LightInTheBox Holding Co., Ltd. (LITB) is scheduled for an initial public offering on Thursday, June 6, 2013. Through an IPO priced between $8.50 and $10.50, LITB is looking to raise up to $87.2m, valuing the company at as much as $516m. While the company has seen impressive growth over the past few years, there are serious questions surrounding the sustainability of its competitive advantage.
Company Overview: A China-Based B2C Internet Retailer
LITB is an online retailer focused on selling "lifestyle" products at attractive prices to consumers across the globe. Operating out of and sourcing most of their products from China, LITB prides themselves on being located close to their manufacturers, allowing them to achieve faster time-to-market with a greater variety of products.
In focusing on "lifestyle" products, LITB attempts to differentiate themselves from other major internet retailers by emphasizing product categories where consumers generally value choice or customization. Looking at their website, it's easy to see that wedding dresses and other special-event apparel are one of LITB's main revenue drivers. Through LITB, consumers can order made-to-measure dresses or outfits at a steep discount to traditional retailers.
In addition to apparel, LITB considers their other "core" product categories to be Small Accessories & Gadgets and Home & Garden. Combined, these three categories accounted for 71.7% of total revenue for fiscal year 2012 and 80.3% of total revenue for the first quarter of 2013.
Despite being based in China, the vast majority of LITB's sales come from Europe and North America. However, LITB has seen strong sales growth from South America and "Other Countries": these two categories accounted for just 14% of total sales in 2010, and now account for 25%.
(Source: Company Filings)
Industry Overview: Booming Global E-Commerce Growth
As I outlined in a previous article, the global e-commerce industry is set to grow substantially over the coming years. U.S. e-commerce sales have grown at a compounded rate of 4.6% per quarter since 2000 (source: U.S. Census Bureau), Asia-Pacific e-commerce sales grew by 30% last year and will likely do the same again this year (source: eMarketer), and global e-commerce spending is expected to grow at a compound annual growth rate of at least 15% through 2016 (source: Forrester Research).
Despite this growth, online retail penetration remains low. According to Euromonitor, e-commerce sales as a percentage of total retail sales in the U.S. for 2012 was 28.3% for consumer electronics, 6.9% for apparel, and just 3.9% for home and garden products.
(Source: Product category data from company filings; U.S. Total from U.S. Census Bureau data)
LITB's Competitive Advantage: How Sustainable is it?
As a B2C e-commerce retailer, LITB is competing in a crowded market with some well-established players. LITB attempts to differentiate themselves from the pack based on their apparel-focus and low prices. However, there are numerous questions surrounding the long-term viability of these two advantages.
In 2012, Apparel products accounted for 40% of LITB's revenue. With e-commerce sales currently accounting for 6.9% of total U.S. apparel sales, LITB believes this product category has tremendous upside potential. However, as shown in the above graph, total U.S. e-commerce sales currently account for just 5.5% of total U.S. retail sales, meaning apparel is by no means under-penetrated in terms of internet sales.
It's also worth noting that apparel products are fundamentally different from most other product categories commonly purchased online. While electronics, media, and household goods are often purchased based on their functional use, clothing is often bought based on appearance and fit, two properties that are exponentially more difficult to judge based on pictures on a computer screen.
Zappos, a major online apparel retailer, reports that their customers end up returning 35% of the items they order, with their top-grossing customers actually returning as much as 50% of what they buy. While Zappos has been successful despite this high return volume, they have a generous return policy which likely makes their customers more willing to purchase from them. Zappos offers a 1-year return policy, and pays for all return-shipping charges. LITB, on the other hand, offers a 1-week return policy, and requires the customer to pay for the return-shipping charges. In many cases, the cost to the customer of shipping the product back to China likely negates or even outweighs the potential refund they would receive for doing so.
Another major point differentiation LITB prides itself on is its sourcing and proximity to Chinese manufacturers, which translates to lower prices for consumers. However, it's unclear how long China's manufacturing will remain "cheap." In their prospectus, LITB identifies Chinese labor costs as a major risk they face:
Increases in labor costs or restrictions in the supply of labor in China may materially and adversely affect our business, financial condition and results of operations.
We source our products exclusively from third-party suppliers in China. With the rapid development of the Chinese economy, the cost of labor has risen and may continue to rise. Our results of operations will be materially and adversely affected if the labor costs of our suppliers increase. In addition, even if labor costs do not increase, we and our suppliers may not be able to find a sufficient number of workers to produce the products we offer.
Over the past ten years the average wage level for a Chinese manufacturing worker has grown at a CAGR of 14%, and the Chinese government has vowed to continue raising its minimum wage in attempt to tackle the country's income inequality.
According to a recent study by consulting firm AlixPartners, by 2015 there will be no cost advantage to outsourcing manufacturing to China as opposed to manufacturing in the U.S. While this may not affect LITB as much as other multinationals - as shown above, the majority of their sales currently go to Europe - it certainly illustrates the headwinds they will face going forward in terms of costs of production.
Other Points to Consider before Investing
For investors un-phased by the points above, here are additional issues to consider, both positive and negative:
Viability of Wedding Dress Sales Over the Internet - Consumers are increasingly focused on saving money and getting a bargain. Through LITB, brides-to-be can order made-to-measure wedding dresses at a substantial discount from what they would get through a traditional US retailer. Given the amount of planning and coordination that go into a wedding, will brides really be willing to enter their measurements into a website and wait for a dress to be shipped from China? It's certainly possible, but unfortunately reliable data doesn't seem to exist on this and LITB doesn't break out sales figures specifically for wedding dresses. However, a quick Google search does turn up a number of customers who were extremely pleased with their bride/bridesmaid dress purchases from LITB.
Internet Sales Tax - With the looming Internet sales tax bill in the U.S., it remains to be seen if consumer purchasing habits will shift back towards bricks-and-mortar retailers and away from emerging e-commerce companies.
The Growing Chinese Economy - While the rising wages for Chinese manufacturing labor appears poised to continue its rapid growth, the overall Chinese economy will likely continue to grow at a rapid pace as well. While the cost of providing Chinese-manufactured goods to the U.S. and Europe will rise, it's possible that the financial impact of this could be offset by the growth in sales to Chinese customers. Currently, LITB does not break out their sales volume to China, but rather includes them under the classification "Other Countries."
Foreign Exchange Risk - LITB's parent holding company is registered in the Cayman Islands with their operations headquartered in Hong Kong, their suppliers in mainland China, and the bulk of their sales coming from the U.S. and various European countries. As such, LITB has significant exposure to fluctuations across multiple foreign currency rates.
Prior Chinese IPO Accounting Scandals - In recent history, there have been a number of Chinese IPOs which have later been found to have questionable accounting methods. While there is no evidence to suggest this is the case with LITB, the association alone may be enough to keep certain investors on the sidelines and thus negatively impact the share price.
LightInTheBox has seen impressive growth over the past few years despite operating in an e-commerce industry with numerous well-established "household" names. While they certainly differentiate themselves within the industry, the long-term sustainability of their competitive advantages remains questionable.