Bid on for Its Solid Business Model

Includes: AMZN, BIDZ, NILE
by: Jeffrey Walkenhorst, CFA

In recent months, we established a position in (NASDAQ:BIDZ), which is an online retailer of jewelry that utilizes both an auction format ( and a fixed-price format ( Bidz is another niche franchise Internet company, a description we used in March/April for (UBET), Blue Nile (NASDAQ:NILE), (NASDAQ:STMP), and The (KNOT).

Bidz happens to report 2Q09 results today, 8/10/09, after market close. On Friday, the company actually moved up the reporting date from Wednesday 8/12/09, which is somewhat unusual and could be perceived as a positive sign coming on the heels of Blue Nile's report last Thursday.

Although revenue is down materially amidst the recession, management is focused intently on profitability and leveraging Bidz's variable cost model to support margins. In 1Q09, Bidz delivered an operating margin of 8.1% with earnings of $0.07 per diluted share and guided to a pretax margin of 5.3% (midpoint) with earnings of $0.03-0.05 per share for 2Q09. Consensus 2009 revenue is $129 million (down 38% Y/Y) with earnings per share of $0.29 (versus $0.57 in 2008).

Our long thesis is NOT a call on the quarter, which could look like this: revenue trends still down 40-50% Y/Y on economic weakness and meaningfully lower marketing dollars, yet margins and earnings could be better than expected, providing support to the stock. We'll see -- forecasting is especially difficult at present. Instead, we're focused on the durability and strength of the business model, which we believe warrants a higher valuation.

While shares rallied from recent lows along with the market, the stock remains at the low-end of BIDZ's two-year trading range and currently trade at 12 times 2009E earnings:

We highlight reasons why we believe shares are out of favor, as well as our core thesis and potential positive catalysts on our blog. Let's briefly consider valuation here:

  • As noted above, shares of Bidz are trading at seven times 2008 earnings and 12 times our 2009E earnings of $8.0 million ($0.35 versus consensus of $0.29).
  • Although difficult to foresee improved top-line performance and/or multiple expansion in the current market environment, we believe BIDZ could fairly trade at 15 to 20 times earnings (5% to 7% yield) given the company’s established, difficult-to-replicate, high-ROIC online franchise. Importantly, we believe an informed private market buyer would award a similar valuation.
  • Such a valuation would imply a $5.25 - $7.00 ($6.13 midpoint) fair value today on depressed 2009E earnings. Giving credit for a return to growth at some point and normalized earnings of $12.0 million ($0.50 per share, still below 2007-08 levels) would imply $7.50 - $10.00 per share ($8.75 midpoint).
  • On a relative basis, BIDZ is extremely inexpensive compared to Blue Nile, which trades at 69 times TTM earnings (*pre 2Q09 results for all NILE TTM figures herein) and 50 times consensus 2010E earnings. NILE trades at 39.5 times TTM EBITDA and 2.4 times sales, compared to 4.9 times and 0.55 times for BIDZ, respectively. Further, Blue Nile’s TTM reported operating income of $16 million and 5.5% margin, lower than Bidz’s $19 million and 10.7% margin.
  • BIDZ also trades at a significant discount relative to Amazon (NASDAQ:AMZN), which trades at 56 times TTM earnings and 40 times consensus 2010E earnings, but has a reported TTM operating margin of only 3.8%.
  • We see Blue Nile’s business as less discretionary (please see our May post) than that of Bidz, warranting at least some premium. However, we see no reason why the wide gap should persist over time, particularly if certain Bidz overhangs are removed. We expect NILE’s valuation multiple to compress while BIDZ’s multiple expands.
  • Finally, we have a recent comparable M&A transaction in the online retail space: Amazon’s purchase of Zappos. Amazon management relayed on the company’s earnings call that Zappos has approximately $635 million in 2008A sales with “a small profit”. Amazon’s cash/stock purchase price of $847 million implies a price to sales purchase multiple of 1.33 times. If we awarded the same multiple to Bidz, the implied share price would be $10.46, or 2.67x current levels.

Disclosure: Long BIDZ, EBAY, UBET.