Chit Chat Stocks - Warby Parker (WRBY) | Not So Deep Dive

Episode Date: July 26, 2022

Warby Parker offers various eyewear products. The company's products range all the way from eyeglasses to anti-fog lens spray. Warby Parker was founded in 2010 in Philadelphia. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Warby Parker. Enjoy the show! Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (1:36) Industry | (10:57) Management & Ownership | (15:29) Earnings | (21:28) Balance Sheet | (23:34) Valuation | (25:15) Our Analysis | (26:45) 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

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 recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode on Chit Chat Money. If you are listening to this, that means you are a CCM Plus subscriber. So thank you to the few that have started out with

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That is also the benefit. Ad free. Yes. That is the benefit of the subscription model. No ads for these episodes. And we're talking Warby Parker. if anyone doesn't know it is a glasses company uh new age ddc as brian will talk about in the what they do section and the history they uh they got a lot of good definitions for themselves

right i guess that's a segue to the what they do yeah according to the first line of their 10k they say warby parker is a mission-driven lifestyle brand that operates as the intersection of design technology healthcare and social enterprise and i i mean they literally sell glasses um that is the that's the crux of their business and contacts and contacts contacts are two percent of their revenue so um yeah they sell contacts as well but you know they sell eye care solutions but i don't know why they have to have that that long unnecessary definition for what they do um basically they they operate an omni-channel model that sells a variety of eyewear products. You alluded to it anywhere from prescription eyeglasses to sunglasses or even contacts. They also provide

eye exams, which I'll talk about in a second. And they cut out the middleman as opposed to the traditional eyewear, eye care, eyewear industry. You have a lot of the brands that choose third-party retailers so think um what's a good competitor here the retailer around where we are located sunglass hut seems to be kind of a big one and there's also you could say costco right and basically anywhere where it's like a glasses store but they're not you know the people making the glasses themselves yeah and so warby parker goes direct to consumer they've cut out that middleman and so they're able to sell their items at a discount to almost all of their competitors other than maybe some of the really cheap products. And they design their glasses

at the New York City headquarters. So they have a headquarters based in New York City, and then they have contracted manufacturing and logistics partners all throughout the supply chain, various different partners to kind of do the shipping and building for them of those products. So they are primarily a design, a glasses design and selling firm. And then there's basically two ways you can buy. There's online and then there's in-person. So online, you can either use Warby Parker's website, which is warbyparker.com. You can use the mobile app and customers can easily browse and purchase their eye care solutions from there. And then to ease the burden of buying online, Warby Parker offers free at-home try-ons. So they'll ship you a box,

you can try it on and you can send it back or you can keep it. Think sort of like a Stitch Fix model in that sense. And then there's also virtual try-ons where they're working on this sort of AR solution where you can kind of try on the glasses with the mobile app. Did you test it out? I didn't test it out. The commercials seem very cool. It looks like it worked extremely well. And that seems, I don't know, interesting product. However, it's like a totally different, they had to get some augmented reality stuff correct. So it's like a totally different, even business and R and D they got to go through. Yeah. And then on the, uh, customers can also on the online side, receive virtual vision tests, uh, and receive prescriptions

that way. So they have that sort of telehealth offering, but as for the in-person part of their business, Warby Parker has a 169 physical company owned retail location. So no franchisees in this model. Um, and they're scattered across the U S with, I think there's three stores based in Canada, But I think it's 37 states that they operate in. And the majority of these stores, Warby Parker actually has hired optometrists to help conduct in-person eye exams for customers. That really helps. And that's my future growth opportunity.

It helps convert more glasses sales. And then the last thing I'll say, the retail locations and the founders on a podcast with Guy Raz, the How I Built This, talked about this advantage of having retail locations also serve as a good marketing and brand building tool. So, in places where they have retail locations, they saw their e-commerce sales or their online sales grow as well. So, it kind of has that marketing effect of having a physical location. Kind of like the similar to the very successful, uh what you might call it i mean not all of them are d2c or online native but the similar

apparel brands that have done a lot of success with omni channel um yeah lululemon abercrombie and fitch i guess would be another one that's had success lately i don't i always forget the industry because i don't know any of the brands but yeah i think that am i forgetting anything on in terms of the business partners that cover most of it it's it was a 60 percent maybe it was 65 percent retail uh 65 of sales came from retail and i think it was 35 online and then it flipped during covid uh and has since reverted back a bit yeah did you talk about they're exploring insurance there's a lot of place there's a lot of categories they're exploring um and i guess maybe we should also mention that they have like optometrists like you said in the stores but not

all of them have them so they're really trying to and there's some local regulations and stuff like that to get basically the eye exam people i know everyone who wears glasses knows way how much this works better than me but both of us i don't think wear glasses or contacts so i don't know the exact details of how it works but basically you want a lot of people want that eye doctor there and then they're going to buy it right after so they really want to get all these doctors or just care providers in the stores um because that can give them without that it hurts them versus say a traditional one that has that. Right. And in terms of history, Warburg Parker was started by four friends. So Neil Blumenthal, Dave Gilboa, Andy Hunt, and Jeff Rader. And they

were all attending the Wharton School of Business at the time. And the idea was the founders tell kind of this funny story where they used to lose their glasses all the time and it was very costly to replace, sometimes $500 for a pair of glasses. And so they were all kind of complaining about this and they were wondering why it's so expensive. And they figured out that most of the eyewear brands were all owned by Luxottica. And that was sort of the epiphany. It sounded like they were pretty entrepreneurial people. They had gone to work. They came back to study at Wharton and they wanted some sort of a business idea. And this is what they came across. And so they thought it was a market that was easy to disrupt. They pitched it in a business class competition. I think they

failed or they came in second, went to the semifinals, I think is what it was. And they ended up starting the company with all, pretty much all their own money, $120,000 altogether. And that money gave them enough funds to hire a manufacturing partner who they had to pay upfront. Most of it was paid upfront. And then they also hired a PR firm, which ended up being a very good choice on their part to kind of get the word out about their brand. And they They talked about how they used to consult with all their professors about best ways to go about it and ask them for kind of guidance. And so the model was initially entirely online and the glasses costed, I think it was $95 at the start. Still, that's their base cost today, the lowest cost.

And then the PR firm got them featured in GQ and Vogue magazines. And apparently that was sort of the big launch. They knew they were going to be featured in that. And as soon as those hit, the sales started to roll in. and they sold through all their inventory really quickly. But the demand from that allowed them to raise several more rounds of funding from there. And they continuously raised money from there on out. By 2015, the company was valued at $1.2 billion. And in 2020, the company raised a Series F and Series G. Yes, that's right. Series G private funding round, valuing them at

$3 billion. They went public a year later. So almost a year ago now, September, 2021, at the time of this recording via a direct listing. And so despite the 2020 private valuation of $3 billion today, the market cap sits around 1.4. So. Hey, once they get this, we'll talk about SBC stock-based compensation later, that market cap could creep back up to $3 billion just in that alone. But it's, yeah, I mean, they are, it's been basically knocked down, what, 80%? Yeah, I mean, there's not any IPO that is not affected because I think the IPO market is trailing, I haven't checked the numbers recently, but trailing the S&P 500, which is also down like 20%, it's trailing it by like 30% in the last year or so. So yeah, it's not surprising that they're down. What are they? 77.6% all time. So really tough

start for them. But hey, who knows? That means their IPO, well, I guess they didn't raise money. It would have been better if they raised money at that high price. But I'll move into industry and landscape, as you alluded to, kind of interesting. And there are some unique things that investors should know about. First, though, I should note that the majority of these metrics and estimates are from Warby Parker themselves. So again, they're probably right because it's an easy industry to estimate, but they might be a bit optimistic. So the US eyewear market is valued at $44 billion a year. This is the US and Canada. They are the only countries Warby Parker says they're going to focus on for a long time. They actually had this asked at their analyst day.

They had a strange Q&A session because they didn't do Q&A with analysts. They did Q&A with their IR team, which those are preloaded and it's coming, so they're very boring, but they did ask about that, which I thought was nice. And they said international expansion is not on the docket basically at all. I mean, not at all, but for five years at least, something like that. Now, the global IOR market is valued at about $160 billion. So I guess if eventually they go international, there is a large market opportunity and it has been growing steadily for decades.

And the reason is as countries generally have gotten richer, more people have the freedom and the money to focus on things like getting glasses. Now, according to the 2021 10K, only 8% of the eyeglass market is e-commerce right now. And that is likely because like Ryan mentioned, people like to go into the stores, even people with Warby Parker go into the stores a lot. So it really is an omni-channel model because a lot of people like in-person try-on, in-person vision tests, all that good stuff. The vision insurance market, which I'm not sure if that's included in the global eyewear market, but either way, I think it's important to look at here. That is valued at $54 billion, and that is according to

iBizWorld. This is a market that Warby Parker wants to go after long-term, but it's not the key part of their model. I think they kind of want to have that as an add-on maybe. They've talked about it. I haven't seen any good numbers from them, but again, they talk about it. So definitely something to note. So if we go to competitors, there are two huge ones, and that is Essilor Luxottica, like Ryan mentioned before, and VSP. So EL, as I'll call Luxottica, owns brand lenses like its namesake one, Ray-Bans, Kodak lenses, transition lenses, and many many others it also sells a lot of equipment to optometrists sells and it also sells uh brands like Ray-Bans like okay so there's I guess a bunch of different categories within

these so there's like the lenses part and then the actual glasses and they own uh so like there's you know they sell Oakley and stuff like that for the actual glasses and these might be sunglasses versus eyewear so they compete in both markets I guess Warby Parker really doesn't compete in sunglasses. But lastly, and this is an important one, they own tons of retail shops like Sunglass Hut and Vision Direct and many, many others. So this is the legacy player that Warby Parker talks about. And while SLR, I don't know how to say the name, EL is not technically vertically integrated because they own all these separate companies. Warby Parker is trying to repeat a lot of what they're doing within their sole brand with this vertically integrated model, if that

makes sense. And yeah, they're the one that really Warby Parker is constantly talking about or indirectly without saying the name. And then VSP is important because they are a global vision care provider with over 85 million members. Long-term, Warby Parker wants to disrupt them with its vertically integrated model. And again, even while they don't have, I don't even know if Warby Parker is going to go directly with the vision insurance because it's a whole new market, stuff like that but they have talked about partnering um they just partnered with blue health uh blue cross blue shield excuse me yes for federal government employees so it's really important because people get that discount they don't have to pay those you know full prices for

their eyewear if they're on this insurance getting to partner or even doing it themselves can be a huge advantage and that's something that word park is going to have to go after so to sum up the industry part, there are just a few unique things versus just selling, say, regular sunglasses, selling apparel, selling shoes, anything else online. Eyeglasses have some specific things, which makes sense because they're prescriptions. All right. Management and ownership. This one, I guess this was a fun one to study, but also probably the most disappointing section because I liked a lot of else about this business. They have co-CEOs, David Gilboa, I think it's Gilbauer, Gilboa, and Neil Blumenthal.

These guys were both founders of the company. In 2021, they each got a $450,000 base salary, close to $100 million in stock grants, and $3.5 million in options. And that's each of them. And now the $100 million in stock grants was based on a long-term stock grant plan, similar to, I guess we've seen that with Tesla. You've seen that with Dropbox, a few other companies, and it's getting much more common now. And basically if Orbit Parker's stock hits its first tranche is $47 and $75 a share. And then the upper tranche is $103 a share. If they hit

these for say, you know, a certain time period, they are going to get these stock grants released to them um yeah 100 million dollars worth which is a decent chunk of their revenue well uh yes it is but if if they hit those tranches it doubtfully would be yeah they would have to hit certain incentives i imagine right um what do you mean like uh like if they get to the let's say it gets to 100 a share i imagine it's going to be a smaller percentage that that options payout would be a smaller percentage of revenue, I would think. Yeah, most likely. And Ryan is saying that because the current stock price is $12.20. So a lot lower, but still just, I thought that was a big thing to look on. If we look at the CFO, his name is Steve Miller, and he has been with the company basically

since the inception. So not really a founder, but pretty close to it. And in 2021, he got $5.9 million in total compensation. They are pretty, you know, they like paying people well. And then we also have Jeffrey Rader as a co-founder. He is on the board of directors, but he left actually to start Harry's, which people know about, a sizable CPG business. Outside of a member from General Catalyst, which is a VC company, it looks like all of the board of directors are basically made up of mercenaries, which are just not random people, but people that sit on a lot of boards. I remember there was someone from the Harvard Business School, people that maybe are retired business leaders uh stuff like that and that you know that's excluding the executive team because

i don't really count those i'm looking at you know independent directors and then if we look at compensation for the board some members of the board of directors are getting paid 800 000 to 1 million dollars a year that's so ridiculous that is very very high uh for what well the compensation committee so yeah they're paying the board of directors extremely well typically it's much lower for us company this size it's probably closer to a hundred thousand typically they're getting paid millions in compensation to comprise the compensation committee well yeah no i mean yeah it's not there that's not to set theirs it's to set the executive compensation which you know that's been pretty healthy uh there were and this isn't even before i get to the yellow flag so

there were three yellow flags that i saw and that basically when i say yellow flag it's not It's like something that concerned me when looking at the proxy statement. First yellow flag, annual bonuses are based on revenue and adjusted EBITDA targets. I don't like that because we've talked about it plenty of times on this show, when your target is adjusted EBITDA, that disaligns you or misaligns you, excuse me, from creating true long-term shareholder value. Second, the huge stock grants went to executives that, and this is important, already have skin in the game. So if you look at our shareholder table here, Blumenthal has 6.4% of the shares outstanding, and Gilbao has 8.1% of the shares outstanding. I think it's Gilboa. Gilboa? I don't know. Bilbao? Isn't Bilbao spelled like? Bilbao is A-O. Oh, it's A-O. Okay. Okay. Gilbao. Gilbao. All right.

like I said, they both have more than 5% of the company. So they already have a lot of skin in the game. I don't like when they're basically giving themselves more stock because you're supposed to use these long-term stock awards basically for mercenary CEOs who don't have any stock to get them aligned with shareholders. Blumenthal and Gilboa are already aligned. Then the last yellow flag I had was Blumenthal and Gilboa seem to have started a venture capital firm together back in 2019 that's a red flag not a yellow you don't think that's a you think that's a red flag yeah i mean there's those are what the co-ceos right yeah that's ridiculous yeah i mean it's it's not a good look the now we have the c the excuse me the stock ownership table which

uh i've been making putting together for the newsletter so you'll be able to read this once you get the newsletter sent to the inbox. But the big takeaways I have from that, because I don't want to just read off everything, is that Blumenthal and Gilboa have a lock on voting power combined. They're over 50%. Second big takeaway, most of the A shares of the common stock are tied up with either venture capital or venture capital style public investing firms like Bally Gifford. If we look on here, we got T. Rowe Price, D1 Capital, Durable Capital, FRM, General Catalyst, Valley Gifford. And then lastly, the company gives out healthy, like we've talked about, compensation to both executives and the board of directors.

I don't think we have to go any farther on that. Ryan, do you want to hit Ernst? Yeah. So I'll try to give the way I'm going to do this from now on, I'll give the last 12 months to kind of paint a broader picture and then try to specify by coming into the most recent quarter. So last 12 months, they generated $555 million in revenue. I believe they're guiding to $650 million for the full year, this current full year. But that's kind of top line. And then they have 58% gross margins and they are quite unprofitable. As for the most recent quarter, revenue was $153 million and that grew 10% year over year. They had, and I have some quotes, 15 million dollars in estimated lost sales due to omicron i don't know how they estimate that

they said they said omicron affected their retail sales i apparently at the start of around the new year is when a lot of people do these things so it's just really bad timing they have a bump kind of during the new year yeah anyway so they they thought that revenue should have been a little higher than it was. And then they had active customers increased by 18% year over year. So 2.23 million active customers in total. They have had really steady growth with that active customer base. And then they opened eight new stores during the quarter. So total store count reached 169. That's up 26% over the last year. They said in the next year, they're expecting to open, I want 40, I believe, new stores. So that is really a pillar of their

multi-channel model. It is not just a pure e-commerce business. And then as for cashflow, they had negative $10.3 million in operating cashflow. However, they are expanding store count, right? So there's going to be a lot of purchases of property and equipment. So $16 million in purchases of property and equipment that came out to negative $27 million in free cashflow. I believe their adjusted EBITDA figure was breakeven. So it shows the discrepancy. And this is not even considering SBC, which like we've talked about, they do, you know, pretty wildly. So, yeah, the balance sheet, the good thing about having a big venture capital backed business, the balance sheet is typically pretty easy to read. So Warby Parker has two hundred thirty point three million dollars in cash and cash equivalents and no true debt.

They do have a lot of lease liabilities for their stores and as well as headquarters. and then they've got some uh i believe they call them laboratories laboratories yeah they got weird names for stuff sort of like um like a tesla might you know they have that they name stuff strangely but yeah i forgot what they're they kept referencing laboratories and i was like what are we what are we even talking about here the we don't include that in our enterprise value calculation. I think most investors don't. From a quick search, lease liabilities in bankruptcy are basically, it goes to litigation as to whether or not they're voided. Yeah. And it's operating. So it's operating, right? It's not finance.

Yeah. And so we exclude that from the enterprise value. So it's really $230 million in pure net cash. The inventory hasn't increased too much over the last year, which I thought was a pretty good sign. And then just for context, they burned through $95 million in cash over the last year. So based on their current net cash position, that's about two and a half years of runway if they kept that burn rate. Yeah. And then with kind of COVID in their market, the US COVID, no one really cares anymore about it. They basically have two years to prove that they can generate positive cash flow, I would say, or at least consistently now that COVID's in the rear view mirror. All right. Valuation. This is another quick one. Market cap, $1.4

billion. Ticker WRBY, pretty easy one to look up. The technical enterprise value is going to be below the market cap here. But since, like Ryan mentioned, they are cash burning, I'm going to be using, say, price to whatever ratios because the cash on the balance sheet is probably going to use stuff. It's not going to be able to be paid out to shareholders. So why should I subtract it out. Now, three ratios I'm using here, and that is price to sales, which is at 2.5, price to gross profit, which is at 4.3, and then price to operating income, assuming they had a 10% operating margin, which I just wanted to put in there to kind of get a read on what their valuation could look like. I think it's best to do that when you have an unprofitable company

like this, and their price to operating income, if they had a 10% margin, is 25. You can kind of guess that price to sales times 10. Now, importantly, we mentioned the SBC. Let's put some numbers to that. They have 11.4 million potentially dilutive securities outstanding, or 10% of the current shares outstanding, given management's tendency to use stock as their form of compensation. I would estimate, or maybe if I was modeling this, and I guess we will be doing that for the bull and bear cases, I'd probably estimate 3% to 5% share dilution going forward to be safe uh we don't know if they're going to change their tone on this but most likely with companies they kind of have the same philosophy all right anecdotal evidence um

ryan what do you got i'm not a glasses wearer however both of us don't we don't have prescriptions but neither of us right i did see someone wearing sun their sunglasses yesterday actually the name kind of got brought up which is like oh what are those warby parker kind of thing And they did look pretty cool. They're sleek looking glasses, I guess. Like you could mistake them for Ray-Bans, honestly, at least the sunglasses portion. But the, I mean, the majority of their revenue, I'm guessing it's primarily eyeglasses, like prescription eyeglasses. yeah yeah looks like they just copied ray-bans um yeah the design's a huge part of their philosophy that's a lot where a lot of their r&d is going um and i guess it's important because it's going to be on someone's face if it looks like ray-bans and it's cheaper i guess it's and they're still high quality like my anecdotal evidence is if i needed the service of glasses i guess i'll call

it i would 100 go to them if after researching this company because you're going to have a discount and they have high quality products. Um, also I had, this is not real, but I wonder if all their employees are required to need glasses because at the analyst day, they had like 15 different employees come up and talk and every single one needed glasses. So I don't know if they're faking this or they're discriminatory against people who don't need glasses, but I found that very, very, uh, comedic. Yeah. Something I'll also mention, and this is not anecdotal evidence it's going back to an earlier point you made about the stock-based compensation on the latest conference call they said that optometrists so basically i don't want to get

this wrong but i believe it's eye doctors um like coming to warby parker or working for warby parker because of the mission and in quotes the compensation package that they get i'm wondering if a lot of the stock comp goes to optometrists. Oh, well, yeah, that could be good. Also, they need them. Eye care professionals. Yeah, eye care professionals. Yeah, well, they definitely need them to switch.

So if they got to pay them a lot, that might be the price of doing business. All right, future growth opportunities. What do you have for us? Yeah, so I've got two. So the first one is retrofitting existing stores to be able to serve eye exams. Right now, 115 of their 169 stores offer eye exams

and they've got a quote or i've got a quote here from the conference call it says 70 percent of glasses wearers purchase glasses from the same place they get their eye exam so they are trying to add these to as much storage as they possibly can i believe there's regulations around whether or not they can yeah there's some workaround we don't need to give the details here but they're trying to get some workarounds like i don't even know it's like a licensing the optometrist or something like that but yeah right and so just having it reduces the hurdle to transact i would imagine for a lot of these or purchase for a lot of these glasses wearers to just be able to go in get your eye exam and then instantly uh have products offered to you the other the other

future growth opportunity i have is expanding the in-network insurance relationship so this is another thing they talked about and they added blue cross blue shield the government employees segment of that this quarter, but even if glasses are still cheaper out of network, I think a lot of people want to use their insurance benefits or feel comfortable using their insurance benefits. So being able to include more and more insurance partners or vision, I think it's vision insurance partners should over time add more customers. Yeah. And it'll make Warby Parker even cheaper than the competition. correct and i guess another note is that that insurance aspect is kind of what has made the

legacy players so sticky because as we know when people are stuck with their insurance uh there's just switching costs and it creates a whole ecosystem that like we've talked about warby parker's trying to break or build their own with a cheaper model uh mine is i took the easy one and this is kind of just well probably the most important future growth opportunity opportunity to track, and that is opening more stores across the nation. Like Ryan mentioned, they currently have 169, and management believes they can get close to 1,000 in North America. Now, according to the company, again, Ryan mentioned this earlier, stores greatly accelerate market share gains in these new markets. They serve as free advertising, and they retain

higher paying customers. So it makes a lot of sense for them to try to gain store count like you know 40 to 50 a year if they have the cash to do so because um a lot of people first stuff in person here even if they have a sweet virtual try on stuff and virtual eye exams you might like to just do this in person um so i think these are really really important and especially with the retrofitting these are kind of easy uh opportunities to go after because they have the proven model, you open a store in another place, it is likely that it's going to do well because, um, you know, people wear glasses everywhere. So, yeah. All right. Highlights and lowlights, Brian, what are your highlights and what are your lowlights? Highlights? Uh,

the glasses look cool. Um, I know that might sound like a joke, but I think Warby Parker has found pretty solid product market fit. Uh, people like the glasses, the brand has stuck. It's good. It's a good brand or is it because all of their models that wear the glasses are super attractive? That helps as well. Yeah, very easily could be that. And I do believe that something they talk about is that word of mouth drives a lot of new sales for them. I believe that claim. And so that's a highlight for me. The other one is the pivot to a multi-channel model seems to be helping drive overall sales. I like that they weren't stuck in the... So Stitch Fix, for example, has a model that they are going to do solely online. They're going to ship you your fix.

And for anyone that doesn't know Stitch Fix, it's like solely online retail for apparel. I like that they made the shift and recognize that we can be sort of a multi-channel business and that the multi-channel is going to help drive e-commerce sales as well. So I like that. Lowlights for me, I've got a lot primarily around management. I think the company is still being run very much like a venture capital business um maybe not after the stock drop but we'll see yeah and there are a lot of red flags i encourage everyone to go listen to the interview on how i built this i think there's red flag red flags with management kind of it feels like oh oh we already made this like we already made it we're very successful we've made it and it's not this

focus there there does not seem to be a focus on driving value from here for minority shareholders do you want to talk about the charity stuff as well uh because i don't think we hit on that at all it is so this is a uh public benefit corporation i don't know exactly what all that entails but um it requires i mean they are going to be donating a lot i believe they donate a pair of glasses for every glass every pair of glasses sold yeah and they're giving like one percent of their shares to the warby parker foundation i think the big takeaway for investors is that they may be focused on um this charity stuff a lot and again like that's great for society but it's the the that capital is wearing society yeah well sure i mean there's a lot of poor

extremely poor people that need these glasses emerging markets but again it's the the dollars go somewhere, it's not going to use a shareholder. It's just something to watch out for. Yeah. And I sound like a grump saying that, but if you want to be very charitable with your own money, it doesn't start with giving it away or it doesn't start with losing it in stock returns. So the point is if you're trying to accumulate money, you probably want good stock returns. And I don't think, not to get too far ahead, but if they're giving that away, it's not coming to you as a shareholder. So it's kind of just priorities for them. The other thing, I do not like their use of adjusted EBITDA as a metric. They are not a

software business. They have very clearly made physical retail a big pillar of their strategy. They brag, as they should, about the new product rollouts that they have all the time, which that's great. However, that means depreciation is a very real expense for you, so you shouldn't be backing that out. If you've got the newest model of glasses and you've got some of the old glasses on the shelf and you're selling the new glasses for the same price that you would have sold the old ones, the value of the old ones is lower. That's the depreciation. It's there. So I don't like the fact that they back that out. Additionally, they give out stock like it's candy.

So the adjusted EBITDA figure is nowhere near the true claim on profits the shareholders are getting or the profits that shareholders could claim. Yep, that's a good summary. um although my highlights i think warby parker looks to be pretty clearly on the right side of uh you know innovators dilemma battle and for what that is is just why do you say that because you have the legacy model where you have okay the the old ones that have the ecosystem that are charging whatever 10x of what it takes to make these glasses and they have extremely long profit strong profit pools and they have a really strong moat like we mentioned because of basically luxottica and some of the other players now warby parker comes in kind of innovates with their

business model um is able to offer products for a cheaper price with you know solid um they haven't generated consistent cash flow but their gross profits are pretty good they have it they claim a contribution margin that i think is fairly legit And they've said so far that the legacy players have not been willing to or are unable, because of the ecosystem they're stuck in, to lower their prices, which I believe that's innovators' dilemma right there. So I think they're on the right side of this. I guess they haven't proven consolidated cash flow, but it looks like they can be profitable by offering much lower prices. um it seems like a perfect recipe if they can continue with this current model to continually gain market share now we talked about the problems with management and maybe they're

just capital allocation in general but i i feel pretty confident if they can continue with this and the competitive landscape is the same as it'll be they're going to continue growing market share now i also like the unit economics i think that's a highlight it looks solid they've been consistent um and with all the adjacent products that they're starting to offer which i would kind of count as mobile vision tests and try on they have the actual stores they have contacts and they have eye exams it's going to be harder for other e-commerce eyeglass companies to compete or even start at the same playing field so i think on both ends of the spectrum there's a lot to like there but now with low lights um we talked about the compensation compensation structure don't need

to hit that again. Ryan hit that nicely. The other low I'd have is the looming threat of augmented reality glasses as being the next big consumer electronics product. We know for certain that Meta, Apple, and Alphabet are working on them. If they go mainstream, what happens to Warby Parker's business? They become a reseller. Maybe Apple would buy them, but I doubt they need them to succeed. I think that is a huge low light for me. Yeah. All right. Let's move into bull case. Ryan, what do you think needs to happen for good shareholder returns here? Yeah. So I'll just put some numbers on it. Let's say their active customers grow at 15% a year for the next five years. Their average revenue per customer increases by a high single

digit percentage each year. So let's go with 7%. I believe it's been north of 10% in recent years. It was 12% in 2021. And then they reach a free cash flow margin of 10%. That's all, let's say, in year five. That would result in about $155 million in free cash flow, valued at 20 times. That's a $3.1 billion market cap, a little more than a double from today's market cap. Probably a lot less with SBC, but still, I mean, if you back that out, it'd still be nice returns. Yeah, it would be good returns. However, I think a lot has to go right for that to happen, especially on the margin side. Free cash flow, would you have 10%?

I think they have to cut a lot of costs to make that a real, to make themselves truly profitable. Not all their costs they can just get rid of. Yeah, I mean, especially if they're growing store count, yes. But I don't know if it would be a bad thing if they were free cash flow and neutral while growing their share count fairly aggressively. if they continue to get good returns on invested capital. I see it as a real risk of whether or not they can be free cash flow or cash flow neutral while investing in a store account. Because, I mean, it sounds like they pay their optometrists a lot.

It sounds like they pay their executives a lot. And there just seems to be corporate excess. Yeah. I mean, it's just like we just covered Chipotle. It seems they don't give an AUV or an average unit volume number, But Warby Parker needs to drive more customers to their stores. They could probably be cashflow positive if they stop paying their board so much. Well, yeah, I think some of it might be SBC. I don't have the exact details, but yeah, their board is like eight members and they'll

get paid a lot. All right. My bull case, fairly simple. They continue on their current path and they get to about 10% true operating margins. They are guiding for 20% adjusted EBITDA margins, but given their stock-based compensation and And true depreciation, I think, is a conservative number to go with about 10% operating margins. Now, free cash flow would be probably similar once store expansion slows down, but we already talked about how they might be having lower free cash flow as they reinvest for growth.

Now, at current prices, if they continue on this 20% revenue growth and they get that margin expansion, I mean, it's pretty easy to see where you get solid shareholder returns, even with 3% dilution a year. All right, Eric Case, what do you have? They aren't able to get near, let's say they keep hemorrhaging money or burning cash. I think raising more cash is going to be difficult in this environment for them. They probably don't have maybe some private or pseudo-private or pseudo-venture capital firms that could help give them some convertibles or something. But they

I mean They have two and a half years with their current burn rate And it doesn't seem like that's slowing It's accelerated over the last year Well Yeah, but they We'll see what happens in a full year ex-COVID We'll see

It hasn't looked great last quarter, but When they don't have any COVID excuses We'll see what happens Yeah, that's true Let's see, my bear case Two come to mind First, the stock-based compensation that we talked about really keeps them from generating true profits for shareholders if they keep standing over just to leave it up profitable or blah, blah, blah. Second, like I mentioned, sometime this decade, Apple officially launches their AR lenses and they crush the traditional eyeglass market.

Just look at what happened with the watch market when the Apple watch went mainstream. everything that wasn't um way more expensive than uh apple watch got crushed the non-luxury market uh you sure yeah the yeah i think that's a realistic bear case uh more or less interested i wanted to be more interested but with the management team i have to be less interested i actually had a lot to like about the business model and i do like this industry because it's durable so that was the main highlight for me i do like that durable combined with the kind of innovators dilemma thing that we discussed earlier however i have to be less interested unless um the entire executive team goes yeah i i am less interested as well

i i guess i'm starting to come around to the idea that yeah they're probably on the right side of the innovators dilemma and part of that is simply just that other companies charge too much for glasses and they're probably unwilling to sacrifice their profits uh to lower prices so and they haven't so far so there's nothing to show that you know and warby parker is a huge threat and they haven't yet so no reason to think it won't i just tomorrow i just don't like businesses that are run like private growth venture capital you don't like business that to run badly for shareholders. Yeah, that's simple. It's very true. And okay. So I know we went through a lot of numbers there on that bull and bear case, since if you're listening, you're

a subscriber, you can go and check that stuff out in the drive to see it more visually and the newsletter. Yeah. And the newsletter, it's a little easier to digest in that format. We want, yeah, we want the newsletter and the drive to be in conjunction with how these are listened to. So you can either listen to this show first and then read the newsletter or read the newsletter and then listen to the show. It doesn't matter to us, but we think it's really useful because that's what we do ourselves

to combine both of these, discussion and the written work. All right, stock for next week. Ryan, it is your turn. What do you got for us? We are going to be covering Uber next week. You and I don't really see eye to eye on Uber, actually. At least I think so.

We haven't, that may change after we look at the financials, but it's been pure, Well, your headline opinion so far. But yeah, all right. Uber should be a fun one. That's going to do it for this episode. Thank you all for listening.

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