On May 15, 2013 PFSweb (NASDAQ:PFSW) announced that it had entered into a strategic relationship with Tokyo-based transcosmos, inc. (or TCI) and that TCI had concurrently bought 19.99% of the company for $14.7 million. TCI paid $4.57 per share to buy its stake, a 7.5% premium over the May 14th closing price of $4.25 per share.
At the time, PFSweb was coping with the loss of customers that resulted from the company's failure to adequately prepare for the flash sales and heavy volume that took place during the 2011 holiday season and one large customer, Carter's Inc. (NYSE:CRI), deciding to bring its eCommerce business in-house. As a shareholder of PFSweb, I wasn't particularly thrilled about the equity dilution or the concept of strategic relationships. Having witnessed the negotiation and subsequent lack of follow-through of several such agreements, I had minimal expectations of any significant benefit to PFSweb.
The market seemed to feel the same way. By the beginning of July -six weeks later - the shares were trading at about $4 and an investor could have opened a position at a discount of more than 12% from the price paid by TCI.
Who are PFSweb and TCI?
For those unfamiliar with PFSweb, it is:
...a provider of eCommerce and multichannel outsourcing solutions for global consumer brands, online retailers, and technology manufacturers... [providing] a broad range of services, including eCommerce technology, order management, customer care services, financial services, global logistics, and fulfillment services.
PFSweb's presence is largely in North America and Europe. Its customers include Procter & Gamble (NYSE:PG), L'Oreal (OTCPK:LRLCF), LEGO, Columbia Sportswear, Sorel, Carter's, AAFES, Riverbed (NASDAQ:RVBD), Ricoh (OTC:RICOF), Hawker Beechcraft Corp, Roots Canada Ltd., Diageo (NYSE:DEO), BCBGMAXAZRIA, BCBGENERATION and HERVÉ LÉGER BY MAX AZRIA and the US Mint.
PFSweb's revenue is comprised of certain product sales and fees from consulting and e-Commerce services. The mixture of two very different businesses makes it somewhat difficult to analyze the financials. To assist investors, the company provides a non-GAAP measurement called Service Fee Equivalent Revenue. The measurement is defined as service fee revenue plus the gross profit earned on product revenue. Its purpose, according to the company, is to allow:
...client contracts with similar operational support models but different financial models to be combined as if all contracts were being operated on a service fee revenue basis.
Fortunately, the company has only one customer remaining where the model is still based on product sales and is attempting to transition that customer to the fee based model. This will clear up some of the issues with current GAAP reporting and make the financial statements less complex. (However, investors should keep in mind that Service Fee Equivalent financial statements will be necessary for a few more years due to the way companies present historical comparisons in the 10Qs and 10Ks.)
a leading outsourcing provider of call center, business process and digital marketing services based in Tokyo, Japan with operations primarily in Japan, South Korea and China.
Some of the services provided by TCI are similar to those provided by PFSweb, although their geographic coverages are highly complementary and clients do not overlap.
The Past Year
During the past 13 months the shares of PFSweb have more than doubled, reaching a peak of $10.43 in March of this year. While part of that move can be attributed to expectations from its TCI relationship, the company also began to demonstrate improvements in its basic business. (The basic business improvements will be covered in a future article). I had been quite concerned that it would take a relatively long time for the TCI strategic relationship to bear fruit. However, I became cautiously optimistic when CEO Mike Willoughby disclosed some details about the efforts put forth by TCI on last year's second quarter conference call:
In July , our executive team traveled to China and Japan to make a series of well-attended presentations with the transcosmos' team, to their executives on how to expand their eCommerce presence in United States, Canada and in Western Europe from their base in Asia. transcosmos team put on a full-court press to promote the seminars, issuing advertisements in national newspapers. The level of effort transcosmos put into making our trip a success is indicative of their commitment to making this relationships succeed. transcosmos has made it clear, both in words and actions, that it believes in PFSweb's value proposition, and that it will allow -- allocate the necessary resources to help us grow our business. We're already beginning to see new business opportunity arising from this strategic relationship.
One part of PFSweb's strategy with TCI is to provide PFSweb services to TCI's clients looking to gain access to North American and European markets. (PFSweb has already launched a site for one small Japanese company in the US earlier this year.) The second part of its strategy is to use transcosmos' experience, resources and expertise to provide access to Asian markets for PFSweb's current clients. Willoughby also broadly discussed the magnitude of that opportunity.
The McKinsey Global Institute estimates online sales in China could reach $650 billion by 2020, compared to the $120 billion in 2011. Part of what will drive that growth is access to broadband. Only 30% of Chinese households currently have high-speed Internet. Growth in broadband adoption and the accompanying expansion of eCommerce in China will benefit both U.S. clients looking to expand into China, as well as Chinese brands that want to reach a wider audience in the country.
In addition, we also see tremendous opportunities to work with emerging Chinese brands that are looking to expand their presence outside of China. To take advantage of the opportunities in China, we are working on optimizing our End2End solution to meet the needs of the brands operating in that market.
Entering the Asian markets would have been nearly impossible for PFSweb to do on its own at this stage of the company's development. (And yes, I realize the company has been around for a rather long time, but it is still not yet to the stage where it has the size or breadth of resources to undertake this type of expansion.) The financial resources and expertise needed were simply unavailable and the transcosmos relationship makes it possible.
The Current Situation
It is now more than 15 months since the agreement and more than a year since that trip and presentation. That's an incredibly long period of time for an Internet company. This month Willoughby discussed TCI and said that they were working "effectively with them." He also stated that many of the opportunities were smaller deals, similar to airweave. Airweave was the first deal resulting from the TCI relationship and went live in January of this year. However, he also acknowledged that it was progressing slower than originally expected.
I think we have a limited ability to engage on those small opportunities with an end-to-end model but we have better opportunity to engage on those small to mid-size opportunities once we've evolved the model to include other platforms and additional professional services.
So that may be moving out a little bit slower than we anticipated as we kind of catch up to the nature of the opportunities as we evolve the business model. And as we complete some of these acquisitions that we're targeting, we probably have more to say about how that affects our ability to engage with transcosmos on the small opportunities coming in to our US and European pipeline.
We have substantially completed the work to deploy our technology solution into China, and that's in conjunction with their call center operation and their fulfillment network that they already have in China. So we are now moving into the cycle of actively marketing that solution to our current clients and to prospective clients.
It would be at this point, a 2015 launch for sure that leverages that solution, just given the timing that we have. But the solution is now at the point where we're ready to sell new clients and begin onboard new clients. And so once again, we expect to have more to say about progress on what we call the Project Pacific pipeline in the coming quarters.
The above statement is loaded with opportunity, challenges and disappointment. Not only does Willoughby discuss the need to evolve the platform, but also the need to make acquisitions, to better address the Chinese market opportunity. Both present challenges, especially when those acquisitions are providers of professional services. These are the types of acquisitions where the asset being acquired is people, people that need to adapt to a new culture and people who can simply walk out the door.
The statement that the opportunity is now a 2015 event - and no general time frame for when in 2015 - is a disappointment. I also suspect that the gradual realization that this market opportunity will take far more time and effort to monetize than originally thought is one of the major reasons that the shares have fallen more than 17% from their 52 week high.
There are reasons to invest in PFSweb, although most of those are due to its US, Canadian and European business opportunities. These will be addressed in more detail in a future article, but the two most significant reasons are the US Mint website going live later this year and the fact that the loss of Carter's (taking its operations in-house) and the defection of other customers due to the failure of PFSweb to perform in 2011 will finally be in the company's rear-view mirror. Once those events have been "lapped", comparisons to prior quarters should show improving growth.
There are also reasons to be cautious. PFSweb has stated that it is looking for acquisitions. These acquisitions are often more difficult to accomplish than expected, and CFO Tom Madden had this to say on the matter:
So from a financial standpoint, we are looking for these acquisition opportunities to be at least neutral and hopefully accretive in the short-term to us. And we believe that as we both had [ph] potential candidates for this, that we'll be able to achieve that objective.
At some point late this year or early next year the market may once again begin to factor in the market opportunity in Asia by looking ahead to the Project Pacific growth opportunities available to PFSweb from its TCI relationship. Penetrating these markets with support from transcosmos should be considered as a positive by investors with longer term investing horizons.
And for those unwilling to wait, they might wish to consider the new buy rating issued following the company's conference call. B. Riley initiated coverage with a buy rating and a price target of $12.
Disclosure: The author is long PFSW.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.