What Investors Need to Know About ThredUp Leave a comment


ThredUp is looking to help investors capitalize on the multibillion-dollar-a-year opportunity in digital resale and thrift. But is ThredUp the next RealReal…or the next Poshmark? In this episode of Industry Focus: Consumer Goods, join host Emily Flippen and analyst Asit Sharma as they break down ThredUp’s S-1. This was recorded before shares started trading.

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This video was recorded on March 23, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, March 23rd, and I’m the host of this Consumer Goods focused episode, Emily Flippen. Today, I’m joined once again by Motley Fool Analyst Asit Sharma. We’re going to talk about another e-commerce reseller that’s headed to the public market over the hopefully somewhat near future, ThredUp. Asit, how are you doing today?

Asit Sharma: I’m awesome, Emily, and I’m really excited to talk once again about clothing, about threads. What a really nice name is this, ThredUp, like what-up, ThredUp.

Flippen: It is a nice name. It actually summarizes its business pretty well in a way that we don’t see often with resellers. But in case it wasn’t completely obvious, a lot of what they’re selling are items that have been, you could say, moved up, recycled up the value chain, threaded up, and they’re essentially giving new life to millions of items of clothing that people are looking to get out of their closets. We’ve talked about Poshmark in the past. Hopefully, all of our listeners are somewhat familiar with this industry and the market opportunity headed into today’s show.

One of things that I wanted to talk about as it relates to ThredUp, and this is going to be a little bit of a feel before we get into the actual business, is the personal experience I have with ThredUp. When you reached out to me and mentioned that this company had filed its S-1, and was looking to go public, I was really excited, because very rarely do I come across, especially e-commerce businesses focused on clothing that I’m already personally familiar with. Because as we joke, I tend to be a little bit of a thrifty person when it comes to spending money on clothes or, I guess I should say, not spending money on clothes. But I have personal experience with ThredUp. If we rewind to about a year ago and we’re looking at the pandemic, we’re all stuck at home, I certainly have a lot more time on my hands to do things like watch videos, in particular, videos on YouTube. I found myself going down this weird, somewhat dark place of YouTube watching mostly women do these things called unboxing videos with ThredUp rescue box. They had small businesses, where these people would order boxes from ThredUp, unbox them on camera, and then actually take the items that they were sold and then resell them on other platforms, mostly Poshmark and eBay and sometimes even back to ThredUp.

It’s just a weird sub-business that exists in the reselling market where any inventory that sits on ThredUp’s hands over an extended period of time, they’re able to simply put into a mystery box, sell these mystery boxes to people who then unbox them and then attempt to sell them themselves. It’s interesting, it’s weird, but it’s also a wonderful thing for the world. Not just because it’s making entertaining content to keep me entertained for months during a global pandemic, but also because it’s extending the life of clothing that otherwise would end up in a dump or in the garbage being completely wasted. It ends up being a pretty good thing for the environment. As we talk about the business today, I think investors will find that that’s a trend underlying a lot of the themes of this episode is sustainability.

Sharma: Emily, I’m laughing because you said you went down this hole and it got to be a bit of a dark place. Now, I went back last night and watched a few of these videos because you had mentioned this when we were prepping the episode. I could see how it could quickly become dark for me, because many of these people have super skills. They’re pulling the clothes out of the box and they’re showing you seams that are invisible to the eye and this is why they rejected it. I’m going to fix this here, I’m going to take this thing out. I’m going to put a hem here, and I started to feel very useless. What have I done with my life? [laughs] Look how amazing [laughs] these folks are. They’re contributing to the circular economy. They have a side hustle. They’re doing well by the environment. All kinds of things. I could see me watching a lot of those. For me, that would be the darkness of that hole. But we all went down into our own personal YouTube rabbit holes at the beginning of the pandemic. There’s nothing too unusual there.

Flippen: I think that it’s so important, because there’s a skill when it comes to determining what clothes can be resold, how much money you can get for them. We joke about it seeing it on a small scale with these creators on YouTube who are clearly very talented because they have the ability to immediately pull-up an item of clothing out of a mystery box and know what they can get for it. Looking at these little things and determining what value is attractive based on the pilling of the material or whatnot. But that is applied on a bigger level at ThredUp. We can talk through the business cycle for ThredUp. It exists with just you or I. The average person who is looking to, say, clean out their closets. The person goes on, maybe Google searches where they can thrift their clothes to, and ThredUp comes up. They’ll give you a box, give you a bag that you can put your clothing in, ship it to ThredUp, and then ThredUp pays a commission when those items sell through their platform. It ends up being a good thing for the person who is selling the clothing because they get a percentage commission off of a clothing that would otherwise have probably ended up in the garbage. It’s a good thing for the world, because it’s one less piece of clothing in the garbage. It’s a good thing for buyers because they’re getting a piece of clothing for a discount. For ThredUp operating this platform, it shows a level of skill and their ability to pull clothing in and determine if they can sell it, and if so, how much they can sell it for. It really is a business that benefits from the learning ecosystem that it creates based on the number of items that it brings in.

Sharma: Absolutely. They have spent a lot of money to develop software which gets better and better. Obviously, applying artificial intelligence and machine learning. Not too dissimilar from other platforms that we’ve seen come public in the last several months. It’s such a unique business to me. It reminds us of other platforms. You mentioned Poshmark, which is also reselling clothes. That you’re selling peer-to-peer, you’re putting clothes up as a listing, someone else is buying them. But it also has similarities to another company called the RealReal, which works on the same type of consignment model. But that’s luxury items, a really different type of business model and working on a different average selling price. I was surprised, Emily, or maybe I shouldn’t have been, that ThredUp has an average selling price of about $17. For a company over the long term to be able to make good money off of that type of selling price point, is pretty impressive. It gets into some of the economics that you alluded to. In other words, being able to really efficiently figure out through automation, automated software, etc., what items will sell, how to present those items, how to manage that inventory. I think they do all of this really well.

They process a ton of items. They’ve got three distribution centers across the country and collectively, these distribution centers, let’s call them DCs from now on, they’re capable of holding about 5.5 million items collectively in inventory. The other really cool thing that they do is they assign a unique stock keeping unit or SKU to every clothing item they process. They can process about 100,000 SKUs per day. Now, why is this impressive? Most items that we’re familiar with, have barcodes on them. It’s really easy to get a SKUs just by putting a device [laughs] at a barcode. But they have been able to generate SKUs, or find a way to do this without having any barcodes on the clothing. We’ll talk a little bit later about how they store their clothes, what these DCs look like. But I think it’s an interesting platform in that it combines so many different parts and pieces of other platforms we’ve talked about, but it’s a unique model.

Flippen: I actually love how you connect it to The RealReal because I think my first impression having been somewhat familiar with ThredUp’s platform from a consumer’s perspective, not from having looked at any of their S-1 or their filings; my impression was that it was going to be closer to a Poshmark or an eBay than something like The RealReal. But they really do have a unique model, and while their price point is below that of the RealReal, I think investors can often overlook the intelligence that comes behind a lot of the work that they do in terms of their SKUs. A lot of their business depends on accurately determining the value of items that they’re getting and the mail from people that they don’t have the background of. They may be missing items. Maybe there’s a tag missing. It becomes a challenging business model to create. They’re doing what these individual sellers, like I mentioned on YouTube, are doing where they’re applying their own individual knowledge, but they’re collecting the knowledge in the aggregate and applying it to millions and millions of items across all of these distribution centers. From a business perspective, I think I have a lot of respect for the time and the energy and the work that goes in behind the scenes to make ThredUp even exist.

Sharma: For sure. We should point out that this company, as of now, isn’t trading. It’s going to start trading any day. I believe the symbol is going to be TDUP, T-D-U-P. I also wanted to talk a little bit, Emily, about its two major revenue streams. We’ve already mentioned one, which is selling clothes on consignment. I send them a kit of my clothing. They put it on sale basically, and as those items are purchased, then I’ll get a payout. Consignment, pretty easy to understand, but they are also doing something that they call Resale-as-a-Service or RAAS. [laughs] When I saw this acronym I thought, “Wow, there must be some really automated software type of innovation going on here.” I guess it is innovative, but Resale-as-a-Service is simply their name for getting retail partners like the Gap or Madewell Jeans or Reformation or Walmart, all of which they have partnerships with and helping those retailers to sell used clothing directly back to customers or to participate on the platform with this company. Remember this acronym, RAAS. This is a secondary income stream or revenue stream. But I think it also shows some of the potential of the platform over time to partner up with a lot of retailers and help them participate in the circular economy. It’s a way to also broaden out their own gross merchandise volume. That is the total amount of dollars that are transacted over their platform.

Flippen: Traditional retailers have been left out of the upcycling that exists with the reselling. When you think about the breadth that retailers like Walmart have and the scale that they can have to push people who are budget conscious toward resellers as opposed to buying new, especially given the trends in fast fashion that I think a lot of younger consumers are more and more aware of, it’s a natural expansion. I remember when Walmart made their initial partnerships with ThredUp and I believe it was mid-2020. I remember thinking in my mind that I thought Walmart was going to make a play to acquire ThredUp or to maybe integrate ThredUp more closely in its business. I actually love the fact that ThredUp to this point at least has stayed relatively independent, because it allows them to partner with more and more of these traditional retailers as opposed to being pigeon helped to one. Either way, it’s interesting, I think it’s an interesting strategy for them to make these traditional partnerships and again, generally a good thing for the world.

Sharma: I think so too. In their S-1, they’re offering documents for their IPO. They mentioned three trends that they think are going to propel the business forward, and why they think they’ll have such a wide audience in the future. The first is generational shifts. This is Millennials and Gen Z’s who are shifting their preference from new clothes toward resale. I can attest from having friends that are a bit younger than me, and Emily Flippen being one. Also, my kids, that this younger generation, I should say younger than my generation. [laughs] It’s really into the idea of the circular economy, getting vintage clothes, just the thrill of going thrifting. I think they’re onto something there. They indicate in their prospectus that these two groups are adopting second hand faster than any other age group.

They’re also pointing to this rising interest in sustainability, which to me is a slow trend. It’s something that many of us have been watching for a long time. The idea that we can live a more sustainable lifestyle is not something that’s ever caught fire. But I think with every passing year, more people become aware that we’ve got to live in a fashion manner that doesn’t harm the planet. This is a growing, but a slow-growing trend. Thirdly, they’ve just pointed out that secondhand is becoming mainstream. I would say that this goes for a lot of stuff, not just fashion. I think of electronics that I’ve purchased in the past few years. Some of them have been reconditioned. My kids, again, this younger generation, challenged me a couple of times [laughs] over the last several years, “Dad why are you buying this new? You can reuse something essentially by buying it reconditioned. That’s better for the planet and you’ll also get a discount and it’s just as good as new.” I would never want to believe [laughs] or not that being more old school. But now I’m a happy convert to this type of thinking.

Flippen: I think my favorite aspect of the S-1 was the letter from James Reinhart, who’s the Co-Founder and CEO of ThredUp. He founded the company back in 2009. The letter goes like you would expect every S-1 Co-Founder letter to go, except where he includes this visual diagram that he drew out about what he perceives to be a ThredUp’s competitive advantage. One aspect that I think really gets at the generational shift in this diagram he drew was unlocking supply. It was one of the key aspects of driving this “do good” flywheel competitive advantage. But really his aspect was, we have a generation that wants to do the right thing. That is increasingly trying to do the right thing, but it’s challenging, because the vast majority of thrifts or recycling, upselling, it all exists in person, and this is a generation that likes things to be seamless, likes things to be digital or more accustomed to making online purchases.

I love that he highlighted the aspect of reducing the friction of trying to do the right thing. When you look at your closet and you have too much stuff in it that you’re trying to get rid of, you want to do the right thing, you don’t just want to dump in the garbage. But at the same time, if you’re a young person, maybe you’re living a very digital-centric lifestyle. Having a platform that reduces the friction, expanding the market, and makes cleaning out your closet easy, while also making the buying process as seamless as possible as well, I think has long-term value and I love to see that written out or visually, I guess I’m a visual person. I love seeing it so visually written out directly in the S-1.

Sharma: That was awesome. Basically, a sketch in his own handwriting. I really like the principles that you’ve laid out, Emily. This company started as a men’s shirt swapping company, because James Reinhart literally did, just as he unlocked the supply, he opened the closet door [laughs] and noticed it was full of clothes he didn’t want to wear. He decided to do something with that supply. Hence, this business, which now is going public probably in the next few days.

Flippen: One other aspect before we move on to some of their financial metrics, because it is important to talk about their financial metrics, but one aspect that I saw them breakout, which I was surprised to not only see them break out in the S-1, but how the numbers actually fell, was the demographics that we’re purchasing on ThredUp’s platform. It does skew young, which you would expect. It does skew female, which again, you would expect, but the one thing I didn’t expect was household income. When you look at buyers and sellers on the platform, the single largest demographic for income and the ranges of there’s less than $30,000 to $50,000, $50,000 to $100,000, and more than $100,000 is actually the more than $100,000 bracket. It’s not just people who are looking to save money out of a perception of necessity, but people who are presumptively pretty well off, that are looking to just make more budget conscious and environmentally friendly decisions. That was one aspect, I saw that and I had to reread it because I didn’t really believe my eyes.

Sharma: It’s such a great point, because it reinforces their thesis that there is a market for this resale, and it’s not just a market that’s composed of, let’s say, economic necessity, which would be at the bottom of that demographic range. It’s something that crosses all demographics and especially pointed once people accumulate enough wealth to be comfortable, or enough annual income to be comfortable, they actually turn their attention to these very things. How do I live a more streamlined life? How do I clear out that closet? How do I do well in the environment? I felt that fascinating and in fact, the company itself, and we’ll get to this, I’m prefiguring here a little bit of my thought on this company as investment. This is an idea that I feel like it may take some time to develop, but over the long run the market is there, the product is good, the technology they bring to the table is pretty impressive; it’s a company you can visualize getting into steady profits, steady cash flow generation a little easier than some other e-commerce platforms that we’ve looked at.

Flippen: Speaking of financial state, maybe we should move onto some of their financial performance in key metrics. About on par for the course of what I expected in the business, we have a rapidly growing industry, but again, an industry that doesn’t seem to be able to generate any movement on the bottom line, so this is not a profitable business. When you looked over some of the metrics and the analysis from the S-1, what stood out to you, Asit?

Sharma: Emily, I was actually a little impressed by bad financials. [laughs] Let’s talk about the metrics. A couple of things that I’ve learned from you in looking at these platforms to pay attention to really didn’t show up. We should say here that in an investment prospectus, in an S-1 statement, you get to choose exactly what details you are going to disclose to prospective investors. Now, the best-case scenarios when you disclose as much as you possibly can about your metrics, and that helps investors make an informed decision and should pump up demand for your stock if you’re doing well. They were pretty selective with the metrics that they shared, one that I look at. Gross merchandise volume, this is again, the total amount of dollars that’s transacted over an e-commerce platform during a given period. While management discussed ways in which they wanted to grow gross merchandise volume on an annual basis, they actually didn’t disclose what that total was, which makes it a little hard to compare to other platforms.

Another thing which I didn’t see — again, this is something I’ve learned to pay attention to from watching you, Emily, is their cost of acquiring customers. I couldn’t find anything that really nailed down what that customer acquisition cost was, and I didn’t see any metrics on user churn, so how customers are leaving the platform or decreasing frequency of ordering. They did have some pretty decent metrics on their growth. They broke out their active buyer growth, and you’re going to see a pattern here. I will just throw out some numbers here and then we can discuss them. Active buyers grew 10% year-over-year in 2018. They grew 48% year-over-year in 2019, and 24% in 2020. Similarly, orders grew 28% year-over-year in 2018, then 34% in 2019 and peeled back a little bit to 27% growth in 2020. What’s going on here is COVID-19, which impacted the company’s revenue growth.

What they did was in the second quarter of last year, ThredUp decided to start incentivizing buyers, incentives, promotions, discounts to make sure that they didn’t lose customers during the pandemic. You would think that would increase revenue. If buyers and orders grow, they are increasing, but because they net out those incentives and discounts, promotions from their top line, it actually had the effect of muting through revenue growth, and that’s why it dropped from 2019 to 2020. These are the major things that stood out to me at a glance at the metrics. Any thoughts on this, Emily, or anything that you saw, that caught your eye?

Flippen: It was interesting to see what they did and didn’t break out, and I agree with you, this is a business and I think we’ve talked about it before you start taping, but this is a business that spends a decent amount on advertising. If you’re somebody who watches TV or maybe you watch certain channels on YouTube, ThredUp is not a business that is entirely word of mouth. In my opinion, despite their unique business model, they are still relevant to think about customer acquisition costs. You highlighted some things that I have been mulling over for at least the past day, and I don’t have a good answer for it, but why they have such a decrease in the gross profit by cohort, one of the metrics they did breakout is gross profit, which is important given the consignment model, I understand why they are focused on the gross profit as opposed to just gross merchandise volume. They broke out the gross profit from each cohort, and you pointed out that there is a significant drop-off in each year’s cohort since 2016 after the first year. While it seems like it studies out a little bit, admittedly at a very smaller level than what it was prior, I can’t quite wrap my head around why there is such a steep fall-off. It’s actually concerning to me because what it says to me that it is, in order to grow revenue, they need to grow customers, but they’re not doing a great job of engaging existing customers, which is a little bit of a concern, especially when you see the significant fall off, and it’s not just 2020 where we see that, it’s 2019, 2018, 2017. This is a problem that seems to have persisted.

Sharma: It’s curious, they have been bouncing out there that each year the new cohort tends to contribute sizeably more gross profit than the year ago cohort. Think of it this way: every year the new customers are contributing more gross profit in their first year than customers contributed in their first year, or the year before. But again, neutralizing that is a drop off from the previous year’s cohort from year one to year two. Now when you put it all together, they have a nice graph in their S-1 that shows the trend from 2016-2020. Basically, that gross profit is growing every year and that is helping them scale their business so that they will see some operating leverage hopefully sometime in the future. But it is something without the other types of user metrics that other competitors have disclosed when they went public, we can’t really piece together quite what’s going on here. Maybe in that first quarter earnings report, they’ll be asked by analysts to explain and we’ll get some color there, but for now, it’s guesswork. Maybe some minor demerit points there. But we should say, on the flip side, their gross margin looks pretty good for a resale platform. Last year, they achieved a gross profit margin of 69% and they achieved a 75% gross margin on their consignment business, which they started to shift completely to starting in 2019. You can put those two together and say the picture is really not that bad, but we’d love some more information to understand these numbers just a bit better.

Flippen: I agree and again, that picture is further muddied because as you mentioned, I think around nearly 80% of their orders come from repeat customers. Finding a way to monetize those cohorts, the people that they’ve already spent money on to acquire, even better than what they are doing today, retaining them in a stronger way in their second year. I think maybe that’s a great opportunity for them. Maybe it’s an area that they can genuinely work on and that alone would help increase their gross profit as an overall number. But to your point, yes, it’s wonderful to see that they’re pulling in new customers and the new customers are increasingly contributing more to that medium line there, I guess I should say, the gross profit line.

Sharma: For sure. I want to quickly mention a couple of other things that are going to help drive that gross profit margin and those gross profits over the next few years. One thing I really liked about this company is that management is obsessed with automation. They remind me, Emily, of Revolve, who we did a deep dive on, I think, in December of last year on Industry Focus. That Revolve which is yet another fashion retailer with an online platform has a management team, again, also holding inventory. Their management team just wants to make things more efficient. Some of the things that stood out in this S-1 is that ThredUp has developed these algorithms to predict demand for sellers items, as well as the optimal payout to offer to the seller, so there’s no human intervention there. This is done on pattern recognition. They’ve won up this by automating one of the most expensive parts of the resale process for any online fashion retailer, and that’s photography. They have internally developed software that automatically chooses photo sessions that will drive the highest engagement among potential buyers. When products come in, the software tells the equipment exactly how to take the photograph. I thought that was really cool, and they’re doing hundreds of thousands of high-quality photos continuously, 24/7, without the need for professional photographers.

The other thing which really is going to help drive that gross profit in the future and gross margin is this automation of distribution centers. They have these prototype centers. I mentioned they’ve got centers in three areas of the United States. Within these areas, they’ve got an older model, and a newer model distribution center. The newer model distribution center uses a patented conveyor and hanger system that extends three stories high to maximize efficiency. If you’ve seen a picture of this, you can google it on the web, it’s futuristic looking to me. It looks like someone took a dry cleaning business [laughs] and pulled it up three stories. It’s pretty cool. They think that this newest type of distribution center, which is so highly automated, is going to help keep pushing those gross margins. They show that actually the newer distribution centers have an appreciably better average contribution profit per order. I think this will benefit the company in the long term. They are very focused, as you said, on this idea of extending gross profit, because if you can do that and control your fixed costs, you’ve got that path to eventual profitability.

Flippen: I wasn’t even sure if I should mention this in this episode because it feels maybe just tangential to the conversation. But if anyone has poked around on ThredUp’s website, I’m not sure if they had the same reaction that I did, which was, you mentioned the photography that goes into all of these outfits. They’re essentially just single pieces, oftentimes you get one or two in stock, they’re gone. They may not see that one again, at least not for a long time. Well, the way they have it set up is that every single item is placed on the same mannequin, in the same background. When you scroll through the site, unlike looking through Etsy, unlike looking through Amazon or Poshmark or any of these other sites where you’re getting all of these different backgrounds, all of these different lighting situations, you can’t really quite tell what is what, having all of the presentations exactly the same, on the same mannequin all your size. It makes shopping so simple and so easy and I am convinced it’s because of that focus on automation that management has. It really makes the resale process feel less like I’m reaching into somebody’s closet and pulling something random out, and more like I’m making a genuine, almost like new purchased on a perfectly legitimate website.

Sharma: Emily, I’m no MBA, [laughs] but I know this is something they teach in MBA school. But if you can make the process easier for the customer, you’ll accelerate your throughput and your sales. They seem to really have done that. They’ve taken that to heart. I think the money that management has spent, both on the software side and in the physical equipment, is to their advantage over the long term. Which takes us to this equation, we should talk about the financials just a bit. Emily, I know I’ve thrown out a few impressions to you. What did you see when you were looking through the financials? Then I’ve got some thoughts as well.

Flippen: Well, I have to admit, I was a little less impressed with the financials than you were, because as we’ve seen with most resellers, it can be hard to make an entry into the reselling market. It’s a slow-moving market. People have been slower to adopt it, but I think we want ThredUp themselves, that they do less than I think 0.1% of all of the potential resold clothes in the United States go over their platform. While it’s an opportunity, it also means that they have a lot of challenges in convincing people to use this site. As their revenue has dramatically scaled up over the past year, to me, it was a little bit of a red flag that their losses really hadn’t moved, especially their operating loss. I know you maybe take it a little differently because in comparison to other resellers, at least they’re not losing even more money. But I wish that their net income or their income statement had scaled as their top line has scaled and we haven’t seen that yet, which is a little bit concerning to me.

Sharma: I think those are really valid points. Let me go over some numbers and we can talk about those. Last year, they lost $48 million on $186 million in revenue. If you look just at their operating loss, that’s a percentage of about -25%. This loss percentage has helped fairly steady over the last three years. I think it was 22%, maybe two years ago. It’s hovered in this 22%-25% range over the last three years. Revenue is scaling, but Emily, as you point out, it’s not really dropping to the bottom line. What I liked about this is when you compare this to other competitor, and maybe we’re picking on Poshmark [laughs] today, we talked about them a lot. We did a deep dive in January.

Flippen: I know, I feel so bad. It’s so top-of-mind.

Sharma: It was top-of-mind, but they have not been able to scale as successfully. Poshmark has a faster growth at higher growth rate, but they are losing a little bit more money as they scale. I think that they actually have an even greater allocation expense to sales and marketing. The other thing which I am going to give them a little pass for is that they did slow down some of their processing of inventory during COVID. Now, that was partly because they wanted to protect employees, so they had some inventory buildup. I’m wondering what the effect of that might’ve been on just being able to sell last year, maybe we would have seen a bit higher sales. That’s what management has indicated in the S-1 in their narrative, that COVID impacted sales in these various ways. I tend to believe that seeing the inventory, I’m wondering maybe if we would have seen a little bit more drop to the bottom line last year had it not been for having to slow down the human components at these distribution centers.

The other thing which I noted as a, I guess a yellow flag is that they’ve been cash flow negative each year for the last three years. Last year, they had -$19.1 million in operating cash flow, which means they burned through about $19 million in their operations. But they also had $19.4 million in fixed asset addition. If you’re one of these people who loves to look at free cash flow, that’s about $40 million in negative free cash flow last year. I also noticed that working capital deteriorated over the last year. If you look at their current assets versus their current liabilities, this ratio dropped from a really healthy 2.1 times last year, to 1.2 times by the end of 2020. This simply means that they’ve got a little bit less of a margin in the current assets, like cash inventory, to cover obligations that are due in one year. Now, the IPO should net ThredUp between $141 million and $163 million. This solves the couple of problems I just talked about. It solves the cash burn problems, it solves the problem with working capital.

You can then take a look at this total financial equation. What I like is that they were able to control those fixed costs. Remember, as they scaled, they didn’t really see that benefit hit their bottom line, but the loss didn’t widen, which is a signal to me that all things being equal, if they can continue to control that fixed asset base and then tap more of this supply or unleash the supply, unlock the supply with the current gross margins they have, which are slated to grow by probably a few percentage points over the next few years, I could see this company becoming profitable. More like a Revolve which is already profitable, also manages inventory, but does it very carefully. I could see them becoming more like a Revolve in the next four to five years.

Flippen: I could see that as well, and I mentioned early on that one of my hesitations was just the slow adoption. Maybe I was overly bearish on my perception of the adoption of resale, because it is coming. One of the things I did like that we haven’t mentioned or I mentioned briefly, but didn’t get into was really that market opportunity. I liked the fact that ThredUp split their market opportunity, which they saw as a $20 billion industry today, into two different categories, thrift and resale. I have to be honest, not only pre-reading the S-1, but also during this podcast, I’ve really been using these two words interchangeably, but they actually refer to two different things: thrift being items that are resold that are not curated, and then resale being items that are selectively sorted for sale. The resale is what ThredUp really is their bread and butter. They’re making choices about which items to post on their sites, and that’s the segment of the secondhand market that’s growing the fastest. That’s only $7 billion in 2019. Those are the most updated numbers, but it’s expected to get to $36 billion in 2024. So an over 30% CAGR over the past five years or future five years, which is a big opportunity. I can see their, to your points, having some scalability in our financials, especially as the market expands, that we’re not seeing today.

Sharma: Absolutely. It’s something that has been under, I think, many investors’ radar screen. This whole explosion of resale, it tells you why Walmart wants to get in on the game. It also shows you why companies like Levi’s are getting into the game as well. Levi’s went it alone and they have their own store called Levi’s SecondHand. But it’s a huge market, so why wouldn’t companies try to participate in this? I do like that they’ve got this fast industry to play with. If they just can grow as quickly as the market, then that’s a really phenomenal double-digit growth rate over time. I also like that market opportunity.

Emily, we’ve got I guess just a few minutes left. I wanted to talk about the social creds that this company has really quickly, because you can’t talk about ThredUp without mentioning this. They really want to do well by the environment. I’m going to read you some stats from the S-1, for those of you who are interested in companies that have a focus on sustainability. They say that they have cumulatively saved or displaced a billion pounds of carbon emissions from the atmosphere since they started the company, and they have saved two billion kilowatt-hours of energy. Also, have saved 4.4 billion gallons of water. Also wanted to mention that they discuss the breakdown of their employees and their management, and point out it’s not just their customer base that is female, but I think more than half of their employees are female and I think about 30% of the management team is female. If you also like diversity in management and employees, they do that pretty well as well.

Flippen: But with every good thing, there always have to be negatives. As our frequent listeners know, we can’t have a podcast where we don’t talk about the negatives. I’ll kick-off what I think are some of the bigger risks here, and I’ve made a name for myself, so I need to keep up the name. Asit, this is a company that has weaknesses in their internal controls. I’m not even sure if I should be mentioning this problem anymore, because it has become so pervasive in virtually every company we see go public. In my mind, I had attributed a lot of that to the SPACs, to the unexpected publicness of formerly private companies. But this is a traditional IPO, and I’m not sure if there’s an excuse. While they are aware of these issues and they’re looking to remediate them, I’m definitely a little bit more aware of the fact that ThredUp, alongside virtually every other company I’ve looked at over the past year, just can’t get their internal controls right, and I hate it. I feel like it’s the least you can do if you’re going to ask us to give you money.

Sharma: I agree with you, Emily. Part of it may be the allocation of resources in these companies, which is I’m going to call it backward. [laughs] You should be spending some money upfront on your accounting and financial reporting because you never know. […] I’m really saying this, I tried to give a pass to another company we looked at very recently by saying they’ve grown as a tech company. They have a very good tech platform. If you look at their hiring, they hired mostly engineers in the early days. Looking at accounting and internal controls, financial reporting, all that came later and they decided they would take advantage. When we were actually talking about it, I think it’s a bad company on that day. But if you think you might go public and you’ve been around since 2009, it’s […] you along the way to bulk up your reporting processes, to bulk up your controls, to make sure that if you ever decide that hey, the market’s great, let’s go get some funding and go public, you will look pretty good on paper to an auditor. But it seems like there is such a gold rush in the IPO market that’s going on now. By gold rush I simply mean there is willing capital, investors will buy a lot of ideas that are out today. I think some companies are changing plans and staying private at a smaller interval than they did. My beef is the same as yours. But if you think that might be an eventuality, why not go ahead and take that cost upfront and build out these controls. I wasn’t pleased to see these either.

Flippen: In their defense, they did identify them and try to fix them before going public, but that was after it had already resulted in a material misstatement in prior years. Again, it feels like this really important aspect of what it means to be an investor, and maybe this is a soapbox that I just get on and it’s the hill to die on. But it feels like a really critical aspect of evaluating a business is knowing that you can trust the numbers that you’re being presented, what management tells you. I hate seeing that because I go back to the first date examples, like being on a date with somebody and not having a clue if anything they told you was true about themselves. But I don’t want to harp on it too much. I know for a lot of investors, that isn’t quite the deal-breaker that it can be for myself and I’m increasingly trying to get over it. But the other big risk that I see personally is, I just wonder about what happens to discount retail. We’ve seen a lot of traditional retailers, their inventory end up on the shelves of discount retailers. So it’s off brands, even the Targets, the Walmarts of the world, or TJMaxx [TJX], Burlington, all of these businesses that make money by going after thrifters and playing into this experience of finding exciting thrills while you’re just treasure hunt, that’s the word I’m looking for. I have to wonder if people don’t like the in-store shopping experience as opposed to online, especially as it comes to discount goods or resold goods. Since the vast majority of these sales happen in person, I worry a little bit about long term what ThredUp is able to gain in terms of market share for this industry.

Sharma: I think it’s a great risk to point out. Either very few companies who do this extremely well, you named one of them, TJMaxx. They’ve got this global group of buyers that’s been together for a long time and they are just really astute at buying out, just close out merchandise of good brand names and they pull people into the stores. This is a big risk for any business that is trying to take a slice of this market. I guess the advantage that they’ve got is they’re pulling a lot of inventory right now from people, from sellers who are cleaning out closets. But as they extend this, again RAAS, so resale as a service and offer it up to other retailers, they increasingly intersect with companies like TJMaxx, who could be a competitive threat in the future as that business grows.

Flippen: A very good point. It’s an interesting business, I’m excited about it. I have to say, I think I’m more generally bullish. When I think about the risks here, I feel less worried than I did when even looking at, oh, not the throughout Poshmark, I feel terrible. We’ve been harping [laughs] on it so much, but I feel better about the write-up that I did about Poshmark. I still think there are a fair number of questions. But personally, I’m interested in this one. I think I’m going to let this one sit as I do most all IPOs, but I like it. I liked it more than I thought I would.

Sharma: Same here, Emily. I’m really thinking that they’re only going to be a few players in this space over time that grow into very persuasive investments, but this could be one of them. The reason is that aggressive market growth that you mentioned and the fact that they have a really great system for taking in the merchandise, for displaying it, for moving that merchandise. I think these advantages, if they can grow them, will play out in the future. There’s only, I think, so much space though, for online resale of used clothing, if it’s not the luxury segment. [laughs] We’re talking here again, as we did at the outset, about an average price point of $17, but so far, they’ve got the niche in this. I will also be following them from quarter-to-quarter. I also feel better about them than I did Poshmark, which has a higher price point, but bigger losses and not as clear a runway to becoming profitable over the long term to me.

Flippen: Completely agreed. Asit, as always, thank you so much for joining me for the conversation.

Sharma: This was really, really fun, Emily. Thanks so much.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say, “Hey,” feel free to shoot us an email at industryfocus@fool.com or tweet at us @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don’t buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I’m Emily Flippen. Thanks for listening and Fool on.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.





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