Chit Chat Stocks - Farfetch Revisited (FTCH) | Not So Deep Dive

Episode Date: June 14, 2022

Farfetch operates an online marketplace for luxury fashion goods. The company operates in three main segments: Farfetch Marketplace, Farfetch Platform Solutions, and Farfetch's private label brands. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Farfetch. Enjoy the show! This episode is sponsored by Stream by AlphaSense, the highest quality expert network library. Sign-up here: https://streamrg.co/CCM Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Contact us: [e-mail] Timestamps Company Background | (2:42) Industry | (9:50) Management & Ownership | (15:15) Valuation | (18:36) Earnings | (19:53) Balance Sheet | (22:56) Our Analysis | (26:55) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode on Chit Chat Money. Today, we're going to be talking Farfetch Limited, right? Limited is on the end there. Whatever.

Yeah, I think it's got limited in the name. Yeah. Farfetch, either way, it's just going to be me and Ryan today. No outside guest, uh but we will have brad back on next week i believe talking a little lemon we're gonna let ryan talk about the company who's picked this is my pick i believe i guess i just picked it because it was down 90 we're gonna revisit it we did talk about it i believe a year ago and the valuation was quite steep but that was because it was caught up in the archegos um what was that type of deal or they were just bidding on liquidation, liquidation, the run up and the liquidation, if you look at their stock price. Yeah, so last time we talked, we're like, wow,

this is quite expensive. I wonder what's going on. Turns out there was an artificial or there was an outside source making that happen. So I'm going to Ryan reintroduce the company because it is quite complicated. But first, let's talk about our sponsor today. This episode is brought to you by Stream by AlphaSense. Stream is an expert interview transcript library that has been integral to our research process. They cover all industries, including TMT, which is, you know, telecom, media, technology,

consumer stuff, industrials, real estate, and plenty more. They have over 300 expert interviews per week. And so how this works is that someone does an expert interview, Stream records it, and then uploads the transcript to their service. So if you're a professional investor, and you want access to a lot of these transcript libraries with investors, and you want to get up to speed with a company, say like Farfetch, or any of the other companies that we've covered on the show, I'm sure they have transcripts on there. You can find them at streamrg.co slash CCM. The link is in the show notes. That is S-T-R-E-A-M-R-G dot C-O slash CCM. All right, Ryan, do you want to introduce Farfetch? Yeah. And Farfetch is a good example of a company where we were kind of talking about this beforehand. An expert interview would be quite helpful because there's a lot that's going on with a business that's a little murky, I guess, difficult to understand.

So I'm going to try to explain the business the best I can. So Farfetch is a luxury e-commerce platform that basically lets brands and retailers distribute their products to consumers around the globe. And they take a 30% commission that's sort of on average to do so. And there are essentially three elements to the business. So the first is the far-fetched marketplace. The second is far-fetched platform solutions or FPS. And then the third, I just basically call it their own retail brands, which is exactly what it sounds like. It's their own businesses or luxury retailers. But as for the Farfetch marketplace, there are more than 1,400 sellers on the platform, more than 3,500 luxury brands, and one big selling point. So they are not, it's not Farfetch's luxury goods. Some of it is, but a lot of it is other brands and sellers. And none of the brands that they own are marketed as Farfetch like stuff. That's just-

Right, they have different names. But the big selling point for brands to join the Farfetch platform is that Farfetch allows them to maintain control over their own brand. So they allow them to set or determine what they sell, determine how they sell it and set the prices. So you don't have to do heavy discounting if you don't want to. Basically, you have control over your own brand, which is that was a big differentiator when it came to their platform compared to others. And I saw someone basically describe it as a shop within a shop for a lot of these luxury brands. So it's a great distribution point. Obviously, Farfetch has access to millions of customers.

I think as of latest quarterly reports, 3.8 million active customers around the globe. So that's part of why there's this attractiveness from a seller's point of view. And then the second one is the far-fetched platform solutions or FPS segment. This was a little difficult to get a grasp on, but the way I understand it, they call it their white label enterprise offering. So whenever I say white label, I'm basically, I had to relook up this term just to define it properly, but it's a product or service produced by a company that other companies can rebrand to make it appear like their own.

Similar to Shopify. That's exactly what I was going to say. Sort of a Shopify-like solution for the luxury brands. And it helps them with a few different things running their shop online, but it includes optimizing their inventory, activating global payments, helps with digital marketing and customer service. But then one really big factor is that it helps them easily tap into the Farfetch marketplace and their Tmall marketplace. So Farfetch has a strategic partnership with Alibaba and the big marketplace over in China is Tmall. And so they have a custom storefront or a flagship store on Alibaba's Tmall platform. So there's five tabs.

And the last thing I heard about it was there's five big tabs on the Tmall luxury platform. One of those is Farfetch's solution. And the Chinese luxury market is really, really big. I believe it counts for mid-teens percent of Farfetch's volume. So, it gives brands that traditionally wouldn't have access to that giant Chinese customer base, obviously, a new group of customers to sell to. And then the last thing I'll say is the third segment of their business, this is their own brand. So, this includes Browns, which is a British fashion and luxury goods retailer, Stadium Goods, this is a premium sneaker retailer. So Stadium Goods, I think I may need to correct you.

I think it's more of a marketplace, but for sneakers. Really? Yeah, I believe so. Let me just confirm, but that's, yeah. Okay. But it's wholly owned by Farfetch. Farfetch owns it, yes. And then there's also an additional component called New Guards.

They do the manufacturing and distribution for several other brands. Popular ones, probably people will recognize Off-Whites. And then there's several others under that umbrella. And I know, Brett, you're going to talk about that in a second. So I'll let you do that for your future growth opportunity. But that is the basics of the business. I hope I gave a good understanding of the marketplace. They did not break out how they generate revenue on FPS.

So I would assume they're just plugging in. They're basically just taking that same take rate on transactions on the platform. I don't know if they sell the software for a certain price or if there's a required subscription. They did not talk about that in their annual report. I will talk about the history briefly, though. There isn't anything that's too fascinating about it. The idea was born in 2007. The Farfetch website went live in 2008.

The CEO is Jose Neves. He's had several stints in the fashion industry prior to founding Farfetch. He's a Portuguese entrepreneur. and there were five people on the team when it started. I think there were 40 brands total on the platform. So it was pretty small. The company's headquartered in London. They've got branches everywhere.

Other relevant historical moments that they acquired Browns in 2015, went public in 2018, 2019, they acquired both Stadium Goods and New Guards. And then in 2020, they announced their partnership with Alibaba and Richemont or Richemont. I'm not sure how to say that one,

but that's one of the luxury houses. That was, and not only it gave them access to T-Mall, but Alibaba and Richemont invested in Farfetch as a part of that. So they got some capital as well. And then in 2021, Newguards acquired a stake in Palm Angels, which is basically another luxury fashion brand. And then two months ago, they acquired a company called WANA, which is a virtual try on technology company.

So trying to get into the AR game, it sounds like, which maybe creates higher conversion on luxury e-commerce. Yes, that's very, a lot of fashion companies, at least the new age one, seems to be doing similar stuff, exploring augmented reality. As they say, we'll see what the return on that invested capital will be. There were a lot of quote unquote strategic partnerships throughout their history. with various companies and brands that use a far fetches platform, which it was difficult to parse through, but yes, very, very messy. So messy. So many things, so many moving parts going on, even though the business isn't that complicated,

all the things that are acquiring just tons of different names, really hard to understand. All right. I'll hit industry and competition. Interesting one to go after here. Luxury goods market is valued at about $243 billion of this year or expected to be valued at about $243 billion this year and is expected to steadily grow each year through, say, the next five years. Now, Farfetch itself estimates that Chinese demand will be about $100 billion a year by 2025. So that's, I think, by that point, it'll be the largest market in the world, at least from country size. Maybe Europe on its own is a little bigger. But yeah, $100

billion versus say 200 and something to 300 billion that it might be in 2025. That's a good chunk. And that's why they've done that partnership with Alibaba. They actually originally had a partnership with JD.com, but I guess JD.com is too Amazon-like and it doesn't have the luxury shopper style. So it didn't really work out. So they switched over to Alibaba. And then also So Farfetch itself expects around 70% of luxury goods will still be bought in physical stores in 2025. So flipping that, it's on its head. That's 30% they expect to be bought online, and it's slightly higher, closer to 80% currently.

That means there's a solid, say, tens of billions. If we want to just have some room for error, positive or negative here, there's tens of billions of potential GMV or gross market value or the amount of dollars that could be potentially spent on Farfetch's platform to go after by 2025. And I'm sure it'll incrementally get higher by then. Now, if we want to move into competitors, there are also deep, deep to see offerings. Now, these are the ones that are not using fulfillment by, or what is it called? I call it fulfillment by Farfetch. That's what I'm going to call it, but it's a Farfetch platform solutions. Okay. So say a DTC site, that's a luxury house. Um, that's

selling online that is not using any far-fetched technology that is definitely a competitor they are taking online luxury spend there are website builders like a shopify definitely has some fashion brands on there um like the kardashians use that i believe that's the stuff that shopify hypes up a lot uh physical stores are competitor although some of their own brands have physical stores but reality the physical shopping experience at a say louis vuitton or wherever that's competing with demand on the, for the Farfetch platform. And then there are other websites that do similar stuff to them. One would be forward.com. Um, there's other marketplaces.

They have strange names when saying I'm an English because they, uh, a lot of them are Chinese, but they're shop bop use group. My Teresa, I believe is a European one. And then there's, there are a few others. Amazon luxury has also made a push, but frankly, I don't see them as a competitor just because similar to a JD.com, you don't and you and maybe you agree or disagree here that amazon isn't the right marketplace to sell luxury product and that's just not the efficiency you know you know what i mean i agree okay it's not it there's a it would be counterintuitive to what they are supposed to be

which is the cheap online retailer and you're not really shopping for luxury goods to find some bargain you're not bargaining and i think there's a stigma too yeah you're not showing for ralph lauren is that how you said ralph lauren at uh walmart the other thing i'll say is some of the really big ones i think louis louis vuitton or lvmh and uh hermes i believe have built it out in-house hermes is a part of that house yeah but then some of the other ones a lot of the a lot of even big companies like gucci have opted to use farfetch's uh solutions instead and i thought i saw some ldmh ones using farfetch's solution but again we're saying like a lot of these confusing things and they are a bit um unclear on who some of our customers are well

you can be, you can use certain Farfetch solutions without being considered like a big Farfetch customer. Gotcha. So it's kind of hard to categorize everyone as a customer, but do you want to hit management and ownership? So I have one more thing on industry. So there's some evidence out there that Farfetch has definitely the best technology and brand in the space so richmond who if we're pronouncing that wrong apologies but it's if you spell it out it's one of the big luxury houses they were in discussions with farfetch to let farfetch power uh this marketplace called net up order which is a competing marketplace that had the same sort of idea of farfetch luxury good marketplace e-concession online and they were going to let

uh, FPS. I'm gonna call it FPS. I can't remember what it is and bring, uh, Richmont's brands onto the Farfetch marketplace. So it'll, it seems like Richmont kind of gave up on that. And it looks like Farfetch doesn't have any direct competitors and it's all going to be the DTC, the DTC, um, website builders, maybe some of the other ones and then physical, but the other marketplaces, it seems like that kind of a little bit of escape velocity there but let me move to management and ownership founder chairman and ceo is jose neves like ryan mentioned he started the company in 2008 has been involved in a luxury business for looks like all his working life he's about 47 years old which i like to look at because i think in the 40 to 60 range is kind of the optimal one

for me maybe in 45 to 60 for a ceo just because you have the experience but you still got a long runaway ahead of you um important board of directors there's jay michael evans who's the president of alibaba since 2015 i don't think this means he's running the company um because jack ma was running the company for a while there but he is i believe he's canadian he worked at goldman sachs important to have that relationship and having them on the board victor luis was the ex-ceo at tapestry which has coach and kate spade and then jillian tons uh was the ex-ceo of booking dot com solid board of directors all around however this is all about nevis given his voting control i'll get to that in the ownership part next but another important person to maybe research

and see if you can find anything on is uh this is a tough name the cto's chief technology officer cipriano suza uh spelled with a c he's been with farfetch since the beginning kind of treated as a co-founder and he leads all the technology efforts they really focus on this technology build out as their advantage. And he's probably the second most important executive. Ownership, it's the most important part here is that Nevis owns approximately 14% of shares outstanding, but has 70% plus voting power given the class B stock. He has all the class B stock, I believe. He also has a stock plan that will pay him out a lot of shares if the price reaches $75. And then with different hurdle rates up to $250. Current share price is around 10. So pretty good hurdles

there, but that's because the stock has come down a lot too. Morgan Stanley has 11% of shares. Bally Gifford has 9% of shares and Lone Pine Capital has 5% of shares. T. Rowe Price actually owned a huge chunk, but recently has sold 20 million shares, which could have been a reason why the share price is down so much in the past few months. Then lastly, Alibaba and Richmont both own convertible notes at $33 strike prices. I want to kind of do a little discussion here. Does this provide good incentives for creating shareholder value to have those convertible notes at those strike prices with those specific companies?

Yeah, definitely. And they also own combined a 25% stake in Farfetch China, which is a subsidiary of Farfetch, I guess. It was a little difficult to parse that out. So they have a huge, Alibaba and Richemont, even though it's not a giant part of their business, have very much a financial incentive for Farfetch to succeed. If Farfetch can become a $30 million market cap business, they will do well as well. And a lot of it is driven by bringing Rich Funds Brands on and Alibaba doing well in the T-Mall marketplace. However, I would think Alibaba is so big. Is this a giant priority for them?

You know, they're such a big tech company that is telling out their number one focus. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham. They have free high-speed Wi-Fi to stream all your favorite movies. And in the morning, get fresh waffles with their free bright-side breakfast. Or squeeze in a workout at their fitness center. Either way, you're ready to conquer the day.

Tonight, La Quinta. Tomorrow, you triumph. Book your stay at LQ.com. Yeah, great. All right, valuation. Yeah, valuation. We'll do this quick. Market cap $3.4 billion, tickers FTCH.

Enterprise value is actually closer to $3 billion after considering borrowings and cash. However, as we'll maybe discuss later and Ryan will discuss on the balance sheet, there are lots of tricky stuff, lots of just things that make me kind of go, hmm, when I'm looking at the balance sheet that I don't know whether to consider that in the enterprise value or not. But for this exercise, we're just going to consider it $3 billion. Enterprise value to sales is 1.3. Enterprise value to gross profit is 2.92.

So clearly, it looks cheap if you think they can get to consistent positive cash flow. They're currently not. So that's probably one of the reasons why the stock looks so cheap. And then lastly, total potentially dilutive securities are $472 million versus $381 million currently outstanding. The difference is driven by a lot of options, RSUs, which are restricted stock units, similar options convertible notes and far-fetched china at a good table that in the 20f which is their annual report i would just expect without making it too complicated share count to kind of compound

at five percent a year which is some not the best compounding you want uh but ryan do you want to hit earnings yeah so they're i guess just for context this quarter really sucked for him it was pretty terrible um well you'll see why it's kind of out of their control but the gross merchandise value or the GMV for their quarter was $931 million. That grew about 1.7% year over year. That is a steep slowdown from what they typically grow at. And then revenue outgrew GMV slightly. It was up 6% year over year. They had about $515 million in revenue. And so if you're comparing, if you're thinking, all right, 930 million in GMV, 515 million in revenue, that sounds like a lot more than their quote-unquote 30% commission. Keep in mind that only about 72%

of their total GMV comes from third parties. So the remainder comes from either their own brands on the digital platform or their own brands in retail stores. So it's not a 30% take rate on those because it's true sales to their business. And then they said in their quarterly report that on the third parties or third party sellers, their take rates about 32%. So still in line with the long run commission or average take rate. And then their total active customers reached 3.8 million this quarter. That was up 17% year over year. So pretty good. And the average order value increased from $618 to $632. That all sounds all right. And you're probably wondering what's the low light, but the total amount of orders must have declined. They

didn't report that number, but it must have declined. And so they closed their operations in Russia, which was their third largest market. It represented 6% of their total volume. And then China is their second largest market. And as anyone who has companies that are operating in China knows, the zero COVID policy is shutting down a lot of the commerce in that market. And so a lot of the goods on Farfetch's platform are shipped from Europe to China. And so a lot of that incoming commerce has kind of been halted. And so that forced those two factors pretty much forced Farfetch to adjust their full year outlook from 30% GMV growth to 5% to 10%.

That's not bad, all things considered. But I imagine that some of that is factoring in that China comes back online and starts to sort of reaccelerate. Which we're seeing right now, but who knows? Right. So I feel bad for whoever had to try to forecast their GMV growth for the year because it sounds like a difficult thing to do. They did burn through $341 million in free cash flow during the quarter. That, we'll talk about on the balance sheet here in a second, is not sustainable.

but I believe there'll be some improvements moving forward, seeing as they had to exit one of the markets this year and China was really tough on them during the quarter. Balance sheet. This was one of the most difficult tasks I've ever had. I'll start with the relevant assets. So there are pretty much three items worth paying attention to on the asset side. They had $940 million in cash and cash equivalents, $99 million in short-term investments. So just over a billion dollars in cash and investments, and then $300 million in inventory. They have a lot in property, plant, and equipment, but that's not very liquid. So I didn't really add it in here. But liabilities, really tricky. So the bulk of their debt isn't due for at least three years,

but over the last two years, Farfetch has issued several rounds of convertible notes at various interest rates. They categorize, and I think most recently they did $600 million at 0%. So good on them. And I think that was a little over a year ago. They categorize these as quote unquote borrowings on the balance sheet, but then there's also another associated liability on there called derivative financial liabilities that they have as well. I was having a difficult time reading through this, but it says, as of the most recent quarter, Farfetch reported $530 million dollars in non-current borrowings and 330 million dollars in derivative financial liabilities i believe non-current borrowings are all all convertibles correct yes okay unless there

was like one tiny uh debt issuance but i didn't see any in the 20f and i also think in the derivative financial liabilities there's also currency hedges that are in there as well because they get a lot of they derive a lot of revenue in different currencies um and then they've also entered into several put and call option contracts with various companies, including Alibaba, Richemont, Chalup Group, and some other small ones. I think they just did one with Palm Angels too. These contracts allow the counterparties to take additional stakes in Farfetch at predetermined dates and prices. So these contracts get recorded as liabilities based on the fair value of whatever of the stock is at that date. But as their stock has come down, the liabilities on these have come

down. So as of Q1, they had almost $400 million in put in call option liabilities. That is down substantially from last year. It's hard to tell where this is callable debt, I guess, like where this is going to hurt them as opposed to just getting turned into stock. Yeah. It seems like the majority of these liabilities will come in the form of dilution, but we will see. Depends on where the stock is. Yeah, I would think so. And then there's one last thing that really kind of concerned me, and this is probably the biggest red flag from the balance sheet. They had another line item in their liabilities called other financial liabilities, which is very vague. I keyword

searched this on the 20F, which is 282 pages long. So I would have thought there'd be something in there, there wasn't. There was no definition of what that was. And during the three months that comprise the first quarter, so from January 1st to March 31st, the quote-unquote other financial liabilities jumped from $13 million to $345 million. So they just added essentially $330 million of liabilities that I don't know what they are. Maybe that's me missing something, But it was just a very difficult balance sheet to understand. Probably would have taken a week for me to fully grasp it. I agree.

That other financial liabilities thing popped out to me as well. Definitely the biggest red flag, considering that it's moved so quickly. And it's not really that there's other financial liabilities on the balance sheet. It's that it changed so much. And I would just wonder what that is. All right. Anecdotal evidence. this episode is brought to you by kpmg as a business leader how can you innovate build trust

and move forward in a digital era kpmg can help by bringing together the right talent and technologies generating insights that spark opportunities to explore their thinking visit read.kpmg.us opportunities any thoughts here i know we're both not shoppers on the marketplace I thought the website looked pretty good, the Farfetch website. And the other thing that, this is a point that Dennis Hong, who's a popular investor that we follow and he read a lot of his writing, he brought up this good question, which is, is this true luxury shoppers or is it aspirational luxury shoppers on the platform? in kind of filtering through the website i would think this is true luxury well they are what about that stat that one percent of their shoppers are 27 percent of their gmb those seem like the true luxury shoppers and there's also you know probably some aspirational ones on there as well i just don't see i don't know there were like eighty thousand dollar watches on there i don't think

you could fake that oh some of the stuff is only like five hundred dollar jackets or something Yeah, I guess. Not all of it's super, super expensive, but they do have the top notch as well. It's an important question to ask because it determines whether or not it's going to do well in a recession. I think it's kind of determined on whether or not these are truly high-income shoppers. Ultra high-income shoppers. Yeah, who are more of your Ferrari customer as opposed to maybe your restoration hardware or RH. Well, I was going to go auto and say the BMW customer.

But I think one positive in that regard is their pride in client business. So they started that up a lot where, say, these 1% of shoppers that contribute 27% of GMB, they are giving them uh like one-on-one services with what do you even call them like um guides or who is your shopping guides like who's the person in the store that your concierge not and it's not concierge your shopping guides is a good word sure i think there's a specific word but the yeah so they're doing they're replicating that and giving this one-on-one touch that's even elevated uh and you uh it's elevated beyond their traditional loyalty program which I think is called access. So you can only graduate to the private client if you spend a

certain amount. So I do like that strategy of being the exclusive top talent on there, not top spending the whale on there, which seems ridiculous if you're an investor thinking about this, but that's kind of how the luxury status games seem to work. But I'll hit my anecdotal evidence i download the app seems fine worked well didn't buy anything huh no i did not i laughed uh looking at all the 500 stuff um seems shoes yeah 500 socks although i did i did try to look at some of their owned portfolio they were promoting some of the new guards group stuff so that was interesting it's probably smart move um one thing i didn't like though was how they had a 50% discount pop-up right when I downloaded it. And that doesn't seem like the brand strategy that

you want for luxury. That was the only downside I saw. I like the loyalty program and the agents thing that they were talking about. There just seems to be something slightly off from how these top luxury houses would want to sell online. I don't know how to put it, but the luxury houses historically have loved to control every aspect of their distribution and conceding that to Farfetch just feels like there is a bit of a, there's going to be friction over time. Yeah, I agree with that. It seems like they would want to control their entire experience, technology included, if they could. Maybe they can, maybe they've just given up. At the same time, this gives them access to 3.8 million customers that they might not otherwise

have. And 1% of those, which 1% of 3.8 million would be what? 3,800? 38,000. 38,000 of them are spending a boatload of money and that's their true clients. So yeah. All right. Future growth opportunities. What do you got? Mine's beauty. So they launched their beauty category in April. They talked about this a lot on the conference call. I think it's a pretty logical next step. It'll encourage more brands to join the platform, which in turn encourages more customers to join the platform and so far they seem to have gotten pretty good buy-in from their existing brands so a lot of their existing brands the one i'm thinking of is gucci has not only their fashion line but also their uh sort of makeup lines and fragrances and so uh they said that uh they

highlighted three charlotte tilbury gucci fragrances and dr barbara stern all joined and uploaded a whole bunch of beauty related products um the other thing i'll say is this provides another channel to help with their advertising revenue. They talked about this a lot on the conference call where they have promotional spots, I assume, on the website that brands can pay for to have or give maybe a higher take rate to Farfetch to have. So just another channel for them to kind of grow into. Seems like a logical one. Are there any other tangential avenues that you think they could add to the platform over time? If they

already have non- handbags and luggage and stuff and jewelry, which I believe they have all those, then this seems like the core stuff outside of cars. I don't really think so.

They have hats, they have shoes on stadium goods, and I believe a little bit on Farfetch as well. I saw someone talking about they could... uh they're not really the leader in watches which seems to be like a big luxury market and that's where some of their like highest uh ticket items have been could be smart although apple seems to be kind of disrupting this industry which is tough yeah i think it's different

these are like collector's items though true true that that part might not be as hurt as bad but i still think it's a threat when everyone in manhattan's wearing apple watches um all right i'll hit mine new guards group i like this strategy a lot to reiterate because it's a bit confusing this is the subsidiary that owns a bunch of different brands or stakes in a bunch of different brands um they love financial engineering in these complicated things but these are brands like off-white and palm angels i really had no idea what any of them are but and i'd heard you hadn't heard of off-white i could care less about any of these things I have no idea how popular any of this stuff is, but the strategy seems sound.

They can provide some exclusivity to the far-fetched marketplace if these things continue to grow their own popularity among, say, younger consumers. Dare I say it helps kickstart a little momentum for a flywheel where you get all these consumers on and it just creates a bunch of demand. And it's just one of the kind of aggregating strategies where if you get, okay, if you can only buy one of these New Yard products on Farfetch, it might create a customer for life. And those customers could be quite, quite valuable. And those customers attract more brands. More brands attract more customers. Yeah. I don't like to, yeah.

It's a beautiful thing. Yeah. Flywheel gets a tough rap, but in this case, there's the potential. There's definitely a strong potential. and they seem to have kickstarted already. Highlights and lowlights, what'd you like and dislike about Farfetch? They seem to be the leader in their industry,

not only from a customer's and a brand's standpoint, but in reading commentary from competitors, it sounds like they have technology that the other marketplaces can't compete with. A lot of their competitors also have purchased stakes in the company, which seems validating i guess um and then on top of it there's just secular tailwinds at their back i i don't see why a larger chunk of luxury spending over time can't go online it just seems

logical i guess uh and then the low lights for me i don't understand their derivatives book entirely um they also in the last quarter they added neiman marcus group which is pretty big as a customer to their solution side and i think to their marketplace um but they also invested 200 million dollars in the group simultaneously which they they're not necessarily like flush with cash right now which makes me feel like they did it just to attract them to the marketplace like they almost had to buy it and fps right what do you mean to have neiman marcus's dtc stuff be using fps yeah they didn't say that they were using all of fps solutions but they added some of the fps solutions um but i don't

like the idea of having to pay 200 million dollars to get companies to join the marketplace and then someone asked about that on the conference call and basically said like some of our investors are worried that you're gonna have to do this with every brand they said no, this is a one-time thing. We thought it would be a good opportunity to invest in Neiman Marcus Group because our platform is going to unlock a lot of value for them. But it's like, won't your platform theoretically unlock value for anyone that joins? Yeah. Well, I think if you're an investor in Farfetch or thinking about it, you got to hold their feet to the fire with those statements. Yeah. So that just kind of threw me off. It felt, I don't know, it didn't feel great.

And then on top of it, there's just a lot of short term problems going on right now, which China plus Russia. Yeah, not good. But they are seeing good growth. And I guess this should be a highlight as well. They're seeing good growth in their core markets. And it is still just a really interesting business that I think should be able to generate strong margins if everything's going right. Yeah, they do like to hire a lot of people. I think they have over 2000 developers or technology staff. And I was like, all right, you better have a technology advantage with all that. All right. My highlights, I think they have some emerging competitive advantages in the form of the

network effect and the brand. Very, very profitable industry in general, just luxury. And that has shown decades of long secular tailwinds. So it's durable. You can have the quote unquote durable and competitive advantage here. So that seems great. Not very many companies have that potential. They've been the clear winner in this niche so far, and they are aligned with the industry

leaders, which again, those all seem, you know, check, check, check. Lowlights, part of the strategy to me seems very messy and poorly planned. I don't know if it's just a shotgun strategy and they're just going to figure it out. And some of the things are going to be huge winners and some of them are just going to fall away. But man, they like to do a ton of stuff. The China exposure creates a bit of uncertainty, although it's not too bad, especially at the current price.

And I don't have much confidence in management's capital allocation. I've got another low light related to China. The recent comments. The CCP's comments? CCP comments about wealth inequality and trying to rein that back in. They don't want to. Yeah, that's negative. That's true.

It seems like a huge negative for high income spenders on the platform. Well, it's a big negative. I don't even think it's a negative for spending. it's a negative for spending on frivolous stuff like luxury they want to and this is what you're reading I'm not in the CCP's

meeting rooms but the stuff that's come out has said that they want to they don't want to repeat the failures of the west and having people just frivolously spending on luxury items which that doesn't seem very bullish however

Chinese people love luxury products yeah it's a growing market so far yeah that's the fastest growing market in luxury um let's see so yeah i the last one here i don't really have confidence in management's capital allocation yeah the track record as a public company is a little short so it's hard to tell maybe i could in the future but when we're looking at a company we like to ask the question how confident are we that management will act rationally which with the cash that is given to them basically the cash that the company generates i'm not sure the answer is positive here for farfetched so that's a big

low light for me because that's a key question um because a company can generate so much cash if they just burn it on dumb stuff like ar ventures then well you're actually not generating that cash for shareholders it's and it feels weird and maybe this is a lot of like it just happened to be timing but it feels weird for them to have spent the 200 million dollars and neiman marcus the acquisition for the ar stuff in a quarter when it probably would have been in the best interest to rein in expenses um i don't know they're just plowing through their cash pile and it isn't like if their cash burn from the last quarter persisted they would have like three quarters of cash yeah some of that could have been working capital

i can't remember exactly inventories did rise by a lot inventory is a part of the business so and we'll see this is one where i was like okay they could get to 25 adjusted even to margins but does that mean zero percent true for cash flow margin or zero percent growth for cash flow per share possibly all right bull case what do you think ryan china comes back soon as like a uh good growth for them in GMV. I don't think, I think we could probably say goodbye to the Russian market. I don't think that surprises anyone. They don't need it.

No, you don't. And they're able to get back to high. So I would say mid teens to high teens, at least double digit GM or GMV growth. I don't know why I added double digits. Historically they've targeted 30% revenue growth CAGR. That's what they said on the conference call. that's what they try to aim for. If they're able to reach high teens, mid-teens GMV growth, I would assume revenue per share growth is going to be a little less, maybe low teens to 10% because of the dilution. And then I think they'll be able to reach double-digit cashflow margins.

This is the bullish thought process for me speaking. If those things happen over the next five years that this will be a good investment i don't think a lot i don't think the expectations are that high right now no they're pretty low because no one believes they can generate true cash right so i don't know you've put some numbers down here yeah let me get some numbers so if they do 10 revenue per share growth which feels doable 10 free cash flow margins and then five years from now, they will get to a free cash flow per share of 78 cents at a 20X multiple, which I think that's reasonable. That is a share price of $15.60. Current price is $9.13. Seems fairly doable. Yeah. I would say that 10% revenue per share could be much higher as well,

if things go right. Yes, exactly. There is definite upside there. All right. Bear case. uh they burn through their cash pile have to raise money again can't get good terms there was some interesting things i didn't read the details on on the convertible notes but there's something about alibaba and tencent owns yeah they're involved as well there was an ability to like call them whenever they want yeah something like that there was a lot of paragraphs that frankly for not so deep that i wasn't going to read about the debt but yeah there's some things to want to check for that i also think a realistic scenario is that they get acquired by someone whether that's a big luxury company or um even alibaba yeah interesting interesting potential

there the a lot of the luxury houses have been talking about i read some new york times article it could be relevant now but it was a few years ago about the luxury houses wanted to have a neutral internet platform. So I wonder if one house acquiring them would be like not something everyone's agreed upon. And that sounds kind of like a cartel. I guess luxury houses are a bit like a cartel, but yeah, it's definitely a strategic asset for a lot of these companies potentially. Yeah, I agree. What's your bear case? I think the easiest one without even doing any numbers, are they investing in too many things with no sense of return on investment? They have beauty neiman marcus augmented reality the china joint venture discussions with richmont richmont

over fps the new guards roll-up strategy fulfillment that's a lot of things to balance are they really do they have the eye on the ball and all these things i don't know also dilution dilution is pretty clear it's been bad i think that's the only that's one of the things i think we covered it last time we didn't understand it as well i think the thing we did understand last time is that deletion was coming um and yeah it's been bad so far even over the last year yeah all right more or less interested i'm gonna go more interested because given the valuation if the balance sheet worries clear up and this may the opportunity may be gone by this point if the balance sheet worries clear up and they start generating cash then it's definitely on

my watch list because it seems like a very promising strategy i agree it's a large market a lot of potential here would not be surprised if this was a uh large cap stock in the future what about you ryan yeah i agree i'm more interested i know we sounded a little critical throughout this episode and a lot of that was balance sheet related and some of this stuff might not even be a lot of the balance sheet stuff might not be um malevolent it's just potential to be malevolent it just felt uh i guess they weren't very transparent about what it was um and there was a lot of vague terms in the quarterly uh shareholder letter which if you're not going to go to any length to explain it it makes me a little um i guess critical with that said the

This seems like a really sound business, and it seems like they're winning and growing in all the markets that are actually functioning properly. They're growing. Yeah. I guess the other thing that's holding me back is I believe management could be burning a lot of the cash, potential value in cash that they're generating for shareholders on dumb stuff. Yeah. uh i guess here's another question think about the neiman marcus one is it that bad to invest in those companies if they can theoretically accelerate sales on your platform like it's almost like a customer acquisition cost that could go up there yeah there's a lot

of potential with the investment but it's a bit tricky so there's a bit of a leverage on your success there if you kind of get what i mean yeah yeah it's just messy a lot of mess a lot of mess all right definitely yeah stock for next week i don't think we have one but let me just get the lineup next week we're recording with brad on lulu lemon and then after that ryan you've already chosen charter communications just because of the, with Ian gone, we had the whole change up in the recording schedule for who will be on which episodes. So we already had two in the books. So I don't think we have to choose one because after we do charter, then it'll be my choice. And I don't, it'll be three weeks from now. So let's just wait. Sounds good. All right. That's going

to do it for this episode. Make sure to give us a review on Spotify or Apple podcasts. It takes five seconds. Remember, we are not financial advisors. And we say on the show is not formal advice or recommendation. We are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time.