Chit Chat Stocks - Ocado Group (OCDO) | Not So Deep Dive

Episode Date: August 17, 2021

Ocado Group is essentially a robotic retailer. The company is a British online supermarket that uses automation to manage customer orders. Listen closely as Ian, Brett, and Ryan go through the history, financials, and future prospects of Doximity. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested in more of Ian's work? Follow him on Twitter: https://twitter.com/IanGrayLive  Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Company Background | (2:20) Industry | (7:22) Management & Ownership | (10:19) Valuation | (13:43) Earnings | (14:54) Balance Sheet | (17:40) Our Analysis | (19:27) 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 show, a show where you can get the basics of a stock in about 30 to 45 minutes. We have Ian Gray back on the show, and we're talking Ocado Group

for the show today. Ian, have you heard of Ocado Group? Because neither of us have. Is it your first time looking at this as well? Yeah, the first time looking at it. but excited to jump in. All right, Ryan, do you want to introduce the company and then talk about our sponsor for the Tuesday episode, Potential Multibaggers, who Chris was just on the show. If you listen to that, that is the guy that runs Potential Multibaggers and he just gave us some

tidbits on some of their performance and it's been quite well, doing quite well. I'll let you pull up the, uh, the stuff that he just sent over. Okay. Yeah. Yeah. Cause I don't have the exact numbers in front of me, but if you listen to the Fiverr episode with Chris, that kind of gives a glimpse of the way he looks at companies. He runs potential multi-packers, as Brett just said, to seek an alpha service.

I think you get a two-week free trial right now, and you can just cancel with one click. He said he's made it really easy to cancel. He wants people to be able to sign up, see what it is, and decide whether it's – if it's for you or not. And they have like – if I'm not mistaken, he has a bunch of free articles as well, right? Yes. And what – given the CAGR since 2017, what's the compounded annual growth rate of their picks? Yes. Since May 2nd, 2017, they've compounded at 57%. Now, I don't think he's expecting that to repeat, but that just shows when he's talking about potential multi-baggers, he is very good

at identifying those stocks. And if that's something that you're looking for, if that's your investing style, it's a perfect way to augment your investing research. Agreed. All right. Let's talk about Okada Group. So this is a company that I don't, it sounds like none of us had looked at before. Surprisingly, a little bigger than I thought it was. But Okada Group is a robotics slash logistics company that's primarily focused on online groceries. So they have 10 or are expected to have 10 customer fulfillment centers live and operating by the end of 2021. The size of those fulfillment centers range, but the large ones, they look like massive warehouses. And inside they have, it's really cool. I recommend going out and looking up Okado Group warehouse and you'll see the videos, but it's robots that are running on a grid system. And so these robots are basically collecting orders and they're controlled by what they say is an air traffic control system.

And so it's basically just so that the robots don't run into each other. And then it's not an entirely end-to-end system, but they're taking the orders. They are moving them to pick stations where either a human or another robot forms the orders and ships them out to the customers. And so, the way those orders come in is either through Okado.com. I guess there's several ways, but Okado.com is their direct consumer grocery retail business. This is where they're simply delivering groceries right to consumers. They're sourcing the orders from their own site. Very similar to Instacart. yeah, that is where they get the majority of their revenue as well. They say that they have 95% on-time delivery and 99% basket accuracy. And so the other part, and they do have some private label stuff as well. That's part of the stuff you can order, but the rest comes from

suppliers. But the other part that they have is their OSP or Ocado Solutions platform. And so So this is basically their secret sauce, I guess, is their logistics and their tech and their ability to sort through groceries and create orders in a quick manner, an efficient manner, and hopefully do it accurately. And so they basically issue licenses to other grocery retailers to access that tech. And each deal, it's not really uniform because each deal is kind of different because they are all international. So it's all over different areas. And so some of them, they'll have like building agreements where I think the Kroger's one, they, they, I believe they financed the fulfillment center build out for Kroger.

Or either they're jointly spending the CapEx, either way, they're, they're doing a lot of it. It's kind of a mix and match and they can't give away. I was listening to the conference call and they said they can't give away the details on these deals or else, you know, they don't want to give away what kind of contracts they have. Right. But they're doing a lot of the CapEx. The point of this element of their revenue makeup is it's all fee licenses. So, and this is higher margin. It's obviously a much smaller part. I think it's, I want to say 5% of overall revenue, maybe 7% now. But this is really high margin. This is what a lot of people are excited about. A lot of investors, I guess. And it's basically just software licenses. Yeah. Potentially higher margins, but maybe that's something we can debate on the second half of the show? Yeah. And then history about the company. It was started in 2000 by three ex-Goldman Sachs bankers. The CEO, Tim Steiner, was a former bond trader, apparently. And

it was originally started by basically being a branding and sourcing agreement for Waitrose, which was a big supermarket chain in the UK. I think it still is. And then a year later, they began their delivery services. And so it was really, their relationship really started, or their entire business really started with the Waitrose relationship. And then over the next 10 years, they built out a fulfillment center. They started to kind of build out the different logistics parts. They IPO'd or listed on the London Stock Exchange, which gave them a lot of capital that they needed. And then they began launching their own label products in 2010 as well. Other things that have happened in the last 10 years, they began signing a lot of commercial

partners, especially they've really ramped things up in the last few years. They launched a 50-50 new venture with Marks and Spencer, which is a multinational apparel retailer. Yeah. And that's actually for the Ocado retail, the Ocado.com that has now transitioned to a 50-50 deal with Marks and Spencer. I don't know why they did that. That's maybe something to research further if you own the stock, but that's kind of, I don't know, a way they maybe off put some of the expenses or made a better deal for margins on that. Who knows? And then they've also signed, And I think it's nine new partners now all on their OSP in the last few years, which is the solutions platform that we talked about. And they launched Okado Zoom, which is their one hour delivery service in parts of London.

So kind of wrapping up a bunch of new things. And then what you want to talk about competition? Yeah, industry and competition. Global grocery and food industry is over 10 trillion dollars. So there's not, I mean, it's a huge market opportunity, as everyone knows, but grocery is a very low margin business. So of that $10 trillion, there's a lot less that is actually flowing through to profits for the grocers that are, you know, you know, Walmart, something like that might do over 500 billion in revenue, but their profits are a lot less than that. over the next decade, grocery delivery is supposed to make up a larger portion of that. Some estimates have that as high as 20%, but those are kind of just predictions and it's a bit of an unknown, but you can, I don't know what to think of whether grocery delivery is going to keep growing. I think it probably will keep growing as a percentage of revenue. What do you guys think? Do you have any thoughts on that? I don't really have any thoughts on that,

But it did jump from 7% to 14% from 2019 to 2020 as a part of due to COVID. And a lot of bets are that it's going to continue on that. Ian, do you have any thoughts on grocery delivery? Yeah, I think something like COVID really helps people understand the value of online delivery. You get kind of a jolt that that growth won't continue, obviously, at that pace going forward. But it gave a lot of exposure to the space. So people who may have not realized that they would enjoy online grocery have now learned it. And I think that that provides a lot of a lot of good opportunities for it going forward.

Yeah, definitely a catalyst for them. I'll hit competitors for Ocado Retailer. This is going to be, excuse me, Ocado Retail, and this will be in the United Kingdom. So there's Whole Foods, Abel and Cole. You could argue maybe Just Eat, which is a company that we recorded with Brad. that thing will be coming out next week. So you'll hear that next week, but Just Eat kind of competes with that. Although I don't think they're more of restaurant and food delivery instead of grocery delivery. There's Tesco, Amazon Fresh and Morrison's. So tons of competition with that. But then on the OSP side, they are really competing with grocers doing stuff in-house. There's not, I don't think there's anyone outside of maybe Amazon and Walmart for their own

fulfillment centers that have this level of technology and automation within the warehouses. And it probably took a lot of convincing to sign Kroger up for this. There's not really any exact competitors, but you can kind of look at maybe like McLean Food Services is someone I found who is a distributor of food for grocers. There's Kranzwick. I think that is in the UK, another grocery distributor, and then a ton of other smaller players. Really, when you're looking at the Ocado, like the OSP stuff, what you're, they're trying to be the fulfillment center, basically for third parties or helping with that with software and the hardware with all that. Anyone that's trying to help grocers by having them spend money to get products to customers

faster is really competing with Ocado. So there's a ton of them, but there's not really anyone doing the exact thing that they're doing. And that's kind of the big opportunity here. If they're building out their own market. All right, Ian, do you want to hit management and ownership? Yep. As Ryan was talking about, this company was founded by three ex-Golden Saks makers. The only one that's still with the company is the current CEO, Tim Steiner. They also recently hired a new CFO at the beginning of 2021 named Steven Daintiff, who was formerly at Rolls-Royce. It looks like the former CFO is still involved to some extent though because he's on the board of a number of Ocado subsidiaries. So it looks like there wasn't

anything uh this doesn't seem like it should be a red flag it should seem like a growth opportunity potentially for the company um uh let's see the other thing about tim that's kind of interesting is he's been awarded an obe which is order of the british empire which uh is for people who have shown service to england or the united kingdom um it's i don't know it's kind of we have to call him sir now we have to call him sir i don't think it's a sir i'm not sure but it's not he didn't get night he's not knighted he's just got in the order of the british empire so the chairman i believe is a lord the yeah that's that's how you get introduced and i was like all right this company's legit he's a lord he's the chairman uh i don't know that's just

funny uk stuff but sorry yeah exactly it's just it's interesting you don't see that things like that in the united states uh boards and uh and management teams all the time so just a little interesting note there. Um, one of the founders left in 2010 and was sued by the company. I think they settled last year. Um, another one left in 2014 and that seemed to be a little bit friendlier, but he is the only remaining founder. He was the UK's highest paid CEO in 2019 due to an approximately $70 million one-time bonus. Um, so that's, you know, we see that from time to time with some of these companies, but he definitely has been getting big bonuses. He's a little bit polarizing. I think there's some people, as many of these founders are, there's some people who

don't necessarily like him the most. I think he is enjoying being one of the richest men in the UK from what I can tell. But it's hard to argue with the results that the company has had over the last decade, particularly. He owns about 3% of the company. One other interesting note that I found digging up digging in a little bit is that kroger now owns about six percent of the company and so um there's some alignment there as part of that corporate deal yeah that's really right yeah you know interesting yeah i didn't see that uh so it's a good note that you caught that and i would say within those lawsuits they had some very aggressive language in the annual report that this i think was the ex-coo was i don't know that was the person that they sued and they won and

And they said something like, if anyone comes at us and is using our patents, you know, illegally or is trying to copy our products, they will not, they will go down. And they were like, I was like, whoa, all right, you guys are not taking anything here. Yeah, I mean, they talk a lot about it on the annual report, but their big, I mean, their IP, their intellectual property, their tech is kind of their secret sauce. So they spend a lot of money and time with patent lawyers and trying to protect that IP. Yeah. And we'll see if it's worth it. All right. Let's get to valuation market cap right now.

It's about $18.2 billion. Ticker is OCDO in the United Kingdom. If you're in the United States, it's OCCDY. On the OTC markets in the United States, trailing price to sales of five, trailing price to gross profit of 13.65. although i think there's there's some distribution costs that they're not putting into cost of revenue that should probably be in a cost of revenue for example in 2020 distribution costs were 900 million dollars but that is not including cost of revenue i if i was an investor in this company i'd probably make some contribution margin thing where you're including distribution

costs because i see no reason why that wouldn't scale with revenue um besides that they do a lot of adjusted EBITDA stuff that they're basically positive on that and they're right around break even, but there's not really any good multiples to look at there. They're not burning a ton of money, but as Ryan will get into on the earnings, they are spending a lot. They have a lot of capital expenditures. And then from a valuation standpoint, there are some shares outstanding headwinds. It continues to grow each year. So I'd expect that as an investor going forward, but Ryan, do you want to get into the earnings? Yeah. And I would also say that there is, you could probably look at the business on an adjusted EBITDA multiple of the

retailing segment. If you value that part, it's probably, I think they're doing roughly 200 million or that's what they're on track to do and adjusted EBITDA. So maybe, maybe, well, the build out of the OSP stuff does seem to be depressing what they, the profits could be. I would break it into two businesses, the core retail business, which is similar to a traditional retail business, and then the licensing of their tech and logistics. Which is way more early stage, yeah.

Yeah, and which is also, I guess maybe it isn't losing money, but I'll talk about sort of the first half and what we saw. So in the first half of 2021, total revenue for the group, the entire company, was $1.55 billion. That's up 21% year-over-year. 93% of that revenue comes from its retail business. And I think that part was growing around 19% year over year. And the EBITDA margin on its retail business is about 8.5%. And they're using a lot of that cash to fund that as well as some of the convertibles that they've recently raised to fund their other revenue drivers like the OSP and their international solutions, which could kind of be lumped together. And then they report gross margins at about 41%, but distribution and administrative costs make up another 36% of revenue. It's less, uh, actual just pure distribution costs is less than that. So yeah, they group that in. But if you go like to one of the footnotes on the financial statements,

you can find the true distribution costs. It's still a pretty high percentage of revenue. Yeah. And the, uh, the OSP financials are reported in a weird way. And so what, what it's going to show up as on the financials is UK logistics and solutions, I think is what they categorize it as. And that part, so they, they collect revenue, but then it's, then they basically match that with recharges, which the grocery is paying for. If they're collecting it from themselves, right? Yeah. So it's basically those two kind of X each other out. And the number you want to pay attention to is the fees, the fees that are invoiced. And so the actual fee revenue or total

fees for the first half of the year was 86 million. That's up 31% year over year. That portion had 41% EBITDA margins on it. So obviously just giving licenses to your platform is going to be higher margin than the core retail business. That's really all I had for the first half of 2021. Yeah. And I think they're going to be spending almost a billion in CapEx, I think. So there's a lot of capital investment that won't be on the income statement so what about balance sheet liquidity and yep that that goes nicely right into the balance sheet so they have cash of about 2.3 billion dollars and i will note their uh financial statements are all in british pounds and so you'll want to um do the conversion if you're looking for the u.s dollar amount um

and part of that 2.3 billion dollars has been raised a lot in the last couple of years they've raised both um convertible notes as well as just equity offerings and so over the past year they've raised uh over 1.3 billion dollars and like i said both stock and convertible notes and as we talked about that share count should probably continue to rise in the next couple of years due to these um due to more offerings they're spending a lot in capital expenditures and so as they invest in the business and as they try and grow particularly this um their services part of this business look for that number to be high cash burn should be uh high they also make some acquisitions from time to time and even have what they call um a ventures side of the business

where they are part of the business where they um invest in kind of small like one of the investments i saw was in a robotics company and so they do they do make investments out of that cash balance they have as well um but a fairly straightforward balance sheet uh otherwise yeah one thing they said on the conference call is that they want to, in the future, fund the new CFCs. I think they have like 50 contracted through debt when it's better. I think once they scale up some of the, they prove out some of the economics on some of these things, because they're still really in the early phases on some of those international solutions, they're going to hopefully raise it through debt. That's what they said in the conference call, but I don't know how trustworthy

you can see management there. All right, let's take the ad break and we'll get to the second out of the show 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 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 slash opportunities. Okay, welcome back. Next up, we have Anecdotal Evidence. This UK company, so we're probably not going to have much personally, but Ian, do you have anything for us? I'll just provide a little bit of anecdotal evidence for online grocery. I've never used it before COVID and then used it a couple of times during COVID. And whether it was pickup or delivery to the house, I found it to be really nice. I don't like grocery shopping. And so being able to just do it online real quick, pull up to the grocery store and get it put in the back of my car was pretty nice. And I expect I'll be doing some more of that going forward. And I

expect I'm probably not the only one who's discovered that over the last few months. How do you think of, have you had any issues? And I know this is just anecdotal. It's hard to pin it off to one person, but have you had any issues on like, you know, produce quality or, you know, items not being as good as you wanted, stuff like that? I haven't had any issues on quality. One of the issues I've had is ordering something and then actually not being at the store. And so then different, different grocery stores deal with that differently. Sometimes they say,

they like split up your order and say, Hey, you can pick up this piece here and then you can pick up this other piece like six miles away. And that's kind of annoying. That's been the only issue I've had is kind of orders or the selection and actually fulfilling everything that I order rather than rather than any sort of quality issues okay that makes sense brian yeah i don't really have any because okado i believe is only uk based and they're just white label in the u.s yeah yeah so yeah i've never used that i don't really like online grocery i'm not not tech savvy i guess but i would say if you're

looking at the company i recommend and always take this stuff with a grain of salt but looking at the YouTube videos that go through their warehouse because it's kind of cool to see how the operations go and they kind of take you through what the steps are. And the automation does look really cool. It looks a lot like an Amazon distribution center. Yeah, it looks cool. And it's one of those classic like business insider videos. They always like to post those and they have some good overview of how it works. And I think Okada Group has a good YouTube page as well. Sorry, Ryan, you have some. You get a good idea of the difficulty of the problem that they're trying to solve. You get a good idea of the CapEx required. Yes, for sure. Yeah. All right. I'll

hit one. I was looking at some online reviews to try to get to see like the competitors and stuff like that. And here are a few, and this is one just, this is just one, but it's indicative of a lot of the ones I saw. They said, quote, since the Marks and Spencer deal, the standards have fallen quite dramatically. Which I think that's a slight red flag. I think they saw a decrease in users on their Ocado retail thing. So that's a bit concerning going forward. I would be very concerned looking at that. That's something to research. And it also looks like they go through the same problems with all grocery delivery companies. There was a lot of complaints on bad quality, things about to expire, missed or wrong items, stuff like that. That is a little

bit concerning seeing that when Ocado, their whole thing is that we're not going to be like that because of our automation. If that doesn't get solved and people are still complaining about that, it's definitely a concern for me. All right, let's go to future growth opportunities. Ian, what do you have? So I'm going to take a pretty simple one here.

But honestly, I think just improving kind of what they've been doing and just trying to expand more and more into these solutions, both in the UK. I think the UK makes more sense to just continue to try and expand there because of their familiarity with that market. And I do like a lot of the international deals that they're doing.

But I think as online grocery continues to grow, that just provides a good tailwinds that they just need to continue to capture that market. And I think there's a risk in getting too spread out and too unfocused about what they're doing. And I think as far as much as they can, just continuing to grow that piece of it and staying. Because I fear that if they take their eye off the ball, they're going to miss these tailwinds that really are helping propel them forward. And so, if they can really focus on grocery, continue to expand their market share within the UK, and continue to expand the adoption rate, I think that's the primary growth opportunity that they should be focused on and that investors should also be focused on. Yeah, Brian? Yeah, sorry. I'm looking up a figure here to see their customer count. And it looks like their active customer base declined by about 15% from 2019 to 2020.

Yeah, there was some chart that I saw and I was like, oh, yeah, I don't have the exact numbers. But yeah, that doesn't sound great. Yeah, and so I'm kind of torn on my future growth opportunity because part of me is saying that for the long term, a great growth opportunity is that the logistics and the tech of being able to sort through different items and inventory could apply to other verticals beyond grocery. But I think there's still room for them to improve on the actual grocery in the short term. And I don't think they should try to spread too thin. I don't think they should go after a whole bunch of different verticals at once because then they're going to lose sort of their core customer value proposition. And I guess maybe we saw that with the customer decline. They have a lot of projects going, like 20 maybe.

Yeah, that does. So that's kind of, I guess, maybe a potential low light for me. But the 95% on-time delivery, continuing to iterate on that and getting closer and closer. Obviously, the logistics stuff, they're going to learn as they go. And if you listen to – I went and listened to a podcast with the old CFO, and he talked about the evolution of the company and how it's constantly gone. You learn as time goes on all the different problems you're going to have, and that's a testament to the logistics issue that they're trying to solve. um so just continuing to kind of improve that out and then maybe long-term applying it to other verticals yeah for sure i'll hit mine i took this the easy one the international solutions this is

the one where they're signing a ton of partnerships for the cfcs uh which is the customer fulfillment centers i think or you know those are just the third party things uh if you see cfc that's what that means they have the big deal with kroger and then other grocers around the globe they're seeing rapid revenue growth there. And it's going to be slow, but it's almost like it's really booked to happen as long as those grocers have the demand that they're expecting, which is nice. It's kind of like, it's almost like a real estate thing where you know that you're going to have the demand, you know, you're going to have that income stream coming in. And that looks like they have, if the number is right, from what I remember, about 50 of these CFCs contracted to be built.

So a huge pipeline there. They're going to build out, I think, only five this year and nine next year uh so that it's slow to build those out it requires a lot of capex um i would be interested to see what the true unit economics of these are at scale because it's kind of unknown um if they're strong that's that's a great opportunity here but that is definitely a risk where and we'll probably this will transition well to the highlights and lowlights it is unknown whether these billions in spend is going to actually help and get a good good roi here but let's transition to highlights on lowlights. Ian, what do you like? What do you dislike about this business? My major highlight here is that the business just makes sense to me. It seems like

a fulfillment platform for these groceries. Sorry, these grocery stores is a needed service that more and more people are desiring good, efficient, fast online grocery. And so to the extent that they can provide that service to grocery stores across the world, I think that that business model makes sense to me um the other highlight i have is just the lucrative contracts like this they like you discussed earlier brett they don't have a lot of we don't have a lot of information on what those contracts look like exactly but i have to imagine that they're um it's a major win to get kroger on board and some of these other grocers and to be able to create that relationship and start to build their business through these contracts i think is a big

deal and should pay off for years to come and kind of increases their advantage and both in prestige and in switching costs, I believe. I would imagine that these contracts make it so that these grocers would like to stay with Ocado for years to come. A couple of low lights for me, I'd say the big one is competition. There's a lot of rapid delivery partners, both in the UK and around the world. And so I think it's yet to be determined exactly if there's a major winner there. And there's just a lot of competition there. And so the margins are fairly low. And you have to provide a lot of services and a lot of speed and efficiency and cost savings for people to really win those markets. I'm worried about the patent technology or how much they are

focused on their patents. Whenever there's a business that sees patents as essential, that makes me a little bit worried um just because i feel like there's so many ways to to work around that but that shouldn't be the prime i don't want that to be the primary focus of my management teams in most cases i'd rather have them focused on execution rather than protecting intellectual property and they seem to both both with the lawsuits against the former ceo and against um another firm i believe it was based out of sweden um they really are trying to they're they're it seems like they're exerting a lot of energy to protect their patents when I'd rather see them focused on execution.

The other low light I'll have is we haven't seen a lot of competition in the platform and their services piece of it. And I know it's lazy, but I wonder about Amazon because it seems like with Amazon's logistics expertise and their fulfillment centers around the world, that just like they've created this third-party seller platform for sellers and distribution on Amazon more generally, I wonder if at some point Amazon could transition into more of this fulfillment, more widespread for SaaS service as well. It seems like the grocers may not be interested in that because of competition with Whole Foods and Amazon. It's a grocery anyways, but I don't know. There's a little bit of an unknown competitive landscape out there, and it concerns me that that could be a problem. Yeah, when I was looking at competition and researching that, Amazon was definitely the first big threat I thought of, at least in the United States.

Brian, what do you have for highlights and highlights? Well, one of the big highlights is the Kroger deal. I think that's a huge vote of confidence, should be for shareholders, but also for potential next grocery customers. I think having that relationship with Kroger gives new customers that vote of confidence as well. highlights for me, the barriers to entry for a business like this seem really high. And we talk a lot about, well, who else can do this for me, Amazon and Walmart, who else will do this? Not a lot of people. The only people that I think should practically spend money on this probably are Amazon and Walmart. And we saw last, I think it was two years ago, Amazon bought

a logistics company uh for their whole foods deal and they made it exclusive so they that that logistics company or the robotics company had uh deals with a bunch of other retailers in place and they got rid of them and made it exclusive to amazon so i don't i think the threat of them licensing that stuff is low i would see amazon or walmart not being very oh they're not and Retail agnostic, I guess, is maybe the word. Yeah, yeah. Well, Amazon bought out Kiva Systems. I don't know.

I think it was longer than two to three years ago, but that is correct. They have very similar. It's not like the top-down thing with the things on top of the ceiling, but it's very similar sorting items with these little bots. It's very close to what Alcada is doing. They're kind of in a precarious spot where if you're the big retailer, Do you really want to license your platform out to help your competition? Yeah, that could prove an opportunity for Ocado, but we'll see.

Sorry, keep going. And then also I would say that the hardest part of their – this seems like a really difficult business to create, and I think the hardest part is kind of behind them for Ocado. They've been able to raise capital. They've been able to build out the fulfillment centers. I think that the CFO, the ex-CFO, when he was on this interview, he was talking about they had a few make or break moments where they were building out their second fulfillment center and they broke through. They raised the capital they needed and that's kind of behind them. And now they have enough cash and proven, I guess, not great economics on their retail business, but some adjusted EBITDA in there. um low lights for me i think they're i think they're going after too many verticals right

now they're they're really kind of taking a horizontal approach and it feels like they're spread too thin especially and they're also trying to vertically integrate in this one specific thing too so it's like you're going after so many things yeah and it wouldn't worry me if active customer count didn't decline in a year when i would have thought it would be essential Like so many people would be going to a service like this, an active customer account declined. It feels like that has to do with the quality of the product that they're getting. Or they weren't able to meet the demand.

It could also be it as well. Well, yeah, I wouldn't be concerned if a company like Amazon or a huge company that has established cash flows is doing all these other bets. But for a company like Ocado to have all these like robotics, 3D printing, vertical farming things, they have an autonomous vehicle thing. I don't know. That's a low light for me as well. Highlights for me, I agree with what Ian said. I think the customer lock-in with this third-party thing is strong.

I'm speaking not for Okada Retailer, but for the OSP here. I do like the third-party solutions thing. If they can get solid unit economics there, I think that's a good business, but they got to prove it out. Low lights, this is going to require billions in R&D and CapEx. i'm not sure what the return on that spend will be um i think it could be good but it's also if it's not like that's just it's just a zero um or you're not getting any value created to shareholders um okado retail is not a business i would really want to pay up for um it doesn't

seem like a good business and then i do not like again we already talked about this but like the quote, other bets stuff, I would be concerned about them scattering their focus. Those are the big concerns I have. Let's move to bull case, though. Ian, what do you think has to go? What do you think has to happen for this to be a good investment going forward? Yep. I think the major thing is they get first mover advantages, and it leads to OSP becoming the dominant platform for these customer fulfillment services. And retailers around the world or grocers around the world use that platform um and that's dependent on them providing enough value that grocery chains around the world choose to use them rather than build their own

in-house solutions or cobble together some other solution from a variety of providers so that for me is what really makes this a winning investment would be osp just really becoming a dominant platform yeah ryan yeah i think osp fee revenues need to reach probably a billion dollars for this to look like a great investment. And maybe beyond that. With good margins. Yeah. It looks like the margins on OSP are pretty good. The other thing right now, I mean, it says like 350 something million, but I would imagine right now they're probably doing somewhere around 200 million in revenue, close to that on this fees for the full year

21. And a lot of it's contracted out. Yeah. So hopefully it'll just steadily grow. Yeah, I would. And that number might be wrong. So I guess don't quote that. But if you're just treating it like a retailer, this is a premium valuation, like 100 percent. Most retailers do not trade a five time sales. But this OSP element, if it becomes a much bigger and bigger part of the business, that's the bull case. Yeah. That is a huge advantage and every grocery retailer wants it. Yeah. And I think if you're going to be an investor in this company, you can't expect rapid growth just because you'd have to maybe underwrite double digit growth for a long, long time because there's just no way to build out these things rapidly. It's going to be, you know, five a year, 10 a year or whatever. You can't just onboard all these customers all at once. It's a complicated process. It reminds me of the quote. There's like that Buffett quote of you can't have a baby in a month by getting nine women pregnant. This is one where it just takes natural time. And if you go too fast, you could also end up messing up your own business.

Yep. Yep. And also he also did say that businesses that require a lot of capital perpetually are not usually don't, you know, they're not the best businesses in the world and they don't deserve a premium valuation. So, that probably leads into the bear case we're going to talk about next. But mine is, you know, the Kroger Aeon, which is what they're doing in Japan. It's very similar to Kroger, I think, although Kroger is their biggest partner. And then there's a Kohl's contract in Australia. I do not know what Kohl's is, but I assume it's a retailer in Australia. If those go well, I think that's going to lead to us, you know, the investment could be fine. It leads to more adoption from other grocers.

I do not think the valuation would be a concern if that works out. Because if they can really prove the value to Kroger, Kroger's margins improve, or it's more efficient, they're providing better value to their end customers, that would probably entice other retailers like maybe Target or, gosh, I don't know, some of the other ones out there, even in the US internationally, to try to go after this. And that could hopefully build some momentum for the business. Let's wrap things up with a bear case, though. Ian, what do you think could go wrong here? I think the risk here is that since grocery already has such low margins, that Okado has a tough time carving out a lot of value there and earning enough on these contracts and proving the value enough that many grocers end up signing up for it. And so if they don't prove that value enough, I think it doesn't ever become widely used. And even though it's a platform, the margins aren't very good for the customers that they do have just because they keep getting squeezed and there becomes more competition in the space, both from in-house solutions and from other solutions similar to Lakato that could develop in the next three to five years.

And then I think the other risk is that there's consolidation in the grocery industry and the major players are amazon and walmart and maybe maybe one or two others and that all the major players decide to do their fulfillment in-house which kind of leaves okado out in the cold yeah that's a concern amazon amazon's a big concern here ryan uh what's your bear case my bear case is that the uh this idea of the horizontal approach or attacking all these different verticals leads to sort of the decay of their core business and we've seen it if customer to mature and continues, that's a big problem because I think that retail, their retail operations are buying them both time and runway financially. And so I don't want a company that

has to constantly raise just in order to promote that OSP part. I'd like for them to be able to finance it with their retail business. That's sort of the bear case for me is that that starts to decline. Yeah, that does add a risk there. Mine is that it's really just a standard like delivery company and fulfillment center that's masquerading as this high-tech stuff. If all this stuff doesn't, all the high-tech investments they're making, which is the core stuff, and on top of that, the millions of dollars they're spending on robotics. They bought two robotics companies, either... I think they probably closed at the beginning of 2021, but they were announced at the end of 2020. They bought two robotics companies for almost $300 million. That seems

like you got to get some return on that. And they're doing some stuff with autonomous vehicles, which is incredibly risky. They're doing some stuff with vertical farming, which is very risky and unproven or vertical farming. So it gets a little more unproven, but that's just, you know, that's, that's a lot of my stage yet. They shouldn't be doing that. Yeah. That's my bear case. If all the tech stuff doesn't really provide value, then this doesn't work. I'm not saying it doesn't, I just don't know. And if it, and if it, if they don't actually provide value, then this is not going to be an investment, especially at five times sales. Yeah. The other, I mean, the other bear case really becomes, right now they're valuing, I think the market is valuing

that that OSP product becomes extremely successful. They had nine partners last year. They have nine partners this year. They have 10 now. They have one more. They added another one. They have to add a lot more for that too, for the valuation to be warranted. Yeah. Kroger can provide a lot of value though, but that's not everything spending within their existing customers. Yeah. They have 50 CFCs contracted out. So that's promising, but again, they got to make those work. And if they're not really providing value, I'm not saying again, we're not saying they don't, but that is the risk here. All right. More or less interested, Ian, what are your thoughts to wrap things up? I'm a little less interested. I find the business interesting, but at the

valuation as you were just talking about it is requiring osp to be successful to some extent um the i think this would be a no-brainer investment if this was being valued like traditional brochures um just because you'd have that that value in the okada retail and and you would be getting the bonus of osp and even at somewhere in between that valuation its current valuation would probably make some sense but where it is now um there's enough risk factors that I just don't see. It just doesn't quite meet that risk reward threshold for me. Ryan? I'm a little less interested. I'm not sure I have a good enough grasp on how valuable that OSP is to grocers around the world, especially their specific solution. I mean,

the solution in general, that automation is probably great, but I don't know. Yeah. We're not saying it doesn't work. Just what is it worth it? And then there were some yellow flags their annual report was 300 pages of fluff it took me too long to figure out what this business does a lot of buzzwords that's the opportunity and that might just be like that's just maybe that's european annual reports in general i've had some struggles with those but it really felt yeah i i don't know it there were some just yellow flags i guess the other thing was the cfo interview there was a lot of talk about like proving short sellers wrong and talk about the stock price that's how he is the cfo and they had to do raises based on the stock

price but uh i don't know just a yellow flag and then not in love with the valuation yeah i'm less interested i think it's just too hard to understand this it's not hard to understand it's too hard to understand what value they're providing it's hard to understand whether the okada retail segment is sustainable and profitable and won't have perpetual CapEx that's going to not have cash actually distributed to shareholders. That's my other thing.

I have no way of knowing what the economics are going to look like a few years now. They don't paint a very clear picture of that. Yeah, you can maybe try to make some model up, but I have little confidence that that's what makes me less interested as well. They're trying to solve hard problems,

which would be great. Hopefully they can provide some value to society. um are they going to provide value to shareholders though i'm uncertain there and at a premium valuation that just it's not going to do it for me um it'll be fun to watch this company though i could see them getting bought out by amazon if amazon wasn't like barred from buying up companies anymore this seems like a perfect amazon buyout maybe maybe maybe what's our stock for next week ian i'm thinking uh fulgent genetics next week it's been a stock that saw a lot of, um, hype because of like, I believe some COVID-19 testing and they, and they, um,

grew a lot in 2020 and hit a peak like many other companies in February or March of 2021 and are now trading about half the value they were back then. So, um, it was a, it was a recommendation from someone on Twitter. And I, I think it's worth taking a look at about a $3 billion company today. Can you say the name again? I was about unclear what the first word was. Yeah. Fulgent Genetics. So F-U-L-G-E-N-T, ticker F-L-G-T. All right. Perfect. Should be fun. Let's hit the disclosure to wrap things up. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan and I 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. do you wish you could just hit skip on the worst parts of your life you know the same way you can skip an ad i get it i'm siaya and i live in ice cove i've made some questionable decisions that didn't end up the way i planned and today i'm still figuring it out somehow things usually get worse before they get better. Apparently that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem.