Archive - 2017

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How J.Jill’s IPO Could Help Define E-Commerce Valuations
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Looking Out Towards 2017

How J.Jill’s IPO Could Help Define E-Commerce Valuations

You’d be forgiven for missing a small cap retail IPO last week in the midst of the global Snapchat mania. Last Thursday, without much fanfare, J.Jill, a nearly sixty year old former mail order catalog company selling women’s apparel, quietly went public at a nearly $900M enterprise value. And surprisingly, for the complex world of digital commerce, J.Jill’s public market reception might actually be an indicator of what all these next gen direct-to-consumer commerce businesses are actually worth.

How a Small Cap IPO Could Help Define2

In past pieces for BreakingVC during 2016, I’ve discussed Amazon’s impact on both e-commerce and retail at length, as well as the three areas I’ve observed for opportunity to penetrate Amazon’s digital commerce force-field: (1+2) In Why Amazon Has Consumer Investors Bemused and Confused I wrote at length about both off-price retail (Marshalls and T.J. Maxx, for example) as well as mid to upper tier brand opportunities that Amazon fundamentally can’t capture and (3) in The Middleman Strikes Back, I described how Amazon’s anemic commerce margins prohibit it from a service heavy assisted/concierge-commerce provider.

But for everyone else – from Warby Parker to Harry’s to Bonobos to Everlane – what are these weird, sorta digital, sorta omni-channel, sorta personalization brands actually worth? And why is a sixty year old women’s apparel business that was previously spun out of a legacy retailer, Talbots, a leading indicator of value?

As usual, the Company’s S1 is a store of insight and surprises:

Personalization and Loyal Customers

If I were reading an untitled prospectus, I would’ve bet my money that the following block of text from the Company’s S1 “Overview” described a millennial-first next gen commerce brand, with a small but growing retail footprint:

We believe we have strong customer and transaction data capabilities, but it is our use of the data that distinguishes us from our competitors. We have developed industry-leading data capture capabilities that allow us to match approximately 97% of transactions to an identifiable customer, which we believe is significantly ahead of the industry standard. We maintain an extensive customer database that tracks customer details from personal identifiers and demographic overlay (e.g. name, address, age, household income) and transaction history (e.g. orders, returns, order value.) We continually leverage this database and apply our insights to operate our business as well as to acquire new customers and then create, build and maintain a relationship with each customer to drive optimum value.

Believe it or not, that is a sixty year old company talking.

The truth is that most retail businesses are really merchandising and logistics businesses more than personalization businesses. Most big box retailers – or at least the many that I speak with – admit that closing the loop between online-to-offline transactions is amongst their largest struggles.

This is a flaw that digital first businesses – even those with a retail footprint – claim they can solve. And all the moreso, a business such as Stitchfix, which is truly a data business at its core, led by Eric Colson, Chief Algorithms Officer. Case in point, a recent Stitchfix blog entitled “Ruminations on Data Driven Fashion Design,” which noted:

For example, can statistical modeling identify when a successful blouse has an attribute that is holding it back? If so, can we suggest a mutation that replaces the underperforming attribute? To illustrate, can we identify when a parent blouse is successful despite its leopard print, and then change it to the floral print that everyone loves this season? We are also examining how we can leverage less structured types of data. For example, can we extract features from images of blouses or the text feedback that clients provide in response to a blouse?

[To be blown away, visit the Stitchfix Algorithms Tour, built by Colson. It is a wow.]

Data is powerful. But it’s goal is to yield a more engaged customer; in J.Jill’s case existing active customers [within the past five years] represent 70% of annual revenues – an awfully consistent customer who sounds pretty darn comparable to all those subscription commerce businesses that have proliferated the market. And very similar to the vision today’s D2C brands are claiming: own a customer’s wardrobe/apparel/bathroom/etc with a non-commoditizing product and they will come back to you year after year.

J.Jill also looks a lot more like a direct to consumer business than your traditional retailer, with 42% of 2016 sales (growing to 50% in 2017) coming from direct channels.

How a Small Cap IPO Could Help Define E

What about its retail footprint? As discussed in the past, many of the next gen millennial brands are launching brick and mortar stores to prove a new customer acquisition channel against an overly saturated (and unprofitable) digital marketing environment. But with a footprint of only 275 retail stores, its brick and mortar presence is at least relatively comparable to the type of presence today’s next gen retailers are aiming for (as of today Warby has 44 B&M locations, Bonobos has 11, etc.) And these stores, like the millennial brands are conceptually customer acquisition drivers, as the S1 notes: While 64% of new to brand customers first engage with J.Jill through our retail stores, we have a strong track record of migrating customers from a single-channel customer to a more valuable, omni-channel customer.”

At the end of the day, J.Jill, this under the radar retailer looks surprisingly similar to today’s D2C commerce businesses:

  • Data-first approach (97% of transactions properly attributed to customer profile)
  • Heavy direct sales focus, with stores used merely as customer acqusion tool (42%, growing to 50%).
  • Not overbearing retail footprint
  • Brand quality margins (65.9% gross margins), as compared to 42% for Macy’s, 35% for Nordstrom or 40% for Gap – effectively double the margin basis as a traditional retailer.

What’s It Worth

I like J.Jill as a comp for many of today’s e-commerce companies for two reasons. First, as proven in the prior section, I think it looks much more similar than a casual observer might guess to those businesses. But secondly, at ~$500M in annual revenues, J.Jill is surprisingly small for a public retailer. Gap posted nearly $16B in revenue in 2015, Williams Sonoma is on the small side with $4B in revenues – even Lululemon has trailing revenues greater than $2B. This looks similar to emerging commerce brands which are typically much smaller than their relative press coverage would imply: Dollar Shave Club was on a $250M revenue run rate when acquired by Unilever, Warby Parker booked an estimated ~$200M revenue in 2016, and Trunk Club was on a reported $100M revenue run rate when acquired by Nordstrom. Most of today’s emerging brands, even at triple their current size, would look substantially similar to a small cap IPO.

The first piece of very good news for emerging brands is that there was a market appetite for a small cap offering of this nature whatsoever. Although the Company ultimately priced at $13/share, just below its suggested range of $14-16/share, the good news – again – is that market interest was strong enough not to justify pulling the offering entirely.

But that’s mostly where the good news stops. J.Jill’s IPO (even based on an estimated $15/share offering) would have it placed towards the bottom of a peer set on a valuation basis. The following graphs on valuation comps were initially published on Seeking Alpha:

How a Small Cap IPO Could Help Define 4 How a Small Cap IPO Could Help Define 3

Those are sobering multiples (and, the company actually priced 10% below these estimated multiples) for a company that stacks up extremely well on most operational metrics – for example, they boast higher product gross margin that brands such as Tiffany’s, Michael Kors, Ralph Lauren or even Abercrombie. They boast a higher direct to consumer sales percentage than most of their peers. They have an exceedingly loyal customer.

The biggest knock on the company is their growth rate: 10-15%/year – and one of their biggest divergences against today’s emerging brands who are mostly growing at 50-200% annually.

Given these multiples, e-commerce brands need to bank on the following two factors to earn a premium valuation in the market: maintain strong growth rates and maintain high visibility, momentum brands. J.Jill is a fundamentally strong company – and it has stolen much of the playbook from the online brands – but it lacks both velocity of growth nor excitement around its brand proposition.

Looking Out Towards 2017

2016 was a good but challenging year for me. It was a year in which I watched family members battle serious health issues, a year where I allowed myself to become distracted and reactive at home and at work, and one where my professional insecurities often got the better of me. But, like most challenges, they make us stronger and I’m extremely confident heading into 2017.

Numerous investors have announced their predictions for 2017, notably Fred Wilson, Sam Gerstenzang, Rob Go, Glenn Solomon, among others. I’m not smart enough to play that game, but I did want to use my blog to both formalize for myself, and publicize to others, my focus in 2017.

2017-1

2017 Operations

The biggest mistakes I made in 2016 were not taking enough time for myself and allowing myself to become deeply reactive. There is no worse curse in venture than to be a reactive player; it is fundamentally impossible to be extraordinary if your days are prescribed by others.

Deeper, not taking enough time for oneself is a function of being overly reactive. When you allow your schedule to be determined by others, you are in effect conceding that your own thoughts, imagination, brainstorming, headspace are secondary. I don’t believe this to be true.

My 2017 is going to look different than 2016. I believe I am at the point in my career where I can de-prioritize my fears of missing great deals and instead focus on finding the right ones. To that end, I am going to take many fewer inbound meetings in 2017 and instead build a strong pipeline of outbound ones. I am going to chase relationships that I am passionate about, rather than the ones that are convenient or obvious.

I am going to spend less time on e-mail and more time learning, discussing and engaging. One thing I’ve done poorly in my venture career is not go deep enough into the weeds with entrepreneurs. As a writer, I am extremely enamored with stories and storytelling. The benefit of this is that it enables me to quickly parse out big, category defining ideas and hone in on them. The detriment is that I frequently focus too heavily on the vision and ignore the implausibilities and difficulties underlying the story.

2017 Investment Thoughts (not Theses)

Before getting into specifics, I think that 2017 is the year that many investors realize they need to begin learning new industries. Pure play mobile has hit crescendo and SaaS is so mature that we’re now funding SaaS to manage SaaS. In late 2012/early 2013 I decided I would learn everything I could about bitcoin. I mostly didn’t take a meeting for six weeks, but emerged from my cave slightly bearded, had taught myself to mine Bitcoin (and many alts), knew all the big personalities on Bitcointalk and became well written on the industry.

In 2017, I expect to do that again, hopefully twice, if I get my way in genomics and urbanization.

Here are some other areas I have opinions on:

  • Fintech: Over the past several years I’ve spent my energy becoming well versed in many disciplines of consumer internet from e-commerce to retail to marketplaces to bitcoin. For 2016 I put my mind to getting smart on the fintech sector – both consumer and enterprise facing – and we made two related investments over the course of the year: M1Finance and Sunbit.

I had de-prioritized fintech opportunities in 2015, believing that we were a relative late mover to the market and that many of the early winners from Lending Club to Avant to Wealthfront had strong platforms and balance sheets from which to move horizontally away from their core products into adjacent markets. Then, in early 2016 LendingClub experienced a fall from grace, it’s CEO stepped down, and the entire sector hunkered down into crisis mode. I love, love markets in chaos. The chaos reignited my interest in fintech – I was convinced there would be extraordinary opportunities overlooked as investors felt over-exposed. But what I learned in 2016 was that fintech, broadly, remains one of the largest disruptive opportunities of my generation, and I plan to hunt actively for winners in 2017.

  • E-Commerce: As a consumer, I love e-commerce. I love Amazon Prime. I love discovering new millennial brands from Everlane to Allbirds. And yet, over the course of 2016, albeit it kicking and screaming, I was forced to concede that – as one of my business school Professors taught me – “the internet… is a crappy place to have a store.”

The struggle with that statement is that the internet, in many cases, is actually a phenomenal place to acquire and retain customers. But many of the other capex costs can be prohibitive.

In 2017 I am likely to take a material step back from traditional commerce and d2c brand related opportunities while keeping an eye out for the rare few that are fundamentally recasting cost structures and/or reducing consumer friction by a factor of 10.

  • Crypto: This is arguably fintech, but in my opinion, the next generation of distributed applications – although tokenized – are often only tangentially related to anything financial. I continue to believe that distributed applications, most commonly “altcoins” represent an extraordinary opportunity. And while investing in crypto tokens is not something we have license to do at Chicago Ventures, it’s an area where I plan to spend much of my personal free attention and time (and would gladly meet any entrepreneurs building next gen distributed apps).
  • Reimagination of Cities: I spent much of 2015/2016 focused on the future of the home, reflected both in my piece Furnageddon – about how the furniture we live on is changing – and in our investment in Havenly. But as I dived deeper into urban living, meeting with several companies re-conceptualizing the types of spaces we live in, I began recognizing that technology is fundamentally changing the ways we act in our urban areas as well as their associated suburbs.

I saw a nice interview in Techcrunch with Niko Bonatsos at General Catalyst who had a similar observation, in Investing in the future of urbanization. The 2016 election reminded us that the country is a very diverse place, often with misunderstood needs and incentives. It will be a large focus of mine going into 2017.

In 2016, we invested in Predata believing that geo-political instability was increasingly impacting the bottom of lines of many large institutions, from traditional corporates to finance houses. From my vantage point, I believe that consumers also want to increasing manage the perceived risks in their lives. One example of this from 2016 is a company called Point that allows consumers to hedge their investment in their homes by pulling 10% of the value out for liquidity, with no monthly payments. One of my professors Toby Moskowitz once said to me in business school, that “buying insurance is a poor financial decision, but we all purchase it because it’s fantastic from a covariance perspective.” I’ve long felt that should yield some interesting technology driven opportunities.

  • Betting Markets: Many of you know that my background is in the poker industry, initially as a professional and later as an operator. Online poker is probably a $5-10B market, but is contracting slightly year over year. Similarly, daily fantasy sports started 2016 as an exceptionally hot space, but it turns out it wasn’t a fundamentally great business model (see my article: “Game Over: Why Daily Fantasy Has Already Been Won.”)

 Although DFS is unlikely to become the $100B industry that was predicted, betting markets are still amongst the most exciting markets to observe once they become liquid. Heck, the equity futures market is effectively the world’s largest betting market. I continue to believe eSports has an intriguing market in p2p betting and made an investment in multi-table gaming tournaments via Gunslinger.

Some other angles on p2p betting networks such as Quantopian/Quantiacs really excite me as does Numerai. There are also a lot of other areas of illiquidity that make really intriguing liquid markets – from owned assets to information. If you’re building anything in this area, I would love to chat.

I hope that’s helpful and wish everyone a happy and successful 2017. Thanks for reading.

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