We Study Billionaires - The Investor’s Podcast Network - TIP828: Restoration Hardware (RH): Building a Luxury Empire From Scratch w/ Shawn O'Malley and Daniel Mahncke

Episode Date: July 5, 2026

Shawn O'Malley and Daniel Mahncke explore Restoration Hardware (ticker: RH). In this episode, you'll learn how RH was able to reinvent itself as a high-end furniture retailer, using opulent galleries, high-end dining, private yachts, and a membership model based on Amazon Prime and Costco. RH is an incredibly bold and unique business, not afraid to use unconventional viral marketing efforts to drive customers into stores, as they aim to set styles for the ultra-rich. Shawn and Daniel dig into the business, risks for shareholders, and estimate RH’s intrinsic value, plus so much more! IN THIS EPISODE YOU’LL LEARN: (00:00:00) Intro (00:03:32) How RH has built an American luxury brand, defining home-design tastes (00:07:18) Why yachts and private jets are actually core to RH’s strategy to sell furniture to the ultra-rich (00:15:14) About the eccentric and fascinating world of Gary Friedman and his tastes that define RH (00:25:43) Why RH pivoted to a membership-based model for discounting in 2016 (00:40:31) What RH is planning on doing in response to its debt maturity wall looming in 2028 (00:49:42) How RH is using sale-leasebacks and monetizing its real estate to improve capital efficiency (00:53:08) How to think about the intrinsic value of RH (00:57:35) Whether Shawn and Daniel add RH to the Intrinsic Value Portfolio Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences. BOOKS AND RESOURCES Join the exclusive ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Intrinsic Value Mastermind Community⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Track ⁠⁠⁠⁠⁠⁠⁠The Intrinsic Value Portfolio⁠⁠⁠⁠⁠⁠⁠. Learn more about how to join us in NYC for our Intrinsic Value Conference. Check out RH’s investor relations page. Listen to Business Breakdowns’ podcast on RH. Check out our previous Intrinsic Value breakdowns: ⁠Transdigm⁠, ⁠Salesforce⁠, ⁠Berkshire Hathaway⁠, ⁠FICO⁠, ⁠PayPal⁠, ⁠Uber⁠, ⁠Nike⁠, ⁠Amazon⁠, ⁠Airbnb⁠, ⁠Alphabet⁠. Related ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠books⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ mentioned in the podcast. Ad-free episodes on our ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Premium Feed⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. NEW TO THE SHOW? Get smarter about valuing businesses through ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Intrinsic Value Newsletter⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Check out ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Investor’s Podcast Starter Packs⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Follow our official social media accounts: ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠X⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ | ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ | ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Try our tool for picking stock winners and managing our portfolios: ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠TIP Finance⁠⁠⁠⁠⁠⁠⁠⁠⁠. Enjoy exclusive perks from our ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠favorite Apps and Services⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Learn how to better start, manage, and grow your business with the ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠best business podcasts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. SPONSORS Support our free podcast by supporting our sponsors: Plus500 Netsuite Shopify Vanta References to any third-party products, services, or advertisers do not constitute endorsements, and The Investor’s Podcast Network is not responsible for any claims made by them. Learn more about your ad choices. Visit megaphone.fm/adchoices Support our show by becoming a premium member! https://theinvestorspodcastnetwork.supportingcast.fm

You're listening to TIP. I just, I don't know. I think I get it. It's a lot to process for us as value investors, to be fair. I mean, you're really just going to have to sell me on this old yard thing. I mean, not being able to fully wrap our heads around the luxury industry. It's kind of why we didn't invest in, you know, the bluest of the blue bloods in LVMH. But now you've got me Googling pictures of yachts that we can charter for 130K a week.

Look, a good deal is a good deal. What do you write about that? So what do you say? Should we start? I'm ready. Let's do it. Since 2014, with more than 200 million downloads, we have interviewed the world's best investors,

studied deeply the principles of value investing, and uncovered many compelling investment opportunities. We focus on understanding businesses and intrinsic value, investing accordingly, and sharing everything we learn with you. This show is not investment advice. It's intended. for informational and entertainment purposes only. All opinions expressed by hosts and guests are solely their own,

and they may have investments in the securities discussed. Now for your hosts, Sean O'Malley and Daniel Manker. Today, we are covering a company a lot of folks in the US might know quite well, and while I, as a German, have honestly only encountered through their gorgeous galleries in Europe, we're talking about R.H. the company formerly known as Restoration Hardware. Ticker is also RH. And the reason I think this episode is going to be so much fun is that we get to revisit a theme that we've already spent quite a lot of time on this year, which is true luxury. I mean, we covered LVMH a couple of months

back with the whole Arnold empire of timeless brands. And we also did Ferrari a bit before that, where Sean, you made the case for how scarcity and brand authority and also pretty good engineering, compounded earnings at nearly 20% a year for a decade. And I personally covered MS, arguably the most prestigious clothing brand in the world. And R.H. is the American attempt to play that same game. But instead of starting with Louis Vuitton or Christian Dior, the company's CEO, Gary Friedman, is starting with couches, dining tables and trying to scale all the way up to private jets, luxury hotels, and fully furnished homes. So I would say there's a lot to unpack. But Before we get into it, quick plug here, we will be hosting our second Intrinsic Value Conference

event in Midtown Manhattan this September. And if you're interested in joining us and networking with other investors as well as meeting us, you should check out the intrinsic valueconference.com to learn more. And I can already tell you it will be an even bigger conference than the one we had at Omaha just in May of this year. All right, Sean. So you've been digging into R.H for the last couple of weeks. So where do you want to start?

I think I want to start with pointing out to the audience how painful it was for Daniel to recognize pretty good engineering over at Ferrari, right? It's a subtle thing, but you can pick up on that German, Italian engineering rivalry for automobiles. Anyways, though, after you've studied so many businesses, you start to feel like you've seen it all. And then it comes along a company that still manages to flip the world upside down for you. And that's how I felt with RH.

You know, I think it'll come as a surprise to no one that I've never shopped at an RH store because I'm a stingy value investor. If I spent 10 grand on a couch, I would just be kicking myself for not putting that money into stocks instead. And so, you know, I thought because I've been furnishing my house for the last few months, why not invests in the company behind my dream living room? And if I do fabulously well in an RH investment, well, then, maybe that'll help me rationalize splurging on the furniture. So obviously, I'm kidding a bit.

You know, the setup is really interesting. And for starters, most investors will immediately screen out the company because it has a ton of debt, twice the market cap of the company's equity in debt. And yeah, so management has supposedly a pretty credible plan to become debt-free by 2029. So that's important to know for starters. And we'll get more into that. But, you know, I think that all makes the stock interesting because there is a good reason for it to be overlooked with the debt and therefore potentially misvalued by the market. And then I'd argue rather than competing in a more commoditized and a shrily just simply selling furniture, R.H. sells a lifestyle vision. And I know that sounds like consultant word salad,

but really their business is more about selling design inspiration for luxury spaces, two high net worth families and their designers. And so you come to an R.H store or scroll through their brochures or source books, as they call them, to see what your outdoor patio could look like, where you can buy an entire set that's TASSO-c curated in one fell swoop rather than mixing and matching products across variants. And so this is a company whose median customer almost certainly has a multimillion dollar net worth and where the average order value is likely more than $1,000, but can easily scale to $50,000 or more

if you're purchasing multi-room installations. The thing is, with their target demo of high net worth and ultra-high net worth families worth worth more than $20 million, this is a group that owns nearly four homes on average and spends six and a half times more on furnishings than the average owner of one single family home. I'm actually surprised that not once in the last couple of weeks I did get a message on Slack with a new beautiful couch for 10,000 bucks that you sent me telling that you will get it for your house. So maybe that still comes in the next couple of weeks. But the European luxury brands, I would say, usually get these origin stories, right, that are tied to, you know, Napoleon or,

I don't know, the King of England, something like that. With the point being, you have really centuries of prestige and association with nobility to help you justify selling, you. 20K purse is right. But this is a company that was only founded in California in 1979. So they're very much in the process of still building their brand. And for them to have already built such a business with, I think it's about three and a half billion dollars in revenue, I think that's quite impressive. Yeah, well, you know, when you can't say your brand served Napoleon, I guess it makes sense why they have to buy prestige with customers by offering incredible yachts, like the RH3, which costs 150,000 euros to rent for a week in the busy season. But don't worry,

fortunately, that price comes down to the very modest rate of 130,000 euros per week in the offseason. That sounds a lot more realistic. Maybe we can use that to charter to the private island that you wanted to buy when we covered was a co-star group? Think it was. So maybe the listeners get a sense of, you know, our spending habits here by now. And somehow, I'm sure you're actually going to tell me that owning a $15 million yard helps them sell sofas, dining tables and maybe lighting pictures

and other pretty traditional retail stuff, right? And to say nothing of the RH1 1 and the RH2 private jets, the incredible hotels they've opened that they call RH guest houses and the restaurants that they run in historic buildings in places like Madrid and Brussels

or even the fully furnished luxury homes that they've built called RH residents. So they've quite an ecosystem of luxury. say. Well, I mean, isn't it obvious? You know, like, of course, of course yachts help sell sofas. And the strategy is truly experiential, I would say. And that's why they're selling a lifestyle vision. RH wants you to be wowed by every touchpoint you have with their brand. And while some of these things seem like obscene uses of shareholders' money, they do double as viral marketing. And the idea is that you experience one of their yachts or restaurants or galleries and you think,

wow, I trust this brand to, I don't know, design my kitchen and maybe I'm going to spend $100,000 doing it. I mean, it sounds a little absurd, but I can definitely appreciate, you know, the luxury marketing tactics, you know, can be a bit unconventional. I mean, usually you say luxury brands shouldn't market or sell at all, but then you could argue that, you know, that's not what IH is actually doing. I mean, a yard like this is not actually aggressive selling, but more like yet another floating showroom. But before we get into the strategy further, I think we have to set the scene on maybe housing,

because in Europe, the dynamics are a bit different, I think, than in the US. So people primarily spend on furnishing their home when they buy a new home. So there's a close correlation between the housing market activity and R&H's sales. And from what I understand, the environment in the US is pretty brutal from home buyers for housing-adjacent businesses. Brutal is, I think, the right way to put it. Just the headline numbers, home prices are up 40 to 50% since the pandemic started,

and mortgage rates have been hanging above 7%. So the price of the asset and the cost to finance the asset are both blowing out at the same time compared to what it would have cost to purchase the same property just a few years ago. And so it's a double whammy to affordability, which is why you've seen the market. just completely freeze up. And so for first time homebuyers, the cost can just be obscene

compared to renting, right? You know, my mortgage, for example, I think it's basically twice what our rent was. And so if you're an existing homeowner who bought a house in 2021 with a two and a half percent interest rate, you sort of have these golden handcuffs. You know, your home is appreciated, which is great, and you have a killer interest rate. But if you want to move, you're going to lose that rate and probably have a dramatically higher payment for a property of maybe similar quality somewhere else. So yeah, you know, the housing market isn't the most robust it's ever been at the moment. But management has been pretty transparent about this. Gary Friedman has basically said the quiet part out loud on earnings call, suggesting that there

hasn't been any meaningful, sustained recovery and luxury home sales. And he's not expecting one until interest rates come down meaningfully and stay down. And so, you know, even worse, though, is that you've got people like Jamie Diamond, the CEO of JPMorgan, issuing these public warnings, that inflation is stickier than people think, which is basically code for, hey, don't bet on the Fed bailing out this market anytime soon by cutting interest rates. I still remember how happy you were when you told me that, thanks to Robin Hood and you being a customer, your interest rate has been, I think about two percentage points lower than the 7% you mentioned here, right?

So, yeah, I think that, you know, listening to our episodes is not only good. for investing advice, but also for personal finance, especially for Sean, who always knows all the tricks that you need. So with this macro backdrop, Friedman, who again is the CEO of the company, is still deciding to even accelerate investment spending right now, right? I mean, my gut instinct would obviously be to perhaps stop buying yards and private jets and historical galleries. Although I got to be fair here from what you told me so far, it seems that R&H's customers

are probably wealthy enough to not care about the macro cycles too much. when they do decide to buy a new couch for $10,000? Yeah, they probably aren't sensitive to buying a new couch for $10,000. But the question is, you know, do they need to buy a new couch at all? And if you're staying in the same house, you probably don't need to, right? There's, you know, less often are you going to have a need for new furniture? Whereas every time you move, you want to restile things, especially if you're, you know, on the wealthier side, you have more flexibility of, you know, you want to tailor the furniture

you have exactly to the living space that you have. And so there is a very direct correlation between turnover and the housing market, especially at the higher end of the housing market and sales for RH. And so in this situation where things are a little slower and the market is a little more frozen up, conventional wisdom would be to say that you hunker down. You cut SG&A, you cut overhead, you pause new product launches. Maybe you close. some stores and you wait for the Fed to hopefully drop rates. And Friedman is essentially doing the opposite of all that. And his thesis for why is the part I really want, I think, listeners to lock into and decide for themselves how they feel about it. His view is that when a market

freezes like this, your competition shrinks. They panic, they pull marketing dollars, they delay launches of new collections, they close locations. And it's true that a growing number of online D to C furniture brands have also simply ceased operations entirely in the last years. So Friedman's view is that the competition is evaporating while everyone else waits for the weather to change. And if you lean in and aggressively invest while everybody else retreats, the opportunity is there to capture more than just a few percentage points of market share. And that's why RH has increased this number of galleries from 24, just five years ago, to 39 today and grown its least square footage for selling purposes by Kegra of nearly 8% at the same

time. And that's also why in this frozen market, they're able to grow revenues, I think, 8% year over year last year. That's not bad. It actually reminds me of what we discussed in the LVMH episode about Bernard and No, where he was basically patient enough to acquire and then reinvest when others couldn't and didn't want to do it because of the economy. Although this also feels like a really significant expansion. I think he's taking more risk than most other CEOs, especially in this field that we looked at. Yeah, I think that's 100% true. And honestly, there's this Picasso quote that Friedman likes to use. And it goes, every act of creation is first an act of destruction. And, you know, it's kind of profound. To me, it sounds exactly like something

out of a Bernard Arnaud interview. And, you know, except for Friedman is really taking this incredibly literally. He's calling what's happening right now the most prolific product transformation in the history of the industry, which is pretty wild language for a furniture company to use. I don't want to say it, but I might be a bit too skeptical today. I can already tell you that he gives me somewhat of a bad vibe. I don't know as well as you do, obviously, but just from what you tell me here and, you know, Picasso quote plus I would say a quite stark language about the change in the industry, I just get the impression that he's a pretty good storyteller and also maybe pretty good at going against the grain. And more often than not, those people do turn out

to be successful, as he clearly is. But they're also not really my type of CEO. So how about you try to make it a bit more comfortable for me here? So, you know, talk a bit about the background, who he is, how he thinks. And maybe you can also give us a background of the company. Where's it coming from, right? We talked about it being established or founded in 1979. did he take over and what did he do with that? So don't give up on me yet, Daniel, because there is a lot more to this pitch. It is a really good story. And so, you know, the backstory is really key to understanding why I don't think some of

the spending is as reckless as it looks or, you know, at least not as reckless as it first seems. And this is a company that has died and been reborn before and more than once. And so if we rewind all the way to 1980, a man. named Stephen Gordon is restoring an old queen and Victorian house up in Eureka, which is a little coastal town in Northern California. And the problem is he can't find historically accurate hardware. And this would be like period correct fixtures and fittings for his house. And he's so annoyed by this gap in the market that he opens a store to sell exactly that. And so that is the literal origin of the name. Restoration hardware. It was hardware for restoration.

That makes a lot of sense. The name is actually completely literal because the first time I heard about it, I would have thought of a lot of things, but not necessarily furniture, but this definitely makes a lot of sense now. No, it's completely literal. And through the 90s, the business actually grew very fast. I started, you know, five stores in 94, then 10, then 20, and 41 by 1997. And, you know, selling this very specific blend of what I would call upscale, folksy Americana. And so the famous example is this teddy chair, a replica of a leather chair that Theodore Roosevelt, Teddy Roosevelt used when he traveled by train. And so their whole pitch, and this is right out of their 1998 filing, was products with, quote, a sense of history or authenticity that customers could

connect to. And let me know if you recognize the strategy, because even back then, they staged the inventory like rooms in a real house, hoping that you would just buy the whole setup rather than decorate from scratch. Well, Sean, I know you want me to be reminded of the more extravagant version of their showrooms today, but to be completely honest, and it might be me as a European, the first thing I think about, if I think about fully furnished showrooms, is actually IKEA. So I don't know if that's what you wanted me to do, but of course, they do get it. It's cool to see that the whole, by the entire furnished room idea was a part of the company's DNA

from the beginning and is not only a thing of the past 10 years. You're tough on me today. I'm really going to have to fight to make this pitch come through. I think that, you know, moving on with the story, the company would really first need to nearly die before it could embrace what would become this billion dollar strategy of selling the furnished room for them and doing so in a bit of a more premium way than IKEA, which, you know, no slight to IKEA, but that's how they think about it. So Restoration Hardware originally IPOed in 1998, but by 2001, it was,

was basically on the edge of bankruptcy. And that is the moment Gary Friedman walks in. He takes the top job after getting passed over for the CEO role at Williams Sonoma, where he felt that he was being groomed for the job and was the heir apparent. And he was so upset that despite having a cushy job with millions and stock options still left to be paid out to him, he left Williams Sonoma and implicitly made a huge bet on this struggling business in restoration hardware. So you basically arrive with a chip on his shoulder and he went to a company that's almost dead. And I'm going to keep on my ride today and have to keep teasing you about this. But it's quite an origin story for someone who's now buying yachts on the company dollars.

No, it's fair. It's fair. People who know the company well, though, will concede that R.H's entire aesthetic is really just Gary Friedman's personal taste made into a public company for better or worse, but mostly for the better historically. And so he rebrands restoration hardware to our age, pushes away from knick-knacks and towards serious furniture and high-end home goods and design. And when people criticize the prices or the luxury ambitions that he brings to the brand, his answer is the following. And I think this is, I think it's really cool. He says, great brands don't chase customers. Customers chase great brands. That's actually pretty true. I mean, that's basically the luxury playbook, right, that I was also

referring to earlier. And I think it's also a quote that could definitely come from Steve Jobs. So I have nothing to say here that would go against him. No, I think so too. And it explains why when this guy says he's going to destroy his current product line to create the next one. I do take that seriously because he's the same guy who took a nearly bankrupt cabinet knob retailer and willed it into. to being something of a luxury house. And they've undergone a nearly unrivaled degree of creative destruction, emphasis there on creative. And the way he's executing it this time ties back to a retail concept called the thirds.

And so the idea is, if you look at any mature retail assortment, whether you're selling dining tables, area rugs, or lighting, you can break the performance of every item down into a top third, a middle third. in a bottom third. And so if you introduce any new products and it performs in the middle third of your existing assortment, well, your business is going to stay flat. You're just substituting one okay seller for another. If it performs in the bottom third, sales could actually drop because you've now cannibalized something better for a dud. So the only way to meaningfully grow a mature retail business is to consistently introduce

newness that performs in the top third. third of the assessment. So really, the idea behind that framework is you have to swing for the fences when you're a mature business like RH. There is no middle path. And nobody can accuse RH of not having swung for the fences. And to find those top performers, you can't just design a few nice chairs and pray. You have to cast a massive net, which is why they revamp their source books in 2024 with new areas of focus, you know, these massive. beautifully photographed catalogs. Those are the source books.

And the new focuses were RH outdoor, RH modern, RH interior, and RH contemporary, which are these just different types of designs and design source books that you can use based on the style of the space that you're working with. And so the combined source book circulation, which is such an important part of their brand and sales strategy. And actually, their number of customer contacts, that essentially doubled from 2023 into 2024, which has allowed them to aggressively push physical inspiration into more homes than ever before if you want to get a little profound about the mission of RH.

Let's take a quick break and hear from today's sponsors. Curious about online trading, but haven't taken the first step yet. You're not alone. And plus 500 futures is a great place to start. The futures markets are moving fast, and with plus 500, you can explore popular assets like oil, gold, S&P 500, Bitcoin, and more. From crypto to commodities, there's always something happening. The platform is super easy to use, so you can trade on the go right from your phone.

You can get started with just $100 and jump into the action. See something interesting? Once your account is open, you can trade it in just a couple of clicks. And if you're not quite ready yet, you can practice with a free demo account. No risk, no pressure. With 20 years of experience, Plus 500 makes trading more accessible than ever. Check it out at Plus500.com.

Trading and futures involves risks of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500. It's trading with a plus. They say every day your business is late to AI. You fall two days behind. The competition is only moving faster,

so how do you keep up? Fortunately, there's NetSuite next. You probably know NetSuite, the AI-powered business management suite that securely connects all of your data, financials, inventory, commerce, HR, and CRM in a single source of truth, trusted by over 43,000 customers. NetSuite Next is the next huge leap in how business gets done because AI is built into everything you do. It surfaces custom insights throughout your day. AI agents work alongside you to handle the routine work, and anytime you have a question about anything, ask like you're talking to a colleague. I use this and you should too. For the first time ever,

you can try NetSuite Next for free. If your revenues are at least in the seven figures, go to netsuite.aI slash TIP, built for every industry, ready for every boardroom. NetSuite.aI. as investors, we spend all day studying great businesses, but some of the best returns come from building one yourself. If you've been sitting on a business idea, Shopify makes it easy to actually make it happen. Everything you need to start selling is included and ready from day one. Take the moment your first customer is ready to pay. Shopify checkout helps more of them finish the purchase.

And when they come back, their details are already saved. One tap, and they're done. And because Shopify handles the setup and the checkout, you get more time to focus on what actually grows the business, plus the tools to do it. If I were starting a business, I would absolutely use Shopify myself. It powers millions of businesses worldwide from names like Mattel and Jim Shark to founders just getting started at Shopify.com slash TIP.

With Shopify, nothing stands between your idea and a real business, so go make it one. Start your free trial at Shopify.com slash TIP. start your free trial at Shopify.com slash TIP. All right, back to the show. Well, he certainly has a vision. And also, you've got to say, I mean, he did all of that in the middle of housing fees. So, you know, that's a massive marketing cost, of course. But, you know, if it works out, it definitely shows that he has a vision.

And at least you're not buying a mature company, right? You're buying a furniture market, which generally is not the most exciting business. But he has a vision that I believe if you want a growth company and also a company that is, you know, proven that it can get there even if times are tough. It does seem like a pretty good setup generally. I have to say, though, once again, he is betting pretty heavily at the moment, which we talked about earlier. And he's doing that in not the best market generally, pretty cyclical, and we're in a downturn. And also, the company's highly levered right now. So there's not a ton of room for error here. So we'll get to the leverage. And you're right that overhead costs as a percentage of sales.

It's definitely up a bit over the last few years. And if you view their CAPEX, these acquisitions of planes and yachts as partially a form of marketing expense, that's also elevated too. But the source books are not entirely marketing. They do double as sort of this giant data collection exercise. Because RH uses them along with its website to basically test what actually resonates with the consumer before they make the manufacturing commitment. to produce different inventory at scale.

And so one example Friedman has been giving is finding what they call the cloud sofa of wood furniture. So the cloud sofa is RH's iconic, massively popular premium sofa. And it's, you can imagine it's white and it does sort of look like a cloud. And rather than guess what the wood furniture sales equivalent of a cloud sofa could be, they put a bunch of candidate designs into the source books, wait six to 12 weeks to read the data and customer reactions, and only then do they commit operationally to producing what's popular. And, you know, when they find one of these hit products, they don't just order more of it.

They really do dimensionalize it. And we can get into exactly what that means in a minute because it's actually one of the more elegant parts of the strategy. And it's where the line between an RH as a furniture retailer, an RH as an actual taste curator, really starts to blur. Before we go there, though, the thing I want to understand a bit better is the pricing power underneath all of this. I mean, the thirds only work for your top third products actually carry premium margins. So a discount furniture chain, doubling its catalog could just as well be doubling its losses. And we're talking about this company as true luxury. So I would also expect them to have quite high margin to you.

That's true. Yeah. And going back to the story, if you fast forward from their near-death experience in 2001 when Gary Friedman came in, by 2007, R.H. had gone private in a $267 million deal with a private equity company led by Catterton. And then it became public again in 2012, right as the country was really beginning to climb out of the great financial crisis. And at that time, it listed on the New York Stock Exchange at an initial price of $24 a share. And so by late 2015, shares would quadruple and actually, you know, rip to over $105. And then in 2016, Friedman does something that looks at the time like a catastrophe. He rolls out a membership program where for $100 a year, you could get 25% off

merchandise, more off-sale items, concierge services, and early access to clearance events that they would do. So the thinking was clearly to clone Costco or Amazon Prime, but do it for luxury furniture. And, you know, he simultaneously started stripping discounts out of the business for everybody else, meaning you could only get a discount if you were a member. Whenever we talk about these subscriptions for, for example, Amazon, we always think about them as being these no-brainers, right? Like, spending five bucks a month for Amazon Prime is an absolute no-brainer.

And to me, it seems that $100 a year for a membership like this also as a no-brainer, I would take a guest to and say that the actual customers of our age probably hated it, right? I see where membership programs with savings are great for high turnover businesses, but discounting is sort of to the idea of luxury, right? I mean, part of the sales prop is that true luxury products don't go on sale. Yeah, you're right. And, you know, I wouldn't say RH is close to being true luxury and the way that Hermes is true luxury, right? But it was definitely premium for sure. And your instinct, I think, is sort of half right and half wrong. You know, customers and investors were definitely

confused at first and the stock tanked in response through 2016 into early 2017. But memberships are actually still an important part of the business today. They've raised the price to $200. And so it works well because there's this psychological effect where you've already spent your $200 a year and you don't want that money to go to waste. So you feel like you have to justify that. And even if it doesn't make complete logical sense, you're still going to go and say, oh, well, let me go spend more money so I can justify the $200 that I've already spent. And it's actually a very effective strategy. And so it's very good at driving customer loyalty. And the vast majority of sales today, about 98% of their merchandise sales come from members.

So even though memberships have gained traction, the market thought the idea looked like a huge self-inflicted wound at first. But what's really interesting to me is that given that the stock is puking on itself, despite Freeman's conviction and the membership idea, he started aggressively buying back R.H. at very depressed prices. But if it's not true luxury, then why exactly do you spend money on huge yards and private jets to charter for hundreds of thousands a week?

I mean, if your customers care about discounts, I also have to believe that they're not the type of customers that would actually keep buying furniture in a recession or on a bad housing market. So I think I'm a bit confused of who exactly is the customer of our age. I got to say, you know, apart from that, I still have some open questions and we'll probably get to all of them.

But just regarding the buybacks that you just mentioned, we saw that again in 2022 and also in 2023, where you get these very lumpy buybacks. So the stock during that time was down by half of two-thirds of its COVID peak, and they dumped $2.2 billion into share buybacks. And just for a perspective, the company currently has a market cap of about $2.8 billion. So it does look like pragmatic capital allocation,

but at the same time, the stock is now down to new lows, and they don't really appear to be buying back. at all right now. And between these huge buybacks and the investments in growing the number of galleries and source books, I do see how the company has gotten into this position where they seem to have financially overextended themselves with debt and long-term leases, even if I think you said earlier, they believe they can be debt-free within three to four years. So we still have a lot to get to on the debt side of things. But the point I wanted to make is that when the market panics about a transition, Friedman's mindset has been to turn the company

into a share cannibal. And in hindsight, 2016 was not a self-inflicted wound at all. In a way, it was the moment that RH stopped being a promotional retailer and truly became a brand in its own right. And killing other forms of discounts in favor of a consistent membership program helped enable them to pour more money into experiences like the barista bars and rooftop restaurants and aspirational galleries and the yachts, these things that make people want to hang out more around RH's fixtures. And now that defines what the brand is about. And so that elevation is what generated some of the pricing power that we'd seen flow

straight into their gross margins. Gross profits are up by more than nine percentage points, 900 basis points, from 2016. And that's actually on a low comp, right? This year, gross margins are down a bit from past years. So anyways, the point being, they have gained significant pricing power in the last decade. And that pricing power is the foundation behind the whole third's idea, right? Yeah.

So, you know, you alluded to it earlier, but the focus on the top third makes the most sense only when your top third is genuinely premium. And the funny thing is, if you're looking for some non-financial validation of this strategy, just look at who showed up on the shareholder register. In 2019, Berkshire Hathaway took a 6.5% stake, becoming RH's fifth largest shareholder. And as you know, Buffett doesn't just buy any furniture retailers. He buys brands with moats in pricing power. Well, one of Buffett's best known investments actually has been into the Nebraska Furniture

I'm out, right? It's true. It's true. It's a special exception, though. It's a special exception. And, you know, for the sake of journalistic integrity, I should clarify that Buffett will go on to sell out by 2023, which I think had more to do probably with the outlook for housing generally than anything, right? Interest rates are rising post-COVID. And so anyways, Berkshire no longer owns the business. And with the stock trading at a fraction of its 2023 price, you could either say Buffett was right to have exited, or you might argue that the opportunity has only gotten more attractive as they've continued to invest heavily in grabbing market share while the stock has only gotten dramatically cheaper. I guess it kind of depends on how you frame it. I actually got to say

that if I would see Buffett or let's say Berkshire by now, getting back into a business like this, it would probably help me getting more comfortable with this CEO, although obviously you should always have your own opinion on people and not just follow us. I'm super investors, but at least the fact that he invested in it gives me some pause and thinking, well, maybe I do misjudge the people or the management team of this company. So going back to the restaurants that you mentioned, I would love to hear more color about how these factor into this strategy, because I think you told me they are more important than actually would have thought.

Yeah, they're sort of absurd in a good way, right? The restaurants are seamlessly integrated into the galleries, which is, you know, another word for stores. That's R.H.'s parlance. And on average, the operating income that these restaurants throw off covers about 65% of the entire galleries rent. And so in some of these standout locations, the math is even crazier at R.H. Newport Beach, the restaurant alone is a $20 million plus operation and it's expected to generate enough

cash flow in its second full year to potentially cover the rent for the entire 90,000 square foot gallery that they sell furniture from. I was actually insane stats. I think if you would have told me a couple of years ago about a business model and you said that they would now put restaurants or bars into those places, I wouldn't have thought that would work out. What would actually be interesting to know is the data of how much more money people spend on average if they go to those restaurants regularly, let's say, you know, once a month.

So that would be pretty interesting, but I also can imagine that this is data that the company is most likely not going to give you. But for the unit economics, especially the unit economics of those galleries, that's a pretty, pretty remarkable thing to see. Yeah, that's right. And the galleries with their ornate beauty drive way more foot traffic than old school furniture stores. And the ones with restaurants on top drive dramatically more than that.

And the margins do follow. And, you know, notice the through line all the way back to Stephen Gordon and his staging rooms in 1980, right? The entire model is still about walking into a fully furnished scene, falling in love with the whole room and buying the whole room. It's evolved a lot along the way, right? They just wrapped it all in marble and rooftop restaurants and started charging luxury prices for it. But that same idea remains. And for anyone who already forgot, Stephen Gordon is the founder of our age.

And I think it's easy to forget that because the story has been so much about Gary Friedman. And that kind of brings us back to today's question. which is about the yachts, the jets, the guest houses, the residences. Do you think, or would you consider that to be sort of the same instinct of Stevens taken to its logical extreme? Or would you say that it's mostly freedmen having his own idea of what the branch look and also feel like? I think it's a billion dollar question.

And to be fair to the skeptics, the ambitions here aren't actually new, right? They have been telegraphed for a few years. Going back to 2020 and 2021, Freeman was already saying out loud that he thought two-thirds to three-quarters of RH's business could eventually be outside of the United States, putting it in the same conversation as an LVMH and an Hermes. And he's also openly said his real model isn't just the European luxury houses. It's Apple. So what he admires about Apple is the ecosystem.

I mean, you get someone inside your world with products and services, and then the loyalty compounds, right? I know I'm trapped very deep in the Apple ecosystem as I use my Mac and my iPhone and my Apple Watch. And so, you know, he said pretty flat out that he wants that kind of brand loyalty for R.H products in people's homes. You know, I'm honestly questioning myself here and why I am so skeptical today. I'm kind of sorry for it, but I kind of feel like he wants everything, but you can always

have everything. So on the one hand, he wants to be too luxury. On the other hand, he also wants to be Apple and that everybody sees his brand basically as Apple. I would also say, you know, there's obviously a difference in the products. You know, Apple just has, because the products that it sells significantly better chance to become this brand where people go through every single time,

and I think that's just different for, you know, furniture in general. But I got to say that I do really like the idea of having an ecosystem around the brand. And after seeing the success with the cafes and bars and restaurants that they do have, it seems that that is working quite well. And maybe the hospitality angle could be something like that too. So is that a new idea? Is it an old idea and how is it playing out?

RH's very first hospitality experience goes back to RH Chicago years ago when they put a restaurant inside a gallery. And then it changed the trajectory of the whole brand, honestly. By 2021, they were building a guest house, which again is just a fancy RH term for hotels in New York City. and then they would put $105 million into a real estate project in Aspen, alongside a gallery, a guest house, a spa, restaurants, and these homes all under one roof. And so today's RH residences and RH guest houses are not a wild pivot, even if they have fancy names.

They're basically this Aspen blueprint, but just scaled up. I guess there are two questions that jump out to me here. So the first one would be is whether a brand that, that's known for furniture generally becomes credible as an architecture or interior design or landscape firm and even our hotel year and also a real estate developer. I mean, one thing, for example, that we do see with these two luxury brands is not only history, but most of them focus on one specific thing, then get incredibly good at it, and then over time they expand into other things.

We see that with almost all of the luxury brands that come out of Europe. And technically you could say this is the beginning of such a story. you could also say that he tries very hard to be exactly that, and he's not really getting there. I mean, those are all completely different businesses, and each of them need enormous attention and capital. And I don't know, Friedman is a man not necessarily defined by a circle of competence, I would say. That's a really good way to put it in. I mean, for as painstakingly as they've worked to redefine their brand, people have wondered for

years whether a furniture company can pull off being taken seriously as a broader design authority, not just a design retailer. And now, one of the things arguing for their growing clout in the design world is that when they pivoted to memberships in 2016, one perk that they've successfully offered is a free RH designer who helps you set up the home. And so, you know, it very much seems to make the customer relationship stickier, gets them coming back, and then it turns a single couch purchase into a whole home project as you work with your RH designer. And there's a second risk that is almost the opposite problem, which would be that R.H becomes almost a victim of its own success. So when you put up blockbuster numbers, you know, those numbers sort of become the benchmark for your business and you're almost measured against them forever. So the bar just keeps rising. So you said that they made almost 700 million in net income in 2022. And if you compare the 125 million in the last year to that, it looks obviously far less impressed. If we talked about this, couple of weeks ago when we talked about Auto One. And I basically talked about Auto One and it's

competitor, Mobbiler, which is a way higher margin business and way more asset light. And we kind of talked about, well, will they be able to get into their business? And the difficult thing is, if you have a great business and the benchmark is set quite high, investors don't want to see you spend a lot of money and bring margins down. And here, you kind of have the opposite where in the past, your results have been fantastic. And now they're going down because you invest. People just generally don't like to see that. That's right. And you know, you can see the tension in the financials, which is where I want to take us next, because under all this beautiful brand storytelling, does sit what is genuinely a very aggressive balance sheet. And so there's a substantial debt load that we've alluded to

and something of a maturity wall and also a de-leveraging plan that depends on a lot of things going right. And so looking at the company's debt picture, they have two and a half billion dollars of term loans due late in 2028. And again, remember, that's about what the entire company is worth. And then they also have a $600 million asset-backed credit line where they're borrowing against their real estate assets. And that expires in 2030. And so the good thing is that both of RH's term loans require very small, fixed quarterly principal payments of just a few million dollars relative to the total size of the debt. But that's how you get to, you know, what's called a maturity wall. When the bulk of this debt comes due and most likely needs

to be rolled over, which just means refinanced, meaning you need to get a new loan to pay off the old loan, and you're just kind of pushing the can down the road. And should there be some sort of liquidity crisis in 2028, some sort of financial crisis, banking scare, if RH doesn't roll that debt over sooner or be able to pay it off entirely, which would be very challenging. They could be in some trouble because they certainly don't have the cash on hand at the moment, nor the cash flow to tackle that debt. And because of that, that's called a challenge, the $2.2 billion of stock repurchases across 2022 and 2023, it does make their use of cash in the recent past look even more aggressive. And so effectively,

those buybacks in hindsight were debt financed. And when you're also sitting on one and and a half billion dollars of leases, which are effectively a form of debt you've agreed to commit to because you're making set payments going into the future on a recurring basis. I would argue that's debt. It just only makes the picture messier. And so this added leverage plus three years of flat revenue and weaker operating margins and declining gross margins from tariffs and other things, that has all negatively impacted the company's credit profile as a borrower.

And so we actually saw some very meaningful credit downgrades that happened in 2025 for RH, which is not a good sign for equity investors. And fortunately, that is now starting to stabilize. But again, it does them really no favors because with a lower credit rating, if they do go to roll over their debt wall, which I presume they'll need to, they'll have to do so at a higher rate than the otherwise would have, which just increases the cost of debt. So that's more interest payments that are going to reduce net income in the future. Let's take a quick break and hear from today's sponsors.

Curious about online trading, but haven't taken the first step yet. You're not alone. And plus 500 futures is a great place to start. The futures markets are moving fast. And with plus 500, you can explore popular assets like oil, gold, S&P 500, Bitcoin, and more. From crypto to commodities, there's always something happening. The platform is super easy to use so you can trade on the go right from your phone. You can get started with just $100 and jump into the action.

See something interesting? Once your account is open, you can trade it in just a couple of clicks. And if you're not quite ready yet, you can practice with a free demo account. No risk, no pressure. With 20 years of experience, Plus 500 makes trading more accessible than ever. Check it out at Plus500.com. Trading and futures involves risks of loss and is not suitable for everyone. Not all applicants will qualify.

Plus 500. It's trading with a plus. They say every day your business is late to AI, you fall two days behind. The competition is only moving faster, so how do you keep up? Fortunately, there's NetSuite Next. You probably know NetSuite, the AI-powered business management suite that securely connects all of your data, financials, inventory, commerce, HR, and CRM in a single source of truth, trusted by over 43,000 customers.

NetSuite Next is the next huge leap in how business gets done. because AI is built into everything you do. It surfaces custom insights throughout your day. AI agents work alongside you to handle the routine work. And anytime you have a question about anything, just ask, like you're talking to a colleague. I use this and you should too. For the first time ever, you can try NetSuite next for free. If your revenues are at least in the seven figures, go to netsuite.

8.a.a.a.t.com built for every industry, ready for every boardroom. NetSuite.a.com. What's the one thing in business spreading as fast as AI? AI risk. Every new tool your team signs up for every vendor that flips on AI features, every fresh integration, each one is another opening for something to go wrong. And most security problems simply weren't built for the pace AI is moving. Enter Vanta. Vanta is the number one agentic trust platform

trusted by over 16,000 fast-moving companies, including Ramp, Cursor, and Harvey to stay audit ready. And now, Vanta is helping companies like yours catch the risks that show up between audits

across your vendors, your AI tools, and your whole environment. How? The Vanta agent works like a 24-7 GRC engineer running in the background.

Finding issues, drafting fixes for you, and cutting vendor assessment time by up to 50%. Whether you're a fast-growing startup or a global enterprise, Vanta is here to help you automate your security and compliance and earn, improve trust. Get started today at vanta.com slash t-I-P. That's V-A-N-T-A dot com slash T-I-P. All right, back to the show. I feel like the debt question is probably the most important thing in today's thesis. So I would like to take the chance and actually talk about accounting here a bit,

which I know isn't the sexiest topic. But I think understanding, especially lease accounting, can be important for this case. And actually for all of the retail businesses that we have looked at. And given RHS leverage profile, I think it's especially important here. And so when we are accounting for leases as a form of debt, as you have basically suggested a minute ago, How does that actually happen and why do we do that? And also, what does the change for us as potential investors in this case? Gosh, I'm getting flashbacks to studying for six months for the CFA exam.

It turns out some of that stuff, like lease accounting is sometimes useful. And there are two types of lease classification. So there's operating leases and finance leases. And you might be thinking, look, a lease is a lease, but it is not actually as redundant as it sounds. There's some sort of logic to it, right? With operating leases, the idea is that you are renting an otherwise viable asset. Whereas with a finance lease, you're effectively getting someone to lease you a property for, you know, to use accounting parlance, the majority of that asset's useful life.

In which case, you're really, what you're doing is you're buying something. You're not leasing it, which is why some leases get classified as finance leases. And so it would be sort of like maybe to make a parallel, if you customize a car that has your name, you know, branded and big cursive letters in the side with bright pink seats and then you leased it for a decade, given that no one else is going to want the car afterward, it has effectively no remaining useful life by the time you're done. There's no residual value or very little. And so in the truest sense, did you really lease it or did you finance a car purpose? without explicitly getting a loan. That's sort of the point of logic here. And so, on the other hand, if you lease store space in a popular shopping mall for five years, well, that space can be easily repurposed afterwards. And in that case, then you truly just rented it, right? You rented an apartment for the year and then afterwards, you know, it's passed on to the next person. And so that's an operating lease. You didn't really, you know, it's not something that

resembles debt quite in the same way. And so, again, that's the logic of it. And so it's generally important to account for leases in a company's debt picture. And I think this just adds an extra wrinkle to how you think about it because of the way that accounting for operating leases and finance leases can actually have different effects on the income statement. I don't know about you, but if you give me a good price for a Porsche with pink seats and a company slogan on the stores, I still take it. I mean, put a nice little black wrap on it and it's as good as new and I'm also rocking it with pink seats. So it's not a problem for me. But jokes aside, I mean, which one of those two types of leases is R-H? And I would just take a guess

and say they probably personalized or customized quite a lot of the spaces they are in. Does that affect to any extent how we should account for that? Yeah. So they have a decent split between operating and finance leases, but a bit more toward finance leases. And, you know, the reason this matters is because, as we know, they lease a lot of physical assets like galleries and showrooms and restaurants. And many of the galleries they use, some of them can be classified as regular operating leases, but some of the more highly customized properties that they've constructed that really serve no other purpose outside of their role in RH's ecosystem, well, then there's more of a case that those are finance leases. Without getting lost in the weeds at a high level, why does

the distinction between operating and finance leases actually matter for us? I mean, you mentioned there's an impact on the income statement, right? If we can do a 30-second deep dive here into some accounting. So in both cases, something known as a right-of-use asset is created on the balance sheet, reflecting the value that you get from making use of the leases. And then a matching lease liability is also created and amortized over time. That's just accounting 101. But on the income statement, RH records a straight line lease expense and its operating expenses. But for a finance lease, they break out that cost into two parts. And so the cost is separated into the depreciation of the right-of-use asset and an interest expense based on the imputed interest rate

on the lease. If you treat all the lease payments as a form of debt and calculate the present value, the implied interest rate on that debt, that is the imputed interest cost. And so anyway, this interest component then gets accounted for below operating income on the income statement, which means that operating income could be somewhat inflated in a way or look better than maybe reality would show, especially if RH or any company were more aggressive about how they categorize finance leases. And that's just something I think to keep in mind as you dig through the numbers. And that's not to say that they are being aggressive, but really just the whole classification process involves judgment. And so as a savvy stock.

investor, I think you should understand the assumptions that go into these accounting differences and recognize the way it impacts the cash flow statement, the balance sheet, and operating income versus net income. And so I honestly would recommend just treating all lease obligations as finance leases. I think that's way simpler. Accountants may disagree with me, but that's way more of an accounting tangent that I wanted to go down. So I apologize to the audience.

but hopefully that is helpful for some people out there that really enjoy lease accounting. Certainly there are people listening to us who actually do enjoy that. So I think it was pretty helpful. I guess just to kind of get back to the topic, matters for RH in regards to their debt obligations and also their ability to pay them back, right? Yeah, so it's a prelude to discussing the reality that RH is expected to increasingly use sale leasebacks as a way to raise cash to pay off this term loan debt that we keep coming back to that's coming due in 2028. And so in other words, they will sell real estate that they've

developed and owned and then lease back the same property from some sort of outside investor. So operationally, nothing is changing, right? They're still operating out of the same galleries, but they freed up a bunch of cash that they can use to pay off their term debt while effectively taking on more lease leverage. And much of this, I'm guessing, will be classified as finance leases, but that's entirely speculation. So when R.A.H. says they're going to repay all of their debt by 2029. What that really means is they're going to take on more lease liabilities, which aren't

technically dead, but still very much show up as long-term liabilities on the balance sheet. I think that's right. And so Friedman has also. stated that the company is exiting the peak of its investment cycle. So that does help reduce the need for fresh financing going forward. But yeah, it is mainly going to come from selling off real estate, which they're expecting to do to the tune of $200 to $250 million per year. So that will help raise some cash on the balance sheet. And, you know, again, as part of its real estate transformation, RH is shifting away from a traditional retail leasing approach toward

a development model where RH buys and develops real estate for its new design galleries, either directly or through joint ventures with third-party developers. And then once construction is complete, RH's ultimate objective is to execute a sale, lease-back transaction, whereas we said they sell the property to an investor and agree to lease it back from that investor for a set period of time. And to execute all of this, R.H. actually brought back David Stanchak as chief real estate and transformation officer recently. And David is for context, the previous mastermind of RH's sale leaseback strategy. So they're getting the gang back together again to do some financial

engineering here. I don't know if I like that. And maybe that's part of the reason why I'm so skeptical today, because we talked about this before. And to me, it just not seems like the best way to actually get rid of your debt. I think, you know, partly selling assets feels a bit different than actually generating enough quality cash flow. So you can truly say they earned being debt free. And that's just me. I mean, if, you know, all of these investments, they are actually paying off and you can see how they at least believe it will all work out for them. Then, you know, that will be a good investment. I mean, you could see sales rebound while the debt gets paid down with real estate sales.

And realistically, I think they will still have some more debt to all over. but they may actually threat the needle of having done accretive debt finance buybacks, reinvested massively into taking market share, doing a slowdown for the industry, and then done some clever financial, let's call it maneuvering, that doesn't truly eliminate the debt, but certainly reduces the risks to shareholders and then, you know, clean things up. So I guess if I have to summarize anything, that's how I would summarize the bull case, right? With your skepticism today, I appreciate you being able to, uh,

make the arguments for the bull case. And yeah, I mean, management believes the company can hit five and a half billion dollars in revenue by 2030, which would be something like a two-thirds increase. And some of the estimates I've seen on Wall Street aren't as optimistic, but they still model a jump in sales to $5 billion or more. And if you're talking about a 10% net income margin on $5 billion in sales, that would be $500 million in revenue. And I don't think we need to get deep into the valuation weeds here. But, you know, if you put a 10x multiple on $500 million in revenue, that is a $5 billion valuation, which would be a double from current prices. I think there's no doubt that at the current valuation, if they could get back to the amount

of money they've made in the past, this could easily be a good investment. I think the question is, do you think this is a business that can achieve luxury industry margins, even if sales bounds because an 11% operating margins is where we currently are. And for a self-described luxury brand, that's not actually a luxury number, if you ask me. And, you know, I look at the past. They've earned more money in the past, but I just don't see how you can just normalize earnings as with, you know, some of the other value plays that we have had on the show. No, it's not a luxury margin. You know, LVMH would faint, I think, if they, they saw this. But the costs from scaling operations and from tariffs to way. There's definitely weighing down margins. And if tariffs roll off in 2008, while the business

reaps the benefits of these investments, you could definitely see operating margins start to rise back maybe towards as high as 20%. And for context, they peaked at 24% a few years ago. So again, this would mostly be the bull case. Debt reduction after massive buybacks previously, while operating margins normalize and sales take a real step forward after being flat for a couple of years. years following the COVID era bonanza where you then did have a huge jump in sales that I think pulled forward a lot of the business. And the question is, you know, where does the company go from now? And so I would probably say a mid-teens operating profit margin is realistic. And then that's how I get to say, you know, approximately maybe you get like a 10% that income margin on $5 billion

in sales. And then that's how you get to this idea that the company could be worth $5 billion. And then it's just a question of the multiple you use, right? If you use a 20 times multiple, then it could be a four bagger. But there is a question of whether this company deserves that kind of multiple. Contacts it currently trades at about 23 times earnings. So the market is paying a meaningful premium for a business that is highly levered and would otherwise look like it could be in trouble. I think it's always difficult to look at multiples. Whenever you have these depressed times and earnings. I think that's similar to when we looked at Nike back a year ago, where he was basically still trading at a P of 30, but obviously part of the thesis has been

that the earnings will recover over time. There's one topic that actually also comes up with Nike all the time, but you also bring up today, which is tariffs. And it's kind of surprising to me because mostly when you talk about a luxury brand, they manufacture their things locally, which for this brand would obviously mean in the US, for many other luxury brands, it means in Europe, but it seems like they are quite exposed to tariffs. So why exactly is that and how exposed are they? More than you'd want to be, right? They did smartly move some of their sourcing out of China, but a lot of it went to Vietnam and Vietnam got hit with tariffs too. So they definitely did not fully escape it. And they've talked about doing some stuff like

trying to produce a majority of their upholstered furniture in the U.S. and a chunk in Italy, but then also it's probably more expensive to do so in those places. So, you know, I'm sure they'll continue to try and mitigate tariff costs or hope it just goes away with the next administration, but there's really been no way for them to completely escape the effects of it. Yeah, I mean, that's, you know, the case for many, many brands. So I wouldn't say that's, you know, specific to R&H. Although I would say that probably going from Vietnam for manufacturing to, let's say, the US or Italy, doesn't necessarily help the margins, even if you don't necessarily have to pay

the same amount in tariffs. I would just assume that manufacturing in those countries would be way more expensive than it is in China or Vietnam. But how about we bring it all together here? Because I'm honestly still not sure where you're going to land with this one. I'm not sure where I land on this one. So do you mostly see it as a big opportunity with big risks? Or do you just see a big risk and you don't necessarily think that it's highly likely this will be a fallback at any time? I've gone back and forth on this one.

But ultimately, I do see it as a no-mote business. And yet, I would also say even if a watered-down version of Friedman's vision for the next few years comes to fruition, then the stock is almost certainly undervalued. And so to me, it's just a matter of how much conviction you have in Friedman's plan. And, you know, that's where I start to trip up. And 18 months from now, if you told me that R.H. stock had more than doubled, I would absolutely not be surprised. And with our luck, it probably will. But we know from Buffett that the first role of investing is not to lose money. And I don't think we can confidently say that there's no risk of losing money here, that we have a substantial margin of safety. There's a lot of things outside

of the control, right? If macro factors take a turn to the worst, we talked about, you know, like maybe a banking crisis, not to say there is about to be one, but we know that historically these happen every few years. And in that case, they would be quite vulnerable to this debt wall that they have in 2028. And so, you know, I think I'm close here. I could almost get really excited about this one, but I'm just not totally sold that their bets are going to pay off. And for example, you know, Friedman had really big ambitions for RH residences with the homes they built in Aspen. But the plans have, you know, pretty much been very dramatically dialed back in the last year or so around RH residences. So it's not like Friedman is infallible, even if he does

embody a pretty impressive degree of boldness and belief in himself. But to me, that also raises another question of key man risk, right? Friedman is not exactly a young guy. And I think the stock in more than 20 times earnings could get a heck of a lot cheaper if the market has to price in Friedman's retirement in the coming years. And, you know, this is a business that almost just doesn't makes sense without Friedman. So then what's the terminal value of the company without Friedman involved? I don't know. You know, people like to debate whether Berkshire makes sense without Warren Buffett.

And there's something to be said for that. But still, the underlying businesses are all viable. If you have a company here that is really completely dependent on the aesthetic vision of one man, yeah, what is the company worth when he's gone? To me, that is a real concern. And I don't know if he leaves in a year from now, five years from now, 10 years from now, or what, but we know he won't be around forever. So I'm getting enough yellow flags that tell me that, you know, this investment would be

vulnerable to a number of very tangible risks. Well, he would probably say that every act of creation is first an act of destruction when he leaves. Yeah, destroying shareholders' faith in the company, right? I mean, he hasn't been afraid to break things. He has ripped up margins and levered the balance sheet and made some exotic investments along the way. So it really is a very, very interesting story, but one that I'm happy to watch from the sidelines.

Yeah, I mean, look, throughout the entire episode, I might have seemed a bit more skeptical than I've actually been. I mean, I could also compare this case to Wix, for example. I mean, Wix is a company where I feel like if it works, out and it still exists in five years time and Base 44, which is a huge part of the thesis for everyone who didn't listen to the episode, it's still existing and thriving. The company could easily be a three or four X, but you could also make the argument that it doesn't exist anymore and nobody needs it in two or three years time. So we know that people will still need

furniture in two or three years time, but we don't necessarily know if R&H is still existing. If you look at the debt they have compared to the market cap right now, and that's why I really don't know what to think of this one either. I mean, you have a CEO here. who turned this little furniture store into a multi-billion dollar business. So, I mean, honestly, who am I to question his decisions? And at the same time, if I think about putting my money to work, I also have to trust the people at the wheel, right? And to be completely honest, from what you told me today, I don't really know what I

would be buying. I mean, am I buying a top-tier luxury brand? Am I buying a restaurant chain? Or am I buying a founder's vision for what could be a global hotel brand? So, you know, I sometimes joke with you that we are value investors and we have value investors because we lack the vision or the risk appetite to act like someone like Friedman and completely destroy something to build something new. And I admire that, but I also wouldn't want to be invested in it.

And it always sounds like a cop out to say, you know, I could see this double when things play out, but it's not for me. It's sort of like an insurance so that when it's actually doubling, nobody can tell us that we were wrong and when it goes bankrupt, we also seem smart because, well, we didn't invest into the company, right? But honestly, that is, to some extent, the game of investing. Like, we deal with uncertainties and we have to figure out whether they fit our risk appetite and also what chances of success we actually believe this business or this company has. Okay, I think that's a perfect place to leave it. And if you want to keep going deeper on names

like this, the bull and the bear cases, for example, all of that you can do in our intrinsic value mastermind community where almost all the time we keep talking about the companies that we cover on the show with the members in the community. Actually, I also believe that today's pitch has been the recommendation of a member we talked to in Omaha. And of course, we will link to, you know, our community, the network, also the free newsletter that we have in the show notes. And Sean, as always, was a blast joining you and hearing this pitch, even though I might have been a bit skeptical from the beginning. That's not because of your pitch, I can assure you. I'm glad to hear it.

Well, let me leave the audience with a quote. Bernard Arnault, the patriarch of a luxury giant LVMH, says, money is just a consequence. I always say to my team, don't worry too much about profitability. If you do your job well, the profitability will come. And yeah, Friedman has very much, for better or worse, been channeling his inner Bernard Arnault, it seems. And so with that, we'll see you all again next time.

Thanks for listening to TIP. Follow the Investors podcast on your favorite podcast app and visit the Investorspodcast.com for show notes and educational resources. This podcast is for informational and entertainment purposes only and does not provide financial, investment, tax or legal advice. The content is impersonal and does not consider your objectives, financial situation or needs. Investing involves risk, including possible loss of principle and past performance is not a guarantee of future results.

Listeners should do their own research and consult a qualified professional before making any financial decisions. Nothing on this show is a recommendation or solicitation to buy or sell any security or other financial product. Hosts, guests, and the Investor's Podcast Network may hold positions in securities discussed and may change those positions at any time without notice. References to any third-party products, services or advertisers do not constitute endorsements and the Investors Podcast Network is not responsible for any claims made by them.

Copyright by the Investors Podcast Network. All rights reserved.