Chit Chat Stocks - Why We Don't Own Coupang (CPNG)

Episode Date: August 8, 2023

This is our monthly Arch Capital episode. About once a month we will publish an episode that covers a company in the Arch Capital Investors Fund. These episodes will be modeled after our Not So Deep Dive episodes and will also be available on YouTube. Coupang Corp. (CPNG) is a major South Korean e-commerce company known for its rapid growth, emphasis on fast delivery, and navigating challenges in a competitive market. Brett and Ryan dive through Coupang and outline the investment thesis for why we don't own the company in our Arch Capital limited partnership. ****************************** What is Arch Capital? Arch Capital is a concentrated, long-only equity fund aiming to compound capital at an above-market rate. Arch managers are perpetual learners with a long-term focus that strive to build wealth with our partners through intelligent capital allocation. Learn more here: https://www.archcapitalfund.com/ ****************************** Timestamps Company Background | (3:25) Unit Economics | (15:35) Developing Offerings | (29:15) Cash Flow | (40:21) 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, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode on Chit Chat Money. My name is Brett Schaefer, and I'm joined as always by Ryan Henderson. This is our special monthly episode

where we go through one of our, we call it the Arch Capital episode, which is the investing limited partnership that we run. If you're more interested in any of the actual information on that, we'll have a link in the show notes or in the newsletter that we provide for each episode that we do on Tuesdays. But this one, we're going to either go through something we own or something we are looking at, and we'll talk about why we'd like it, but we don't own it or why we looked at it in past. And today we're looking at something that we don't own at this time, but we'd be very interested in owning it at the right price or given some other things you know depending on a certain circumstance or a certain scenario we would definitely own shares

and that is coupon the south korean retailer so ryan are you sure it's coupon i think so all right did you listen to the conference call i read the conference call i think it's coupon but could be coupang whatever i think people know it might sound like idiots but that's right no i think it's coupang the yeah we're going to be going through it if anyone doesn't know for these episodes we do a interview style where we interview each other basically start out with a discussion question ask one person and then we go through different sections we'll go through what the business is to kick things off unit economics management what we think the potential for growth offerings, their new initiatives, valuation work, all that good stuff.

And then come to a conclusion and what we're looking for or what sort of scenario we'd want to actually buy shares or where it would come up, where we would try to against one of the companies that we already own in our portfolio. I think it's a really fun way to do this because we can do it publicly with everyone else and get feedback. So I guess before we kick things off, Ryan, anything? I guess subscribe to the newsletter for the show notes. It's free.

It'll be in the show notes there or search Chit Chat Money on Substack. But anything else before we get started? I'll just add, this is the end of our Fallen Angels theme. So we do a different theme every month. Most of our listeners probably know that. But if you don't, we're trying to kind of center our focus around a single theme. Next month, we're going to have, I think it's Compounders or no. Cannibals.

share cannibals, which is companies with big outstanding buyback programs or a history of buying back shares. But today we're talking about Coupang. Most people probably aren't aware of this business unless we have a big listener base in South Korea, but I don't think we do. So can you explain how the business started and really what the business is, the different offerings they have today? Yep. And for reference, as a fallen angel, Coupang is down 63% since its IPO. So definitely fits into that category. I'll go right into it. Coupang was founded in 2010. So barely a decade old, and they were founded by Bong Kim. originally, given its name, the company was actually trying to create a Groupon-like business because at that time, that was one of the hottest concepts in the VC market.

However, a few years after its founding, it transitioned to an e-commerce marketplace model, which is still running today. And again, I will say, as of this writing, we'll talk about the international expansion, but the vast majority of the revenue is coming from the South Korean market. and once they transitioned to this model, they took it and they ran really aggressively. The company took strong advantage, similar to a DoorDash, similar to an Uber of the venture capital boom of the late 2010s. They raised a ton of money to push for growth and market share gains in the South Korean e-commerce industry. They got multiple investments from SoftBank. I think they got one point in a single investing round, a $3 billion investment from the SoftBank

vision fund. So it gave them a ton of breathing room, especially during the early pandemic days to get aggressive and invest for growth when there's that e-commerce boom during the pandemic lockdowns. And they really went for it and they've succeeded and they've really continued to grow this business. They went public in early 2021, raised $4.6 billion. I think it was the largest IPO of the year, or at least at the time when they went public in early 2021, it was the largest IPO of the year. And just for context, for anyone worried, since we're covering an international company, the stock does trade on US exchanges. If we're going to go through the actual business, Ryan, you have something to add? Yeah. The financials are also,

they earn in the South Korean won, but they report in dollars. So foreign exchange is a big headwind here, but just so everyone knows, it's very much, I guess, advertised towards American investors. And I believe it's headquartered in either Boston or Seattle. I think it's Seattle. I read it in the latest proxy statement, but that's kind of a fake headquarters because the real headquarters are in South Korea, but they're technically a Delaware corporation and have a United States-based headquarters. And yes, they are operating in US dollars, or excuse me, they report in US dollars, but they make all their money in the South Korean currency, which Ryan said is a headwind. But

who knows? I kind of think of it as a 50-50 chance of some volatility. It could be a tailwind. And we'll see. But in recent, the last two years, it's been a major headwind. So what is Coupang? It is perhaps the e-commerce business internationally that is most similar to how Amazon's retail business is run in the United States. And I would say, in fact, I can make the argument that Amazon has borrowed or stole a lot of Amazon's best ideas, but has actually improved on them. It is possibly the best run e-commerce business in the world. So here are a few examples of the company services. One is the classic first and third party e-commerce marketplace.

This is the everything store in South Korea where customers can shop an endless supply of merchandise, paper towels, diapers, the whole gambit. Anything you can want, you'll get it there. Now, the second one is going to be the Rocket Wow membership. So this is similar to Amazon Prime. So if we talk about Rocket Wow, just think the Amazon Prime type bundle for coupon members offers free shipping for only $4 a month. Members get things like same day and dawn delivery,

which means you can get 7 a.m. delivery the next day if you order by midnight or same day delivery if you order by 10 a.m. the day of. You get free returns, you get discounts on a lot of items, and there are currently around 11 million RocketWow subscribers versus a South Korean population of 52 million. So a huge portion of the country is a RocketWow member. We'll see how far that continues to grow, but versus their active customers, I think

they do have a long runway to continue growing the RocketWow service. Third one would be Coupang Play, which is a video streaming service similar to Prime Video bundled into the RocketWow membership focused on the Korean market, of course. Fourth, Coupang Eats, which is a food delivery service. Think about similar to Uber Eats, DoorDash is core stuff where we can order stuff from restaurants directly in the app. fifth rocket fresh grocery delivery think instacart amazon fresh something like that you can get same day delivery on rocket fresh if you have rocket wow so for only four dollars a

month you get same day grocery delivery i think that is an incredible value on probably the most shocking one as an american reading this and it is why or i don't know if it's the core reason wide, but it is much more popular to have grocery delivered in South Korea. And RocketFresh is a pretty large portion of Coupang's business. So this has been a very successful expansion of the marketplace. Another service they have is Coupang Pay, which are payments application that lets users easily pay for things on Coupang. They're a little unclear on this. We're not in South Korea, so we don't really know exactly how much consumers like this, exactly how much activity they're using on here,

whether they want it to be a virtual wallet, or they just have ambitions to make it a payments button or reduce friction on shopping on coupon. They're a bit opaque here on the long-term plan, but they say consistently that they're investing in this. So we'll see, but it's something to watch out for. Another thing they offer is MyStore, which is a Shopify-like eCommerce website creator kind of self-explanatory can help the coupon merchants here then the last one and the most important is coupon logistics i don't know if they call it coupon logistics but i think people will understand it if i describe it as coupon logistics similar to amazon or god right they say flc in a lot of their earnings or companies but yeah and that's not the entire

coupon logistics that's the service they offer the third party merchants which we'll get into So don't skip ahead here, Ryan. Similar to Amazon, Coupang has built a vertically integrated delivery network. So think the delivery trucks that Amazon has, Coupang does something very similar. They have their own warehouses. They have basically everything. Again, vertically integrated e-commerce business, meaning they do storage, transportation, drop-off, and returns. With no real presence of a UPS or FedEx in South Korea, Coupang was forced to build out its own delivery network earlier than someone maybe would have said to do because it's so expensive in the early days as a smaller company um i think though they would say that having that

disadvantage at the start was an advantage and has helped them over the long term because i mean they're they're clearly the best at this and they're clearly far away from every other competitor in South Korea. And given how different it is in this market, which we'll get into later, it is going to give them a little spoiler, we believe, a very strong long-term competitive advantage. For reference on building out this fulfillment network, in 2022, the company spent $825 million on capital expenditures. Almost all of its businesses, excluding digital stuff like pay or play, are run through the Coupang Logistics network so we think eats all the delivery stuff is you know it's so vital for having a better

value proposition or better you can have a better value proposition at an actual strong you know unit economics as ryan will get into later and now the company is starting to open up the network to other networks similar to fulfillment by amazon i know a lot of listeners have probably heard of fba fulfillment by amazon they call it flc which i i think is the same thing as fulfillment by Coupang. So the third-party merchants can start storing all their stuff at Coupang warehouses for a fee, probably. Coupang will be taking a higher cut of that revenue. And it should give them even a longer runway to reinvest in this business. And what gets me excited about this is that it is still very early days for the Coupang Logistics Network because fulfillment by Coupang or FLC

was only at 4% of units sold last quarter and growing, what was it, 90% year over year, Ryan? I don't remember the growth rate, but I remember they talked a lot about it and then they mentioned that it's very nascent in terms of the units sold that are sent through FLC. So I suspect that's going to be north of 10% at some point. Yeah, and I think they could just continue

to try to get more and more and more. There should be not an endless runaway, but a very, very long runaway to reinvest. I also forgot to talk about, which they don't break out, is the advertising business. So they have that as well. Again, they copied Amazon.

And Amazon provides a ton of value, right? And there's no doubt that Amazon, for the Amazon Prime subscription, if you're a core user, it's going to provide a lot of value to probably all of them, all the people that subscribe. But I think Coupang, even if it costs the same as Amazon Prime, offers an even better value because one, you have faster shipping times. So you have same day and dawn delivery, like I mentioned. You have free grocery delivery with reusable bag systems under the RocketWeb membership, which again, it only costs $4 a month for the subscription.

Third, you have frictionless returns where you just tap a button on the app and then leave items outside your door for pickup, which I think is also fantastic. I would love to be able to do this. And then you also get as a Rocko app member, this is a new one discount on coupon eats. I think it's a 5% discount. And then again, if we're going to go price comparison here, it is much cheaper than Amazon Prime at only $4 a month. So one, it's a great value. And two, I would say it's not a stretch to say that RocketWow has a lot of pricing power if they want to implement it in the future. Yeah, I agree. And I think we don't have any questions to discuss this, but I think maybe it's important to talk about the market that um coupon operates in so the south korean

market just as far as like the population goes it's very dense um and i think a lot of people probably know this anyone that's studied coupon has probably seen this touted as a big advantage and stuff like that but to give some numbers around it south korea is about one percent of the US size. Geographically, it's about 1% of the US size, but it's almost 16% of the population. So it's a very dense country in terms of population. And then I believe 70% of South Korea's population lives within seven miles of a Coupang Logistics Center. Now that's probably even higher percentage today because that was from the S-1 and they've added a lot more fulfillment centers since the IPO. So very dense population, which kind of allows them, we're going to talk

about the unit economics here in a second, it allows them to be a little more efficient and profitable than your typical e-commerce business in the West. Yeah. But I'll talk about the geographic stuff and the physical footprint of South Korea during the competitive advantage section as well. So we'll hit on that again. The Royal Canadian Legion is celebrating its 100th anniversary and now our change has a two dollar coin to mark this milestone honor the legion's mission to carry forward stories of service and sacrifice to new generations and their dedication to supporting veterans and their families from coast to coast to coast celebrate this enduring legacy find the 100th anniversary of the royal canadian legion two dollar coin today

So let's go to the unit economics, the financials here. Ryan, what are the unit economics of the e-commerce business for Coupang? How have they changed in the last few years? Because we had the huge disruption or really bullwhip effect of the COVID-19 pandemic. And any other interesting things for background for the listeners? Yeah, let's start with the market size. So as Brett mentioned, there are roughly 52 million people, I believe he mentioned that, in South Korea. 98% of them use smartphones, so it's a very high digital penetration in terms of different

countries across the globe. And then they are the fourth largest economy in Asia and the 12th largest economy globally. So it's a pretty big market. And the total retail, grocery, and consumer food service, so the Coupang Eats or the Coupang Eats business. Those TAMs combined are estimated to be about $500 billion last year in South Korea. And I know we're not a huge TAM podcast, but for a business that's big like Coupang, it's important to know what the opportunity is, especially in their core market, because you don't want to be buying something where it's maybe potentially saturated already.

So revenue for Coupang over the last 12 months was $21 billion. That equates to about 4.2% market share within the total retail, grocery, and consumer food service categories. And that has just grown really, really quickly. I mean, I'm not sure on the exact growth rate in terms of market share, but their revenue has drastically outpaced the overall category growth. So you can assume that market share has increased. um as for the coupon financial profile i want to give some like sense around what they earn

95 of the revenue is driven by product commerce so they break it out into developing offerings and product commerce product commerce is like the sale of first party items and third party items and then it also includes rocket fresh which is the grocery delivery and then advertising is also included here. And on that revenue, they spend about 75% of each dollar on cost of sales. So cost of sales includes paying for products from suppliers, inbound shipping and handling. They have intake centers as part of their fulfillment network, and then they have outbound shipping and delivery. So the truck fleet, as well as I think they have people on bikes as well. Yeah, specific. And I think a key difference for Coupang versus someone like Amazon is unlike with Amazon who contracts a lot of their delivery drivers, Coupang has full-time employees that get benefits, that get stock options. So I would argue they treat their employees much, much better than maybe Amazon does.

I think maybe the most telling way that they treat their employees is they're not considered cost of revenue. They're considered operating expenses, so true staff to run their business. Anyway, this leaves about 25% gross margin. Just think about that. Amazon retail is nowhere near 25% gross margin, or at least it wasn't when it was at a similar stage to what Coupang is at. And I think that's a real testament to the ability to run an efficient e-commerce business in a dense area. So 25% gross margin on today's sales levels, that's about $5 billion in gross profit that

they can invest into operating expenses. And so they're really operating in terms of the big operating costs, they pay for staff for the fulfillment centers. Those are considered operating expenses. customer service expenses are also lumped into operating general and administrative. And then all your general corporate costs, really any SG&A, so sales, marketing, kind of getting their brand out there. That's all included there. Ryan, I would say, I think a lot of listeners who maybe are newer don't know where to find this info. And I think as newer investors,

we didn't really know how to find this info, what the definitions were for each one, because it changes for every business. So can you maybe let them know where they can find this stuff? yeah i found all this on the 10k their annual report in the discussion around financial statements which i think is usually one of the first things after risk factors so you can just go to the table of contents in their 10k and look up discussion around financial statements and they'll break down basically every line item and try to yeah yeah some are a little more I guess, willing to share than other companies, but I thought Coupang did a good job describing all this. So after paying for its operating costs, after paying for fulfillment, cost of sales,

Coupang is left with about 5% of its revenue or a billion dollars in operating cash flow. Historically, this is changing. Historically, they spent, I guess, over the last two years, They spent about $700 million to $800 million on purchases of property and equipment each year. And that was to further kind of bolster out their fulfillment network. In total, to kind of give some – Brett gave a little bit of color on it earlier, but in total, between 2019 and 2022, Coupang spent more than $2.2 billion on purchases of property and plant and equipment. And so a lot of that was because they had a whole bunch of cash from the IPO. They had a whole bunch of cash from private funding. But these investments, while it seems like a lot of spending, have drastically improved the gross margin line and the time to delivery. So gross margins in 2019 were 16%.

In the most recent quarter, they were 24.5%. It's grown pretty consistently. but there was a big fire in one of their fulfillment centers, which threw a wrench in their gross margins, but they have it insured. So they're in the process of basically getting some of that money back, but a lot of the inventory was gone and it got included in that cost of sale. And I would say that they're guiding for margins to continue to rise to 30% or higher. Right. And the gross margin expansion, it doesn't really stop there. They've been very efficient with their operating expenses as well. So it's led basically in 2019, they were losing

half a billion dollars in free cashflow. In the last 12 months, they were generating 441 million in free cashflow. So there's just been a pure operating leverage or improvement, not profit margin story over the last four years. And they're really seeing the benefits of that scaled infrastructure or the vast infrastructure network that they have. So hopefully that gives a little bit of a glimpse. At this point, I guess I should also include the fact that they collect revenue from customers before they pay out suppliers. So free cashflow margins, unless it's a big capex period should be higher than adjusted EBITDA margins that they report or even gap operating margins. So just kind of keep that in mind. It's that same working capital advantage

that Amazon had in the early days and it- Still has. Yeah. Still has, I guess, maybe isn't talked about as much anymore for Amazon with the cloud business. But I think that gives some color around the financial picture. It's very profitable for a retail business. Yep. And for a company that has low-ish gross margins like this, I'll talk about this in the next session too. I think it's even more impressive as we'll go kind of into why we'd like the company is they're still investing in a lot of other bets that are making their American counterparts unprofitable. So I guess I'm stealing the question, right? But do you want to ask it to me? Yeah. What are some of the new

initiatives? And what do you think of, or what do we think, I guess more to you, but what do you think of the potential for the adjacent segments outside of the core e-commerce business? Yeah. So first off as a caveat, or just as a note, I would say that the largest opportunity for Coupang is clearly the e-commerce marketplace. And that's the main reason that we're really interested in this thing. If they can get say to a hundred billion dollars in revenue with that margin profile of 30% for gross margin. That's what $30 billion in gross profit. I don't think these other businesses have that potential, but they're a good core part of it. And actually, as I'll argue at the end here, they really drive back a lot of the customers to that

e-commerce marketplace. So they're key in locking in customers. But besides coupons, core marketplace, I think that there are two other things that at least, and Ryan can maybe discuss after I go through this, that have a lot of promise and that is RocketFresh, which is the grocery delivery. I know they describe things a little bit strange, so I always want to say what we're talking about. And then their fulfillment services, which is the FLC, call it fulfillment by coupon. So RocketFresh was on a $3 billion revenue run rate in Q2 of 2022. And that makes it a sizable portion of the business. Again, Ryan mentioned that they're at $21 billion of revenue over the last 12 months. So $3 billion versus $21 billion is a sizable portion of this

business, I would say if you look at RocketFresh versus Amazon's initiatives into grocery in the United States, it is a much more successful offering versus the size of Amazon's retail operations. And as a more mature business, probably 10, 15 years more mature. I'm not sure of the margins here. I know grocery is typically very low margin, but clearly, everyone in South Korea gets groceries. It is the best value proposition in the country for grocery delivery and maybe for all of grocery shopping and has a huge runway to continue growing this revenue. We'll see what the margins are on that, but still seems strong. Now, fulfillment by coupon is also extremely interesting. There seems to be a ton of white

space in South Korea to be, say, without the UPS, without the FedEx, without probably the United States type postal service type stuff. There is an opportunity to be the backbone of all e-commerce and delivery operations in the country. And with their infrastructure being the lead with a lot of it already built out, Coupang is now opening up their operations to other merchants, like we mentioned, with the fulfillment by Coupang stuff at 4% of unit sales. And it gives them a huge runway to continue investing in that property, plant, and equipment. Like Ryan mentioned, $2.2 billion over the last, what was that? Three, no, four years. They could probably do twice that while still being profitable and getting good return on invested capital over the next five

years. Since, as we talked about already, but this is a key point for the competitive advantage that we'll hit on again and again, since they are a small country geographically and with a much denser population than the United States, think of it like having, what would it be, like just New Jersey and kind of New York maybe with a giant urban center. And then I think some other more rural areas but just kind of one giant urban center something i think would yeah have to be even smaller similar to like new york that's what yeah new york and new jersey or something like that yeah all right but either way i think the point stands they don't have a giant wide open spaces like the united states and it should lead them to have even better margins

on this stuff than a lot of other countries given this geographical density plus with a lot of limited space with all the mountains like ryan mentioned like just not much space at all to build out stuff in in urban areas it'll be hard for other companies to really physically imitate the fulfillment centers that coupon has and there is a growing hurdle as everyone that's followed amazon knows the more they invest in the fulfillment business the less likely someone is going to come in and repeat that. We saw that with Shopify. I think with Coupang, they're on a similar trajectory. And with Coupang, given the geographical stuff, given they don't have to spend as much money, they can get higher returns because of that,

I think we could see them getting really high ROICs on this fulfillment by Coupang business. And the key is with a long reinvestment runway. Now, before we go to the other stuff, Ryan, do any pushback or disagreement on the rocket fresh and fulfill my coupon stuff no i think it's a major i mean i guess part of the difficulty is that we don't live in the area so we're not sure what i don't know what competing services offer i don't know if there's anything close to what coupon provides but clearly you're going to be able to generate good returns if you have a well-located fulfillment center because you're not wasting time driving really long distances to fulfill certain orders. Maybe that's kind of an edge case, but a lot of the time you

can really optimize and go door to door and ultimately kind of fulfill orders much quicker than you would in a bigger market like the US. Yep. All right. And now I want to talk about the nascent kind of offerings. They talk about this, but they're developing offerings in the two segments they put out in their income statement. And I think it's really interesting or really nice that they're actually generating positive operating income and positive cashflow while still investing in a lot of these things. They have other stuff here that has very tough unit economics. Coupon Eats is an example here. They have a lot of stuff here that they're investing in that might not really add on much revenue growth on their own. And they're spending

a lot of R&D or content costs on, which would be coupon pay or coupon play, which again is the payment stuff and the streaming service. And they're over $220 billion in revenue. So you need something to be quite sizable because again, they're growing. I mean, it's going to be probably $30, $40 billion business sometime here in the near future. You need it to be a sizable business if it's going to impact it. You need it to be the size of something like Rocket Fresh. But I wouldn't say the sole purpose of these businesses is to drive revenue growth, but to reduce friction, increase customer value, and increase customer lock into this rocket wow ecosystem. For anyone that knows the huge value unlock that Amazon Prime was, they're following the exact same playbook here. I mean, if you include adding value to merchants with the fulfillment stuff, my store, adding value to customers as add-ons with the payment stuff, coupon play, eats discounts, frictionless delivery, and returns, those things are all major investments and they might be very unprofitable in a vacuum.

But with the third-party and first-party marketplace, plus the subscription business, plus the advertising business, they can make it work much better, I think, than any other competitor in the country. Now, we're going to talk international expansion, Ryan. So what are their plans here? What are we seeing? And I guess add on any follow-ups on the nascent stuff if you have some. Yeah. Coupang has slowly tested a number of international markets. Really, the business is still driven entirely by South Korea from what I can tell. But when they enter these markets, they try to be very methodical and cost-conscious.

So right now, in addition to South Korea, they're operating in Taiwan. I believe they launched in Taiwan around two years ago, and they've been slowly adding new products and features to the Taiwanese market. They were asked about this on the conference call, and I believe it was Bom Kim said, regarding Taiwan, as I mentioned, we are encouraged by the response. We're getting the same transformative potential that we saw in our early days in Korea. We're starting to see some signs of that. We'll, of course, test and learn at this stage. Now, it's not that they're just being, they're not just saying that they're being methodical. They are actually like, you're of seen it uh proven out in their actions so um they've been very slow to roll out new products

let's use taiwan as an example in 2022 which is a year after their first launch they introduced rocket fresh for the first time and then a couple of months ago they actually rolled out a new product called coupon global marketplace which allows taiwanese small and medium-sized enterprises to sell made in taiwan products in south korea so this will certainly expand the pool of customers for the merchants in Taiwan. Now, some of the other efforts, if you go back to some of the old conference calls, they mentioned some other international efforts. One was Japan. They launched in Japan two years ago, and this is proof that they're willing to close up shop on things that aren't working. They withdrew recently their operations from Japan. I think they still

kind of operate there, but they're basically getting out of the market. They've also, I believe, done something similar with Singapore. I know they've launched one flagship store in Thailand, but I really haven't seen anything else. So they enter these markets, test it out slowly, gauge interest. And if they see it, they'll invest heavily into it. I appreciate that. It feels like there aren't a lot of management teams that are willing to call it quits when they don't see the signs early. And it seems like Coupang has done that. And if they don't see the potential return on investment, they're quick to recognize our money can go elsewhere and generate better returns somewhere else in the business.

Yeah, I think it's interesting. Just for reference, I want to pull up the Taiwan population here. It's about half the size of Korea, so 23.5 million people. So a sizable addition, it could be, to the business or the total addressable market here. People were excited about the Japanese opportunity, but I think it makes sense they had to leave because Amazon has a pretty good presence in Japan and I think Rakuten and a few others, but I think it makes sense. The one thing I do worry about with this business is competing in the Asian e-commerce space is tough. Now they've locked down South Korea and we'll talk about the

competitive advantages in the next section here, but going to some of these other markets where We have in India, Amazon and Flipkart and some other people, Sea Limited, Grab, a lot of these companies that are investing in a ton of these different markets. It can get hyper-competitive and eventually the costs have to get rational, but there are a lot of people or a lot of companies that are operating at a breakneck pace, really trying to go into land grab mode. And I just worry, I don't know how successful they can be, but I think if I had a couple other markets like South Korea, that could really, really expand their growth potential,

their runway for reinvestment. Yeah. Let's talk about the competitive advantages here. What gives us confidence that this coupons competitive advantage will be durable over the coming years? Yeah. And look, if you're listening to this one, you could insert Amazon retail into this and think it's something very similar, but that's what really attracts us to the Coupang business model is they really follow the Amazon business model and not just building an e-commerce business. A lot of companies decided to do that, but they follow the stuff that gave Amazon or gives Amazon a competitive advantage. So from my seat, Coupang has two strong moats. One, economies of scale. Two, network effects. First is the economies of scale with

the vertically integrated fulfillment network. This allows them to offer a much better customer experience than competitors with ultra-fast shipping times, frictionless returns, all the stuff we already talked about before. And then it layers on the subscription business in a rocket wow, which allows it to offer much better discounts on other services than, for example, I'll use this again, the 5% discount on Coupang Eats that they just launched. None of their competitors can do this, at least in the South Korean market, or none of their competitors can do this and be profitable because they don't have the fulfillment network. They don't have the subscription service, the food delivery competitors, for example, they can't just

offer big discounts to their customers and have a positive ROI. They're going to have negative unit economics. But for Coupang, which has the economies of scale with the fulfillment and the subscription service that they can add on here, they're going to be able to have positive ROIs. Now, if we go to the network effect, this one's pretty easy to see. It's a classic two-sided marketplace here you know the more merchants that sell through coupon first party third party and you know join the fulfillment by coupon stuff the better value proposition there is to the customers and then if you flip it around the more customers especially rocket web customers that spend a lot of money on the platform the more money they spend on the coupon marketplace

the more value there is there for the merchants to you know they're incentivized now to sign up to invest more in their storefronts and it's just a classic network effect we see with amazon you We see it with a lot of other e-commerce marketplaces out there. And it's not probably as strong as a network effect as maybe a social network or a payments network, but it is still really, really damn strong and should insulate them, I think, from any competitive upstart. I mean, who's going to invest $5 billion in capital expenditures in South Korea to try to replicate this? I mean, Amazon technically could, but I don't think anyone... It's a lot harder to do it now. Yeah, that's true.

Capital is a lot more expensive. Yep, 100%. Now, it's easy to see why I think this advantage can be durable because, well, obviously, as long as Coupang doesn't form some sort of self-sabotage, that's true of any company. But the industry that Coupang operates in, which is essentially all of commerce, all of retail, which is grocery or consumables, food versus non-consumables, it will be relevant forever and ever and ever, as long as we're in our current macroeconomic system. So as long as they keep investing in infrastructure and are smart about investing in infrastructure and then attract more customers and merchants onto their platform, the wider and wider these moats will become. So I think it's good in theory to have a thought on a competitive advantage, but you also have to look at the results and it should show up as strong, outpacing growth of their competitors and expanding margins.

As Ryan mentioned, they are expanding margins, but the proof here is in the results. Coupang has gained market share in South Korea consistently. It's a tough market. It's a giant market and they're growing share in a growing market. one of the fastest growing large economic markets for commerce in the world. I mean, it's just a classic recipe for durable double-digit revenue growth when you're gaining share in a growing market. Now, I guess I have another note here about the geographic stuff, but I think we've hit that enough, Ryan, right? Yeah. I think we're maybe sound like a broken

record around the fact that it's easier to be profitable in this market. I will say for any listeners, we do have a link in the show notes, which will be on that free newsletter with a Bloomberg video that went into one of their warehouses. So I would check that out. They're very automated. They're very advanced. And if you're more interested in the company, definitely watch that five-minute video. Next question though, Ryan, as we get closer to the end here, let's run through the numbers. What can Coupang earn, do we think, in a few years? And let's compare it to its market cap today, which is approximately $31 billion. Sure. So Coupang's management team has stated that they think the company can get to 10%

adjusted EBITDA margins in the long run. Over the last three years, they've gone from negative 4% to 1.9% to 3.4%. And then in the most recent quarter, it came in at 4.2%. So it's clearly been moving in the right direction. The Royal Canadian Legion is celebrating its 100th anniversary and now our change has a two dollar coin to mark this milestone honor the legion's mission to carry forward stories of service and sacrifice to new generations and their dedication to supporting veterans and their families from coast to coast to coast celebrate this enduring legacy find the 100th anniversary of the royal canadian legion two dollar coin today Now, when it comes to cashflow, adjusted EBITDA margins historically have been a couple percentage

points higher than free cashflow margins because of all the spend related to really building out their fulfillment network. The last three years were huge investment periods. They had a lot of capital to create more, basically buy more buildings. Plus the pandemic. Buy a larger fleet. And so they ended up spending a lot in CapEx, but typically, or maybe I shouldn't say typically, now free cashflow margins have basically ballooned because CapEx as a percentage of revenue has come down.

But on top of it, they have that working capital advantage that we talked about. So in the most recent quarter, I mentioned adjusted EBITDA margins were 4.2%. Free cash flow margins were almost 8%. So they're getting to a level of profitability where it's not necessarily theoretical anymore. A lot of the times we talk about if they get to this amount of margin, they're at 8% free cash flow margin. So let's just run some numbers. I'll try not to throw too many numbers out at once, but I'm going to mention some of

assumption so over the next four years i assume that revenue grows by ten percent that that's light i think but still it's it's the the point is to be kind of conservative here and you know there there's the chance that maybe there's a slowdown or something and foreign exchange korean one could get totally devalued yeah so far i mean there has been a red big revenue deceleration because of that foreign exchange. So 10% revenue growth, adjusted EBITDA margins reach 7%, and free cash flow margins are at 9%. So slight improvement to today on the free cash flow margin side. If that's the case, Coupang would be generating $30 billion in revenue in 2026 with roughly $3 billion in free cashflow. I've got dilution at around 2%. So the share

count increases every year by about 2%. And I assume the company is valued at 20 times free cashflow. That might be optimistic. You can obviously toy with these numbers how you want. We're going to have this included in our sub-stack write-up. So if you want to check it out, You can see the numbers on paper and it might help, but basically if they get to 10% free cashflow margins and they're valued at 20 times, the market cap would be $60 billion or a $30 stock price. That is 70% higher than today's stock price. So 70% upside over the next four years, that would be above our hurdle rate.

Like I said, you can toy with these numbers how you want. And I think, frankly, there's the chance that revenue growth is significantly higher than the 10% figure. I estimated right now, I think they're going high 20% in constant currency. And when someone joins Coupang, they have a really pretty cohort chart on all their slides because the people that join Coupang quickly start spending more and more with the service because I think they realize the value. And so while the user growth is not that high anymore because they're at basically 30% to 40% of the population already, they're getting a higher chunk or a greater percentage of each customer's spending. So basically, I think if you put some reasonable numbers on this, we're looking at more than 15% annual return over the next three to five years. Yeah, I think those numbers make sense. And I don't think they're crazy either, where maybe the Korean won goes way down, like could get devalued by half, you know, something like the peso happened after the 2010-2015 period.

But it seems, I mean, yeah, it's an international market. We'll talk about wanting a big discount because it's an international market where we don't have boots on the ground. But those numbers don't seem crazy at all to me. I honestly think that margins could be even higher, but we'll get to that later. What's the next question? Yeah. Yeah. Let's talk about the founder, the CEO, Bombsuit Kim.

Obviously very important to the story here. What are your thoughts on him? Yeah. So I think Coupang, and I'll say this a couple of times during this section, is really a breath of fresh air. I think they have a great corporate structure. We are typically skeptical of dual class share structures. Coupang has a dual-class share structure, and we're typically skeptical of these that give a founder or an executive kind of a dictatorship over the business, except when we think they

have a very strong operator at the helm. So there's a big caveat there. I think the prime example of this working out is Mark Zuckerberg with the dual-class fully controlled voting at Meta. This does give a company key man risk, but can greatly reduce bureaucracy on the executive front at the board and stuff like that and kind of create a competitive advantage in itself you move a little faster you don't get caught up in just the medic stuff of everyone trying to copy everything from the corporate stuff i thought it was actually nice i listened to the conference call this morning to try to get a little bit of a better sense of you know bombkin here and someone asked him on the q1 call about generative ai and he kind of uh chuckled so i like that because he

wasn't just trying to hop on the trend and boost his stock price. But yeah, I think that leads me to say that I think Baumkin is one of these top-notch operators, or at least I believe he is. I think we believe he is today. A lot of this is based on the qualitative feelings we have. I would recommend listening to the conference calls. That's the best way to see it. He doesn't really go into the public except for that. But there are also some quantitative measures to back it up and some stuff they've done. So for one, their philosophy around creating shareholder value, I think it's in the 1% of companies in the world. They consistently talk about creating per share cashflow or optimizing per share cashflow. And I think that is a fantastic

breath of fresh air versus the people that talk about crazy stuff of, I don't know, adjusted even to margins or whatever you want to call it. But yeah, Ryan, you have something to add here. Yeah. I mean, they brag about how low their share dilution is while growing. I feel like you never see that. Yep. And that's what I was going to say. They also walk the walk here, especially compared to their new technology company competitors, or not even competitors, I should have said. Basically, their cohort of people that got founded after 2010. dilution has been minimal, even though they invested in a lot of sometimes speculative ventures, which again, isn't a bad thing. That's what Rocket Fresh got created. But the key difference between some of these freewheeling, unprofitable tech stocks,

I mean, you have Spotify as a key example that we follow a lot as this. They've done so with discipline. They've done so well profitable. The company is growing quickly, minimizing dilution, investing in quote unquote, other bets, quite a few of them too. And they're also generating on profits. So to me, that shows, again, that they're talking the talk with the growth and free cash flow per share and consistently talking about that, but also showing it and creating the value on a per share basis for shareholders. And I think Kim also has a few qualities that I like to look at from a higher basis. If you're creating an executive, a cyborg of an executive you'd want to have in a company, I think it's good to have someone that's not too young,

but not too old. He's in his 40s. I think that's a good age for a company. You want someone to be there that's going to be there for the next 10 or 15 years while you own this business. I like someone that has a good pedigree. He went to Harvard Business School, but it's not bogged down in a lot of the American corporate culture that we see all these executives that are mercenary CEOs just repeat the same thing over and over and over again. It's like they're all robots. I like someone with home market experience. The guy's from South Korea, So he kind of knows probably better than a lot of other people competing there. I like someone that is passionate about building the business, not just about being the executive

that gets paid a lot of money. I think Kim suits that here. And I like someone with skin in the game, although it's not my favorite thing. I don't think I would say that's my number one thing, but with combined having skin in the game, combined with a rational mindset on, again, creating per share value for shareholders. Anything to add here, Ryan, before we go to the final question? no no i mean he frankly seems kind of perfect for a ceo to be honest and he says all the right things which there's a lot of people that say all the right things i think

danielek says all the right things but he backs it up and really i think the proof is in the pudding here you know you can just look at the operating leverage you can look at the minimal dilution and And you can see that this is the guy that truly wants to create long-term shareholder value. Yep. All right. Let's go to the final question here. We like to ask for the companies on the watch list, which is what is holding us back from investing in Coupang today? And what are we looking for to buy shares? Ryan, final thoughts here. Well, I guess really nothing.

um i'm impressed by the business after taking kind of a deeper look today and if we're right in our assumptions it surpasses our hurdle rate so i mean it should be i guess on those grounds it deserves a spot in the portfolio i'd be comfortable owning it um the only thing for me is i sometimes get a little wary about investing in stories where it's margin expansion just because we've done that before and you get burned because of- Yeah. The margins aren't high today. Why? There's a reason. Yeah. And just looking at this quarter, I keep thinking like, okay, this was a great quarter operationally. CapEx was really light and they only had 4% adjusted EBITDA margin. So I think

how do you get to that 10% if this is what a good quarter looks like? So I just, I don't know, It makes it a little tough to buy that. But even if you just take the current free cash flow margin, so that 8%, apply it to a full year of sales, and that was this quarter's free cash flow margin. If you apply that to a full year of sales, it's trading at like 18 times what would be full year free cash flow. So it's not that expensive. I guess if I'm being picky, I'd like to pay more like 15 times, because since it's still

technically theoretical um but yeah i'm being you know i'm just being nitpicky the other thing i'll say kind of as a closing thought there were a lot of companies that went public at this time there's actually a lot of companies i think there were like southeast asian commerce companies or just asian commerce companies that were going public and raising a lot of money grab was a big C-Limited was already public, but they were kind of high soaring. And there were so many companies that went public with a lot of hype in 2021 that did not fulfill what they said they were going to do. Coupang has delivered across the board on, I mean, they've really walked the walk. They've grown users, they've grown spend per user, and they've been very efficient with their spending and increased margins.

I think it's just kind of refreshing, frankly, to see something like that. 100%. And all close things I was saying, yes, there's not a lot holding me back here. I trust management. I believe the company has a durable and growing competitive advantage in a growing market, which check, check, check. But given that the company operates in a foreign country, we can't get boots on the ground here, given that we are betting on future profits and they have been historically unprofitable.

So again, foreign country, foreign currency, and we're betting it's technically not that profitable. It hasn't had a long history of profitability. I do want a bigger discount than normal to compensate for those risks, higher expected returns going forward. So I'd say I don't think that price is too far away from here, especially given that stock hasn't traded much in a long time. And I do worry about missing the potential 10 bagger here, but I'd say, yeah, not too much lower, but it's still a little bit out of my price range.

But depending on, I wouldn't be opposed to doing a comparison to one of our least favorite investments today and seeing whether Coupang passes the test. Is it really still out of your price range or does it just feel weird to get to the end of the show and say, yep, all right, let's buy it? Well, I mean, it's probably right on the border, right? Because it's pretty... They're not that I think if they were generating the margins they say they were now that you laid out and kind of the estimates, I would be way more inclined to do it. But I think I want that discount because I'm not exactly sure they can hit those margin targets. Yeah, I think that's fair. I mean, could have just been a really good quarter i think capex was 95 million in this most recent quarter and typically it's been like 200 million so or at least that's what it was in 2022 and i think

they even stated on the conference call that they plan to go through a big another big investment cycle so i mean you shouldn't expect those free cash flow margins anytime soon yep all right i think that's a good way to close things out remember we are doing these once a month next Next month, we're doing Share Cannibals, which is going to be AutoZone, Lowe's, Discover Financial, and Sprouts Farmer's Market. So four companies that have consistently reduced their share count. Should be very fun. Love covering these type of companies.

It'll be a little bit more interesting, I think, than the fallen angels from actually finding stuff that's investable. But let's get to the disclosure. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and may hold securities discussed in this podcast. Again, thank you everyone for listening. If you want the show notes with all the estimates and all the charts, subscribe to the newsletter. It is free.

It should be right in your show notes where you're listening to this right now. Thank you, everyone. We'll see you next time. don't 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. The Royal Canadian Legion is celebrating its 100th anniversary and now our change has a $2 coin to mark this milestone. Honour the Legion's

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