper, where customer acquisition costs are a chronic issue, and the same at Smile Direct Club. Both Casper and Smile Direct are trading at huge discounts to their IPO prices. Stitch Fix, after today’s declines, has effectively reset to its IPO price, despite years of growth since that event.
Indeed, Stitch Fix is now worth 1.06x its trailing revenue, according to YCharts data. If we compare its valuation against its current, full fiscal year revenue guidance, its worth less than 1x sales.
What to take away for startups? That if you are building a tech-enabled business, your price/sales expectations (your revenue multiple hopes) might need to shift lower. Stitch Fix is out here making money and this is what happened to it. Brutal.
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