Breaking down the online retailers landscape

A few weeks ago, I tweeted the following in a discussion on Kogan, the pure online retailer who had provided a weak update to the market as the tailwinds e-commerce received from the Covid shutdowns were beginning to abate:

Since then, pure online retailers have continued to come under pressure as others such as Redbubble, Temple & Webster and Adore Beauty have given trading updates where they also confirmed post-Covid weakness.

While most of the conversation around the weakness in these stocks has centred around a softening in demand as consumers are now able to return to physical retail and many one-off purchases such as furniture and electronics have already been pulled forward. I don’t think enough attention has been paid to the cost side of these businesses which is where most of the profit weakness is coming from.

As I alluded to in my tweet, it cannot be underestimated the reliance that sub-scale e-commerce businesses have on the likes of Google and Facebook who aggregate and funnel traffic through their targeted advertisements. I have captured screenshots from similar web for each of the businesses listed above, showing their reliance on Google (Search) and Facebook (Social).

Kogan

Redbubble

Temple & Webster

Adore Beauty

It should be noted that search is broken down into paid and organic. Organic search is fine for customer acquisition, but the % of paid search for each business is 63% for Kogan, 16% for Redbubble, 68% for Temple & Webster and 32% for Adore Beauty.

As you can see, all these businesses have a heavy reliance on the tech majors, paying Google and Facebook to funnel high value customers to them. Unfortunately, capitalism has an exceptional ability to quickly whittle away any excess value that is generated from Google and Facebook ads as competitors come in and bid up the price, eating into margins. To that point, Facebook on their latest quarterly result conference call noted price increases as the major driver of their business:

Seeing this dynamic, it becomes clear that for the long-term health of these businesses they need to find “escape velocity” where they are less reliant on Facebook and Google and have high value customers coming to them directly and re-purchasing. With a loyal customer base established, they could then target their sales and marketing budget into other areas and really start to leverage the margin expansion you would expect from an online business.

Investing heavily to build out that brand and loyal customer base is exactly what Redbubble, Temple & Webster and Adore Beauty spoke about in their updates to the market:

Redbubble

Temple & Webster

Adore Beauty

Can they do it? Maybe, but the pragmatist in me would point out how few e-commerce businesses have largely removed themselves from a reliance on Google and Facebook. This is primarily because the acquisition channel they provide is so valuable that if e-commerce businesses don’t purchase the ads and allow competitors too, they would quickly find their market share eroded.

Factoring in lowered near term profitability as the businesses above embark on targeted brand building spending and the uncertainty of future margins, we also need to consider what price the market is asking us to pay to expose ourselves to the risk:

Looking at the FY22 earnings multiples and they are steep. Kogan is somewhat reasonable at 26x, but 39x for Redbubble and 89x and 93x for Adore Beauty and Temple & Webster respectively. It is mostly for this reason we have avoided the pure online retailers in the Oracle Emerging Companies portfolio, instead preferring to get retail exposure from the omni-channel players who are able to serve the customer in the most profitable method be that in-store or online.

Given the length of this post I will save the other part of my tweet for another day, and look at the brick and mortar retailers who are seeing the opposite effect of the pure online players; lowering rental expenses and higher margins as landlords look to fight a shifting power imbalance in physical retail.

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