CafePress: 20% Growth Trading For Book Value
Overview
CafePress, Inc. (NASDAQ:PRSS) is an online manufacturer and retailer of custom printed products, such as coffee mugs, t-shirts, stickers, stationery, home accent pieces and more. Users can login to CafePress.com and actually submit their own designs for virtually anything, have CafePress produce the products, and sell them in a "store" on the website. Users include individuals with creative ideas they'd like to monetize as well as licensed content from individuals or other companies who need print-on-demand capabilities. The company gains and retains customers via its easy to use platform and the ability provided to users to access a large manufacturing base with no investment on their part. CafePress leverages its manufacturing capabilities in order to produce and sell its customers' goods more efficiently.
Segments and Operating Metrics
The company operates in two broad segments, US and International based upon the destination for the final product for an order. As you can see in this table from the most recent 10-Q, the International segment is a relatively small piece of the entire business at roughly 10.5% of the business through the first three quarters of 2012. In addition, you can see that the International segment is actually contracting in terms of total revenue. This is somewhat troubling except that the International piece is so small and that the US portion is growing so quickly, it dwarfs the small contraction in International revenue. Looking at the table below, from the 10-Q, we can see that, for the nine months ended in September, YoY total revenue growth was 23.2%, International revenue contracted 3.8% and US revenue grew a staggering 27.4%. Note: these two tables are recreated from the 10-Q as the 10-Q tables weren't legible.
Nine Months Ended September 30 | ||
2012 | 2011 | |
United States | $116,762 | $91,623 |
International | $13,775 | $14,322 |
Total | $130,537 | $105,945 |
Components of this revenue growth can be seen in the following table from the 10-Q, summarizing how the revenue is derived.
Nine Months Ended September 30 | ||
2012 | 2011 | |
Key Operating Metrics: | ||
Total Customers | 1,987,019 | 1,673,059 |
Total Number of Orders | 2,558,278 | 2,144,179 |
Average Order Size | $51 | $50 |
What we see is two very encouraging trends for future prospects. First, total customers rose 18.8% YoY in the nine months ended in September. This obviously bodes well for the company as its extensive marketing expenditures are clearly paying off. Second, the average order size rose roughly 2% over 2011. While this is not a huge gain by any means, it shows that customers are spending more when they do buy something at CafePress. Obviously, increasing order size and increasing gross orders are a dream for a manufacturer/retailer and that is exactly the situation we find CafePress in at present.
Acquisitions
CafePress has spent a comparatively enormous amount of money over the past two years acquiring complementary businesses to its core lines. While I am generally not a big fan of growth by acquisition, I believe the acquisitions that the company has made are well reasoned and have reasonable valuations attached to them. While this is expensive in the short term, long term CafePress will strengthen its family of brands with the largely bolt-on companies it has acquired.
In October of 2011, CafePress acquired L&S Retail Ventures, Inc. for an initial payment of $4.5 million and an additional performance-based contingent of up to $5.0 million, subject to certain revenue and operating income targets for three years. This company is an online provider of invitations, announcements and various other stationery products. It is my personal belief that CafePress is lagging rival VistaPrint (VPRT) in this area, and I'm speculating that this was the reasoning for this acquisition. VistaPrint is a leader in custom paper products such as business cards and other stationery, and CafePress is pushing into that arena with the L&S acquisition. I believe this will prove to be prescient as CafePress can offer this service to its business customers and small business owners, in addition to the great work the company already performs on its other product lines.
In April of last year, CafePress acquired Logo'd Softwear, Inc. for $8.3 million in initial cash and stock and a potential $6.4 million in additional, performance based payments, subject to revenue and operating metrics for a period of three years. With this acquisition, CafePress eliminated a key competitor in the apparel line of its business. In addition, this acquisition provided additional print on demand manufacturing capacity in the Northeast United States, which CafePress did not possess prior to this acquisition. Again, I think this was a great move strategically since Logo'd was already a successful brand, had manufacturing capabilities in a region of the country where CafePress didn't exist physically, and eliminated some competition simultaneously.
Finally, in October of last year, CafePress acquired EZ Prints, Inc., an e-commerce platform that is core to CafePress's brand and operations, for $30 million. Additionally, CafePress is on the hook for a potential total of $10 million of performance-based payments, subject to operating metrics. This is an enormous acquisition for a company with a market capitalization of just under $100 million. However, EZ Prints is a smaller version of CafePress, offering custom water bottles, photo frames, phone covers and virtually anything else you can think of. This is a great acquisition for CafePress as EZ Prints is a huge bolt-on company that already performs many of the same services as the parent company and has the advantage of being known amongst customers and businesses. This was a stroke of brilliance from CafePress management as EZ Prints was a direct competitor to CafePress's core business of print on demand and now, EZ Prints is a huge asset instead. Strategically, I love this acquisition.
Flash Deals
Flash deals, as they are described by management, are basically gift certificates that are sold either through company promotions or deal websites like Groupon (GRPN). The company recognizes deferred revenue for these certificates and then recognizes actual revenue when the certificate is used. This is a great marketing tool for CafePress and is made even better because of the "breakage" that occurs. Breakage is when a voucher or certificate goes unredeemed and can therefore be recognized as "free" revenue. This essentially occurs when a customer purchases a voucher or gift card and then does not redeem it for products at CafePress before the deal expires, producing high-margin revenue for the company. For the nine months ended in September of last year, breakage revenue totaled $3.7 million, of which only $1.3 million was paid out as sales commissions. This left a total of approximately $2.4 million of operating profit just from the gift certificate/voucher programs CafePress has in place.
I mention this for two reasons: 1) $2.4 million of operating profit is enormous for CafePress as it represents over 2% of the entire value of the firm and 2) this segment is growing rapidly and could prove to be a source of profitability in the future. For the nine months ended in September 2012, breakage revenue rose YoY 131%. If CafePress continues to exponentially grow its gift card/voucher programs, it could prove to be worth a significant amount per share in the future.
Risk Factors
Although I am painting a bullish picture of CafePress, I would be remiss if I didn't discuss the many risk factors that face this company. CafePress is, at the core, a company that provides a nearly commoditized service in that basically any print shop is a competitor in one way or another. The reason I am bullish on CafePress in the face of its myriad competitors is that its platform is very easy to use and it provides quick, accurate manufacturing and shipping of products. In addition, it provides a virtual one stop shop where consumers and businesses can print virtually anything with their kids' pictures or their business's logo on it. In addition, management has shown a penchant for acquiring complementary businesses that I trust will prove to be long-term accretive in both strategic and financial terms. I believe this is a very powerful platform and that its customer base and average order sizes will continue to grow.
Seasonality is a big issue with CafePress as the company does a disproportional amount of its business, like a lot of retailers, in the last quarter of the year. As CafePress is a manufacturer as well, this presents the problem of having enough raw material on hand during this period as well as the labor and factory capacity to produce what customers order without depleting working capital. Of course, the opposite problem occurs in the first quarter as it is dwarfed in size by the last quarter of the year. This means that CafePress must ramp production capacity into the fourth quarter and then rapidly decrease it in order to meet the trough demand for its product in the first quarter. There are frictional costs associated with constantly changing production capacity such as idle labor hours, vastly different raw material needs and physical space needed to produce products. This is a risk CafePress will probably always face and its ability to meet this surging and collapsing demand will be a challenge it must face going forward.
CafePress is also hostage to content acquisition costs. In a lot of cases, the customers themselves are providing content for free, such as their own designs or photos they'd like to print. However, CafePress does license content from certain providers and, as Netflix (NFLX) or Amazon (AMZN) can tell you, content acquisition is expensive. While I don't see this as a huge risk to CafePress in the future, if management decides to license more content in the future, it could become a large expenditure.
In reference to the acquisitions described above, the risk exists that the acquisitions prove to be ill-timed, expensive or strategically incompatible with the rest of the company. As I said in my acquisitions commentary, I like the companies CafePress has acquired and I think management is selective and thoughtful with the company's acquisition targets. However, there is always the risk that I am wrong and that these acquisitions will serve only to waste shareholder money and distract management from the parent company's operations.
Another risk factor CafePress faces with respect to its customer base is its ability to increase brand awareness and attract new customers. CafePress spent $12.4 million on sales and marketing expenses in the nine months ended in September of last year, or roughly 28.5% of total revenue. This reflects management's desire to grab market share and continue to grow its customer base for the long term at the expense of short-term earnings. This is a classic, high growth company strategy and it has been proven to work time and again. In fact, Amazon is still doing this and it is a $120 billion company. While I agree that CafePress should be spending in order to market itself and attract new customers, I recognize that the risk exists that some or all of these expenditures will be for naught and the business will decline. Obviously, I don't expect this will happen, but if management can't attract new customers at a reasonable cost, shareholders will suffer substantially. Management doesn't break out its average cost to acquire a new customer but since new customers are increasing at a rapid rate and sales and marketing expenditures are doing the same, we can only assume that the effort is working, at least to a degree.
One risk factor that is out of management's control is shipping costs. With shipping costs slated to rise in 2013, shipping costs as a percentage of revenue for CafePress is likely to climb. If prices increase moderately, these increases can likely be passed on to customers, but if it gets out of hand, CafePress may be forced to take decreased margins, which would be disastrous for net income. As I expect oil prices to moderate in 2013 and requisite shipping cost increases to do the same, I don't think this is an outsized risk for management right now. However, if an exogenous shock occurs in the oil markets, all bets are off as the rising price of oil would ostensibly raise the cost of shipping for CafePress, further impacting margins.
CafePress has a very short history as a public company, having been public for less than a year, and this may also turn off some institutional investors. The lack of years' worth of financial data and management commentary, combined with the "busted IPO" moniker PRSS currently sports may serve to scare off institutional investors.
Lastly, a somewhat unique risk factor for any small company, including CafePress, is that it is now classified as an "emerging growth company" under the
Jumpstart Our Business Startups Act (2012). I mention this only as a side note insomuch as it affects the amount of external reporting the company is obligated to produce. Under the JOBS act, the company:"May choose to take advantage of exemptions from various reporting requirements afforded to "emerging growth companies," including, but not limited to, exemptions from compliance with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes Oxley Act, exemptions from certain of the disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved."
This reduced external reporting may or may not serve to turn off certain institutional investors so I felt like it should be mentioned, even if the company elects not to use the exemption granted.
Competition
The competitive landscape for CafePress is vast. This is not a company that has innovated its way into a new product niche or industry. Instead, CafePress operates in a highly competitive, largely commoditized environment where differentiation can be challenging. Competitors include traditional printing businesses, e-commerce companies in general and online retailers like Amazon and eBay (EBAY), catalog or mail-order retailers as well as physical retailers of personalized merchandise and many online, direct competitors.
I am not overly concerned about mom-and-pop printing shops challenging CafePress in terms of personalized merchandise. I don't feel that the fragmented network of one-off printing shops can match what CafePress can do with its manufacturing and procurement capacity. However, it is possible that CafePress does lose customers to neighborhood print shops and this is a series of competitors to be aware of if you are going to own the shares.
Amazon and eBay should be considered direct competitors to CafePress's business model and sizeable threats indeed. Obviously, neither is in the print on demand business, but they are both avenues for someone with personalized goods to market them to the entire world. This is core to CafePress and is a real risk to its long-term sustainability. CafePress must meet the challenge and differentiate in order not to be cast into oblivion by its much larger competitors.
Lastly, online providers of unique merchandise such as Etsy, CustomInk, Spreadshirt, Threadless, Zazzle, Shutterfly and Vistaprint are core competitors to CafePress. Based on my research, none of these competitors has the wide range of products and services available that CafePress possesses. While these competitors are worthy foes in their specific arenas, I don't believe any of them can challenge CafePress one on one as the competitors simply don't possess the wide array of products and services available that CafePress does, coupled with its immense manufacturing and procurement capabilities. For this reason, I believe CafePress's competitive strength is shown here as it is the largest and most diverse in its industry.
However, even if that is true, competitors in certain industries can bring pricing pressures on both the revenue and cost sides of the business. If content is being bid up because multiple retailers want access to it or one of CafePress's competitors is willing to sacrifice margin, PRSS shareholders will suffer as a result. In addition, just because I view CafePress's diversity as being a competitive advantage, nothing is stopping one of its competitors from dominating each niche and nickel-and-diming CafePress into operating losses. This is a risk PRSS shareholders must take on and I believe the strength of the business and the strategic takeovers management has performed over the past couple of years serve to buttress CafePress's position as a powerhouse in this industry.
Valuation
CafePress went public in April of last year at an opening price of $19.00 per share. The stock subsequently rallied north of $22 and has since cratered to trade in the $5.60 range. This epic wealth destruction has occurred on the back of some awful earnings misses, and analyst estimates have been slashed as a result. Let me start by saying I don't think PRSS is worth $19.00 per share currently, or at any point in the near future for that matter. However, the selloff to below $6 is overdone and we are still dealing with a profitable company that is growing rapidly. However, the stock is being priced as though CafePress will never grow again, and I believe it is this inefficiency that ambitious investors can capitalize on. In addition, it looks like shares have been forming a base around book value, which could serve to limit investor losses from here.
At current prices of around $5.60 per share, CafePress has a market capitalization of about $96 million. Nearly all of this, $5.21, is book value, giving PRSS a price to book ratio of just 1.08. In addition, the enterprise value of PRSS is currently only $44 million, reflecting the large cash and equivalents position management has built. Given the $44 million EV, the EV/EBITDA ratio is currently only 2.73. This is a ridiculously low valuation for a company that is growing the top line by 20%+ per year and is investing in the future the way CafePress is. In addition to this extremely cheap valuation, PRSS has a great liquidity position with a current ratio of 2.5.
These valuation metrics have the makings of a potentially great investment for individuals and institutions; however, I believe CafePress's valuation has become so cheap that competitors will now look at acquiring some or all of CafePress common stock. Given that management has made growth and investing in the future of the business by acquiring strategically desirable competitors, I believe larger firms will see the value that could be unlocked in owning the entire company. Make no mistake, this value is probably at least a couple of years away, but I believe long-term holders of PRSS will be handsomely rewarded, even if CafePress isn't acquired outright. Given also that insiders still own 30% of the common stock, management is far more motivated to unlock such value than most companies.
Let's now take a look at what CafePress might actually be worth, given the arguments I've laid out. First, book value is currently $5.21 per share, making up nearly the entirety of the value of the company. Recall that EV is only $44 million, making CafePress a very attractive target for a potential acquirer. Lastly, an acquirer could recoup their entire investment in CafePress in just a few years on an EBITDA basis, even if a significant premium to the current stock price is paid.
We are going to attempt to value PRSS using the Abnormal Earnings model in which a discount rate is used to "tax" shareholders' equity. This means that if management isn't an effective steward of the company's equity assets, it will be assigned a negative Abnormal Earnings number, depleting the present value of the company. This tactic is akin to the Economic Value Added model and follows the same line of thinking.
A couple of notes on the analysis: 1) 2012 and 2013 earnings numbers, as well as the next five years' growth rate of 21% are from Yahoo! Finance analyst compilations, 2) the discount rate I chose of 11% is sufficiently high enough to cover the inherent risk of owning a micro-cap stock and provide a fair return for your capital, 3) we are assuming no dividends will be paid in the next five years and lastly, and 4) the long-term growth rate is 7%, which is solely my number. You may debate the efficacy of some or all of my assumptions but any DCF-type analysis is subject to conjecture as estimates must be made.
2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |
Earnings Forecast | |||||||
Reported earnings per share | $0.41 | $0.46 | $0.56 | $0.67 | $0.81 | $0.99 | |
x(1+Forecasted earnings growth) | 12.20% | 21.00% | 21.00% | 21.00% | 21.00% | 21.00% | |
=Forecasted earnings per share | $0.46 | $0.56 | $0.67 | $0.81 | $0.99 | $1.19 | |
Equity Book Value Forecasts | |||||||
Equity book value at beginning of year | $5.21 | $5.67 | $6.23 | $6.90 | $7.72 | $8.70 | |
Earnings per share | $0.46 | $0.56 | $0.67 | $0.81 | $0.99 | $1.19 | |
-Dividends per share | $0.00 | $0.00 | $0.00 | $0.00 | $0.00 | $0.00 | $0.00 |
=Equity book value at end of year | $5.21 | $5.67 | $6.23 | $6.90 | $7.72 | $8.70 | $9.89 |
Abnormal earnings | |||||||
Equity book value at begin of year | $5.21 | $5.67 | $6.23 | $6.90 | $7.72 | $8.70 | |
x Equity cost of capital | 11.00% | 11.00% | 11.00% | 11.00% | 11.00% | 11.00% | 11.00% |
=Normal earnings | $0.57 | $0.62 | $0.68 | $0.76 | $0.85 | $0.96 | |
Forecasted EPS | $0.46 | $0.56 | $0.67 | $0.81 | $0.99 | $1.19 | |
-Normal earnings | $0.57 | $0.62 | $0.68 | $0.76 | $0.85 | $0.96 | |
=Abnormal earnings | -$0.11 | -$0.07 | -$0.01 | $0.06 | $0.14 | $0.24 | |
Valuation | |||||||
Future abnormal earnings | -$0.11 | -$0.07 | -$0.01 | $0.06 | $0.14 | $0.24 | |
x discount factor (11%) | 0.901 | 0.812 | 0.731 | 0.659 | 0.593 | 0.535 | |
=Abnormal earnings disc to present | -$0.10 | -$0.05 | -$0.01 | $0.04 | $0.08 | $0.13 | |
Abnormal earnings in year +6 | $0.24 | ||||||
Assumed long-term growth rate | 7.00% | ||||||
Value of terminal year | $5.90 | ||||||
Estimated share price | |||||||
Sum of discounted AE over horizon | -$0.05 | ||||||
+PV of terminal year AE | $3.15 | ||||||
=PV of all AE | $3.11 | ||||||
+Current equity book value | $5.21 | ||||||
=Estimated current share price | $8.32 |
The most glaring thing that stands out to me is that, given my assumptions, PRSS won't be producing any economic value until possibly two or three years from now. This is of course less than a certainty, but the point stands that a long position in PRSS now is a long-term position; I am not expecting PRSS to rocket to $10 next year, barring a takeover offer. What we can see is that when the abnormal earnings (or economic value added) values are discounted to the present day using our 11% discount rate, it sums to -$0.05. This is clearly not what we typically look for in an investment, but the important thing is EVA starts to ramp up in 2016 and beyond. As I said, we are looking at a long-term position here in PRSS.
Although cumulative abnormal earnings are essentially worthless in my model, the important thing is that after the model ends, the perpetuity of earnings for PRSS is worth about $3 per share. Couple this with the robust current book value of PRSS and you have a current fair value north of $8. What my model is saying is that you can profitably purchase PRSS shares currently for any price less than $8.32 and expect to have an excellent chance at a positive return over the long term. Given that shares currently trade 33% below that price, it makes CafePress look like quite the compelling value.
CafePress's current TTM PE ratio is about 14. Extrapolating this out to the final year of my model, 2018, we see that a multiple of 14 (which is quite reasonable for a small, fast growing company) times the earnings estimate of $1.19 would suggest a price of $16.66, more than triple current prices. This example doesn't even consider that once CafePress becomes consistently profitable, ostensibly after management slows the expensive investments in the future, the multiple could expand, creating even greater potential returns.
Another situation that could help increase EPS in the future is the fact that CafePress's long-lived assets (PP&E) have already been depreciated from a purchase value of $48.81 million to their current carrying value of only $16.68 million. Assuming these assets don't become completely worthless, which seems like a stretch, depreciation on these assets should slow down significantly in the future. This will serve to increase EPS as the depreciation component will no longer affect it.
One huge risk factor that reared its ugly head last quarter for CafePress is declining gross margin. Gross margin slipped from 43% of net revenue to 41%. In dollar terms, had GM percentage held steady, CafePress would have received roughly $871,000 in additional GM dollars. While this is certainly not a good thing, I don't think this should necessarily sound the alarm that PRSS is a declining business. Many businesses endure GM% declines only to see it rebound later when supply chain issues are resolved, new suppliers are found, and so on. If we see many quarters of declining gross margins, it will certainly be cause for concern, but I do not believe we are there yet. Management explained the gross margin percentage drop as follows (from the 10-Q):
"Within cost of net revenues, content royalty expense decreased by 0.8 percentage points due to an increase in sales of products with lower royalty rates. This was offset by a collective increase in materials, shipping, labor and fixed overhead costs as a percentage of net revenues by 2.5 percentage points due to promotional pricing and changes in the product mix."
The key question here is whether you believe the issues pointed out by management are transitory or structural. If you believe they are structural issues, you should stay away from CafePress because structural cost issues can sink even a great business. If, however, you believe that the cost pressures are transitory, there is room for CafePress to deal with those issues and once again raise and maintain its gross margin percentage. Coupling rapid revenue growth with increasing gross margins is an investor's dream and if CafePress management can accomplish this, which I believe they can, investors will be generously rewarded.
Conclusion
We have seen many reasons why I believe PRSS shares are grossly undervalued at present. However, many risks persist for shareholders, as I have described above. Given the attractive EV/EBITDA valuation of less than 3 and the 30% insider ownership in the stock married with the price to book ratio of just over 1, I believe the downside risks are extremely minimal at these levels. In addition, earnings are forecast to grow at double digit rates for the next several years, meaning that PRSS could be earning well over $1.00 per share in the next couple of years. This, combined with its market multiple of 14, could mean a triple in PRSS shares for patient shareholders. I think we are looking at a situation where there is maybe $1 per share of downside and a potential $10-12 of upside if management can execute.
Disclosure: I am long PRSS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (13)
As an independent designer and operator of a number of Cafepress "stores" I can tell you that last Christmas was my best Christmas since 2008. My personal numbers were greatly helped by Cafepress' move into household items, such as shower curtains.
Secondly, you mention but underestimate how ultra-competiitve space the "custom products" space is. There are dozens of smaller competitors, and new ones all the time springing up all the time, competing for same customers and compressing margins. POD/custom products may be a commodity but there are lots of little niches for competitors to define and win. Over time growth may get harder for Cafe Press.
This technology change is lowering the barriers to entry to PRSS's competitors. Small printers, small art communities, ringtone sale businesses, online dictionaries, etc can all move into the "custom products" space with ease and probably will over the next few years. Many of these "small fry" might aim to operate on low margins and build some product revenues and hope to get bought out. This will put the squeeze Cafe Press and on existing Cafe Press competitors like Zazzle, CustomInk, Spreadshirt, Threadless, Shutterfly and Vistaprint. The overall effect of proliferating technology and lower barriers to entry will be lower margins, lower revenue multiple valuations and prices below NTA as incumbents such as Cafe Press, Zazzle etc have in effect paid too much acquiring their customers and building their business up to now. The only people making good profits out of custom products will be those with special niches such as premium or highly specialised products.
Josh
Josh
Josh