Revolve Group (RVLV) has gone public in an offering which has turned out to become a huge success. Despite a bloodbath in the wider retail and apparel sector at large, investors like the combination of data-driven intelligence in these industries, as Revolve is demonstrating solid growth in combination with real profits.
Despite the upbeat stance on the business model, I do think that valuations have been carried away quite a bit at this point in time, as I am in no means inclined to jump onboard at current valuation.
Revolve calls itself a ''next-generation'' fashion retailer which focuses on Millennial and Generation Z customers, targeting these customers with a premium lifestyle brand.
The company was founded in 2003 as it aimed to leverage digital channels and technology in order to transform the shopping experience. The goal was to provide a one-stop solution for youthful and aspirational consumers.
The company caters these customers by its proprietary technology platform which includes automated inventory and pricing management, as well as trend algorithms. The company is, therefore, perfectly positioned to benefit from changed shopping behaviour of consumers, which are underserved by traditional mass market retailers. The focus on personalisation, loyalty, and usage of influencers has resulted in the company distinguishing itself from its competitors.
IPO And Valuation Discussions
Initially, Revolve aimed to sell nearly 11.8 million shares in a $16-18 price range. Strong demand resulted in the final offer being set at the higher end of this range as we have to recognise slightly less than 3.0 million shares are offered by the company itself, with the remainder coming from selling shareholders. This implies gross proceeds of about $53 million in connection to the offering.
The company has 68.4 million shares outstanding following the IPO which gives the company an equity valuation of $1.23 billion at the offer price. Including a modest net cash position of about $23 million ahead of the offering, while the IPO proceeds will not be used to reinforce the corporate coffers, I peg the operating asset valuation at $1.21 billion.
The company has shown some real operational progress to justify this valuation. Sales were up by 28% in 2017 to levels just shy of $400 million as operating profits quadrupled to $20 million and change. Sales grew another 25% last year to nearly $499 million as operating profits essentially doubled to $41.8 million, as the company is demonstrating on real margin gains. Absence of interest costs and working with a 20% tax rate work down to $34 million in earnings power or about $0.50 per share. At the offer price of $18, that works down to a 36 times earnings multiple.
The timing of the deal is a bit interesting given the first quarter results reported for 2019. Sales growth slowed down to 21% as first quarter sales came in at $137 million. Disappointing was that operating earnings of $6.9 million were down from the $7.5 million reported in the first quarter of last year.
The problem with this lower pace of growth and margin pressure is heightened expectations. Shares almost doubled on their opening day to $34 per share which resulted in valuation rising with earnings only totalling half a dollar per share in 2018. This is certainly the case given the slower growth in the first quarter and, certainly, the lower margin profile of the business in the first quarter of this year.
The main risk in this investment case is the valuation, with shares trading at a steep multiple of nearly 70 times earnings. Note that this is not the result of very slim margins, as operating profits came in at high single digits, but more so from high sales multiples attached to the business. While 20%-plus growth is impressive, it's not impressive enough. If growth slows down, this implies a lot of downside if valuation multiples compress.
Other risks include the rapid changes in the operating field, competitive marketplace, reliance on social media, and influencers, as well as dual class shareholder structure, as selling investors appear to be happy to step out of the shares at the offer price.
Reality is that I find the valuation simply too high to consider shares at this point. Based on the 2018 results, the company trades at 4.6 times sales with operating margins in the high single digits. With a $2.3 billion market valuation, it comes close to the $2.8 billion valuation of Stitch Fix (SFIX), a peer in this area. Stitch Fix is seeing sales at nearly $1.6 billion this year, which implies that it is about 3 times as large as Revolve and anticipated growth of 28-29% reported by Stitch Fix is quicker than that of Revolve. The only issue is that margins of Stitch Fix are considerably less, hovering around the flat line.
That being said, Stitch Fix has been able to report similar margins as reported by Revolve. For all these reasons, I am not convinced that Revolve currently offers great value, despite the radically different approach to apparel, fashion, and customisation.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.