Not So Deep Dive: Farfetch Revisited
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Show Notes
(Ryan) What they do: Farfetch is a luxury e-commerce platform that basically lets brands and consumers distribute their products to customers around the globe and takes a 30% commission to do so. There are essentially 3 elements to the business. 1.) The Farfetch Marketplace 2.) Farfetch Platform Solutions (FPS), and 3.) Farfetch’s own retail brands.
On the Farfetch Marketplace, there are more than 1,400 sellers and 3,500 luxury brands. And one big selling point for brands to join the platform is that Farfetch allows them to maintain control over their own brand. So they get to choose what they sell, how they sell it, and determine the price. Saw someone describe it as essentially a shop within a shop.
The FPS segment was a little difficult to get a grasp on. The way Farfetch describes it is that this is their white-label (product or service produced by one company that other companies rebrand to make it appear as if they had made it) enterprise offering. This solution helps luxury brands, optimize their inventory, activate global payments, helps with digital marketing and customer service, and allows brands to easily tap into Farfetch’s digital distribution points. And one of those big ones is Farfetch’s partnership with Alibaba. Farfetch has a flagship store on Alibaba’s Tmall luxury platform. It isn’t clear exactly how FPS derives revenue.
The 3rd segment of the business is their owned brands. These include Browns (a British fashion and luxury goods retailer) and StadiumGoods (a premium sneaker retailer). And then there’s this additional component called New Guards which does the manufacturing and distribution for several brands like Off Whites and others which Brett will talk about later. Altogether, these give Farfetch some exclusive items as well as stores to experiment with.
(Ryan) History: The idea was born in 2007, but the Farfetch website went live in 2008. The founder and still CEO is a Portuguese entrepreneur named Jose Neves, and when the company first launched there were 5 people on the team. The company is headquartered in London but has branches everywhere.
Acquired Browns in 2015, went public in 2018, and in 2019 acquired both Stadium Goods and New Guards. Announced a partnership with Alibaba and Richemont in 2020, which gave Farfetch access to Tmall. But allowed Alibaba and Richemont to acquire a fairly sizeable stake. And then in 2021, New Guards acquired a 60% stake in a company called Palm Angels (another luxury fashion brand). And lastly, 2 months ago, they acquired a company called Wanna (a virtual try-on technology company).
(Brett) Industry/Landscape/Competition:
The luxury goods market valued at $243 billion in 2022, is expected to steadily grow each year
Farfetch estimates Chinese demand will be $100 billion a year by 2025. Expects around 70% of goods will still be bought in physical stores in 2025. That means solid tens of billions in GMV TAM to go after by then.
Competitors: DTC offerings (not ones using FPS), website builders, physical stores, other websites (Forward.com an example), Shopbop, Yoox Group, MyTheresea, and a few others. Amazon’s Luxury push is also a competitor, but likely not a threat.
There is some evidence that Farfetch has the best tech/brand in the space. Richemont was in discussions to let Farfetch power Net-a-Porter (a competing marketplace) with FPS and bring Richemont’s brands onto the marketplace. Will be interesting to watch this develop.
(Brett) Management and Ownership:
founder/CEO/Chairman: Jose Neves. Started the company in 2008. Been involved in the luxury business all his working life it looks like. 47 years old
Important BoD members:
J. Michael Evans, President of Alibaba since 2015 (don’t think this means CEO).
Victor Luis, ex-CEO at Tapestry (Coach, Kate Spade)
Gillian Tans, ex-CEO of Booking.com
Solid BoD all around, however, this is all about Neves given his control
CTO: Cipriano Sousa. Been with Farfetch since the beginning and leads all the technology efforts. Probably the second most important executive
Ownership:
Neves owns approximately 14% of shares outstanding but has 70%+ voting power given the Class B stock. He has a stock plan that will pay him a lot of shares if the price reaches $75 and then with hurdles to $250
Morgan Stanley 11% of shares, Ballie Gifford 9% of shares, Lone Pine Capital 5% of shares
T Rowe. Price owned a huge chunk but sold 20 million shares recently which could have driven down the price
Alibaba and Richemont both own convertible notes at $33 strike prices. Does this provide good incentives for creating shareholder value?
(Brett) Valuation:
Market cap of $3.42 billion, ticker FTCH
EV closer to $3 billion after considering borrowings and cash (however, lots of tricky stuff on the balance sheet).
EV/s of 1.3
EV/GP of 2.92
Looks cheap if they can get to consistent positive cash flow (they are not right now)
Total potentially dilutive securities of 472 million vs. 381 million currently. The difference is driven by options, RSUs, convertibles, and Farfetch China. Expect share count to compound at 5% a year
(Ryan) Earnings: This quarter really sucked.
Gross Merchandise Value (GMV) for the quarter was $931M, up 1.7% YoY
Revenue outgrew GMV slightly up 6% YoY to ~$515M (That might sound like a larger than 30% take-rate which it is. Keep in mind only about 72% of their overall GMV comes from 3rd parties. On those they report a 32% take rate.)
Their total active consumers reached 3.8M this Q, up 17% YoY
The average order value increased from $618 to $632
Now for the bad: They closed their operations in Russia which was their 3rd largest market (represented 6% of GMV)
And China is their 2nd largest market. A lot of their goods are shipped from Europe to China, but with China’s zero-covid policy, much of the incoming commerce just wasn’t allowed.
These 2 factors forced Farfetch to adjust its full-year outlook from ~30% GMV growth to 5-10%.
They had -$341M in FCF for the quarter
(Ryan) Balance sheet and liquidity: One of the more difficult balance sheets I’ve ever looked at.
Let’s start with relevant assets:
There are pretty much 3 items worth paying attention to
$940M in cash and cash equivalents
$99M in short-term investments
And $300M in inventories
Liabilities: The bulk of their debt is not due for at least 3 years.
Over the last two years, Farfetch has issued several rounds of convertible notes at various interest rates. They categorize these as “borrowings” on the balance sheet but there are also associated “derivative financial liabilities” that they have as well.
As of Q1, Farfetch reported that it has $530M in non-current borrowings and $330M in derivative financial liabilities. (I believe there are also currency hedges in there as well)
They also have entered into several put and call option contracts with various companies including Alibaba, Richemont, Chalhoub Group, and some other smaller ones. These contracts allow the counterparties to increase their stakes in Farfetch at predetermined dates/prices. These get recorded as liabilities based on their own calculation of fair value the day of.
As Farfetch’s stock has dropped, its recorded put and call option liabilities have declined as well.
As of Q1, they had almost $400M in put and call option liabilities.
The last thing I will add is that they have another line item called “other financial liabilities”. I keyworded this and did not see a single definition of what it is in all 282 pages of their annual report.
And during the 3 months between January 1st and March 31st, the number jumped from $13.3M to $345M
Anecdotal Evidence:
(Ryan) The website looks good. I don’t think I’d have a hard time buying items digitally.
(Brett) Hard to tell, but the app seems fine. Didn’t like how they had a discount pop-up. Having a loyalty program and agents for special clients seems smart. E-concession model also seems fine in creating luxury appeal, but still feels like something is off for how a Louis Vuitton, etc. would want to sell on the internet.
Future growth opportunities:
(Ryan) Beauty. In April, Farfetch launched its beauty category. I think it’s a pretty logical next step. This will encourage more brands and customers to join the platform. So far they seem to have gotten pretty good buy-in from existing brands including Charlotte Tilbury, Gucci Fragrances, and Dr. Barbara Sturm. This also provides another channel to help drive advertising revenue for Farfetch.
(Brett) New Guards Group. I like this strategy a lot. This subsidiary owns a bunch of different brands like Off-White and Palm Angels (no idea how popular any are) that can provide some exclusivity to the Farfetch marketplace. Dare I say it kickstarts the momentum for a flywheel?
Highlights and lowlights:
(Ryan) Highlights: All their competitors seem to have purchased stakes in Farfetch. They seem to be the leader in their respective industry. And they have secular tailwinds at their back. Lowlights: I don’t understand their derivatives book. I find it weird that they made a $200M investment in Neiman Marcus Group. It feels like they had to do that in order to get them to join the marketplace.
(Brett) Highlights: Some emerging competitive advantages (network effect, brand), highly profitable industry that has shown decades-long secular tailwind, been the clear winner so far and is aligning with industry leaders. Lowlights: Part of the strategy seems messy and poorly planned, China exposure creates uncertainty, and no confidence in management’s capital allocation. We like to ask the question: How confident are we that management will act rationally with the cash that is given to them? I’m not sure the answer is positive for Farfetch.
Bull Case:
(Ryan) China comes back on soon. They are able to get back to double-digit GMV growth (historically, they’ve targeted 30%), and they reach double-digit cash flow margins. That will be a good investment.
(Brett) 10% revenue per share growth and 10% FCF margins get to a FCF/s of $0.78 in five years. At a 20x multiple that is a share price of $15.60. The current price is $9.13. These seem like doable numbers.
Bear Case:
(Ryan) They continue to burn through their cash pile and have to raise more money. A whole bunch of dilution already coming down the pipe, and they aren’t really in a great spot to get good terms on any financing. I think a realistic scenario is they get acquired by someone (possibly Alibaba).
(Brett) Are they investing in too many things with no sense of ROI? Beauty, Neiman Marcus, AR, China JV, discussions with Richemont over FPS, New Guards roll-up strategy, fulfillment. How do you balance all these things? Also…dilution
Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.