Smart money is buying TPW, will triple from here

First post but I thought this rare situation might warrant it.  Must disclose that I bought shares in TPW on Friday.

I am interested in Hotcopper user feedback on the below which came from a friend who is a fund manager I respect, especially in this sector…the last two e-commerce tips he gave me were to short Ensogo (E88 AU) at the equivalent of $10 and to buy VIP Shop (VIPS US) at the equivalent of $2.

To wit: “You should be buying some TPW my friend...I just met them for the third time, this has been a massive 'dummy spit' from several simpleminded and negligent hedge funds who took the IPO at $1.10 hoping for a pop in the hot IPO market before Christmas.  

TPW raised $62m in December last year - $26m of this went to the Company coffers, $10m was a cash payment for the Milan Direct acquisition, $21m was a vendor sell down and the balance the costs of the offer.

Importantly, of the 1/3 that went to the sell down, key management personnel sold down 4.7m shares, so just 25% of the total selldown, with the balance coming from early stage investors Macquarie and ArdenPoint funds.  MD Brian Shanahan sold down 1.4m shares and has subsequently bought half of those back on market at $0.23 to take his total interest to just under 4% of the Company on a pre-performance rights basis. Conrad Yiu has made a more pathetic effort, having sold 3.35m shares directly and buying just 200k back so far, although he does directly own 5% of the Company.  We suspect the institutional shareholder base will continue to put pressure on the board to buy back on market and this is a positive catalyst for a stock that is presently priced to fail.

Here’s a brief history of TPW and just what went wrong post IPO...

The original Temple & Webster (T&W) brand has itself demonstrated impressive historical growth, increasing revenues 180% from $9m in FY13 to $26m in FY15. Incorporating the ZIZO and Milan Direct acquisitions (creating "The Temple & Webster Group”) for proforma purposes, Temple & Webster Group on the whole increased revenues 100% from $30m in FY13 to $60m in FY15.  The divergence in these growth numbers between T&W and ZIZO/Milan is key because you can see the T&W operation was growing more strongly than the businesses they acquired, and the success of the T&W brand was largely based around Homewares which accounted for 81% of revenues, with Furniture making up the 19% balance.  In contrast, Furniture accounted for 48% and 81% of ZIZO and Milan Direct respectively, leaving Temple & Webster Group with a proforma sales mix of 56%/44% Homewares/Furniture.  Now consider Homeware category products enjoy margins of 25-40% compared to the higher margin Furniture category at 30-45% (as a side note this is why HVN changed the configuration of their stores many years ago to have large footprint showroom style displays, and one of the reasons why JB Hifi rolled out JB Home)…this is essentially where the problem starts, with the lure of a big post-IPO Christmas campaign focussing on Furniture by leveraging their newly acquired brands.

With the funds raised from the IPO, Brian and the team made some disappointing decisions, ones which they are now determined to reverse.  Firstly, they moved away from their core competency in Homewares and made Furniture the target of the Christmas marketing campaign in search of a higher margin product mix.  Secondly, they shifted from their traditionally successful marketing channels such as social media to more Out of Home advertising.  Thirdly, they upped their print marketing spend but again shifted the mix to Furniture.  All of this resulted in 1. A halving in the Click Through Rate on email campaigns 2. Lower than expected website visitation and 3. Softer than forecast sales.  Ultimately, they were forced to more aggressively discount during the Christmas and Boxing Day period, therein explaining the disappointing GP margin contraction.  The issues were compounded when looking below the GP line, with the unexpectedly slower transition under the rebranding of Wayfair to ZIZO requiring increased marketing spend.  

There were some obvious positives however, being improved brand awareness (up to 23% vs 19% prior), a higher customer rating on www.productreview.com.au (Milan Direct and T&W are 3.7 and 4 stars respectively versus the earlier examples of Harvey Norman at 2.1 stars and JB Hifi at 2.5 stars) and an 8% higher average basket size which takes it to $335. With awareness up and customer satisfaction way ahead of peers, and some hard lessons learned, the Company should be able to straighten things out with relative ease from here.

Additionally, Brian is citing 4 things TPW is very excited about:
i) 9 out of 10 shoppers don't want to register and they now have an open e-commerce site to accomodate (shop.templeandwebster.com.au) - modern day shoppers are more comfortable in these types of environments
ii) Online as a share of total Australian shopping spend is still just 4%; TPW is confident that grows to at least 10% in the coming years citing the US at >10% and the UK at >13%
iii) Online to Offline, aka “O2O”.  The soft launch of Milan Direct showroom in Richmond on the weekend before last saw strong foot traffic with 200 people through despite no marketing push nor signs on the store (needs council approval, expecting it to take another fortnight).  Conglomeration of economies should help given it is around the corner from Ikea
iv) The newly launched ZIZO Pro opens them up to interior designers and tradespeople, allowing these users to get a discount across all three brands.  So far there has been a few hundred transactions with the basket size 5-10x the typical retail customer

On an end of July 2016 basis, the company should have ~$20m of cash (I am using July to account for the $2m deferred consideration payable for the ZIZO acquisition, due 31 July 2016) with zero debt for an EV of $6m at a last price of $0.25/sh.

Paying an EV of $6m for a company which will do ~$70m revenues for FY16 on their revised estimates - a number I believe is conservative on the basis momentum has actually improved in 2016 to date - puts the stock on an EV/Sales metric of <0.1x. If we put the stock on a “bricks and mortar retailer” average multiple of 0.6x, the valuation is $0.59/sh. This is arguably a very harsh case given the best comparison on the ASX, being Surfstitch (SRF AU), trades on 1x FY16 EV/Sales. On 1x EV/Sales TPW is worth $0.85/sh.  In the big leagues, Etsy (ETSY US) trades on 2x EV/Sales, which would see TPW at $1.51/sh.  Recall this is using what I think is now a conservative sales assumption…something TPW should have done from the beginning or the stock wouldn’t be trading at such a discount, but that mistake is now presenting us this opportunity.

Another way to look at it...the Australian online furniture and homewares category is expected to grow to $764m in CY18 vs ~$500m for CY15.  TPW as a group did consolidated sales of circa $65m in CY15, therefore representing 13% of the total domestic online industry.  This reconciles with prospectus data showing Temple & Webster Group being the 6th most visited home and garden website in Australia (after Bunnings, Harvey Norman, Ikea, Etsy and soon to be extinct Masters) and the leader in their category. Even if they only continue to grow at the system rate, 13% of CY18 industry estimate sales equals $100m of TPW revenues.  On the SRF multiple this would see the stock at ~$1/sh.  Revenue upside clearly exists from accelerating organic growth, higher online penetration rates, improved TPW market share, O2O rollout and innovative marketing initiatives such as ZIZO Pro.

Even assuming aggressive GP margin contraction to 35%, TPW would comfortably be breakeven on this notional sales growth assumption.  I think concerns on cashflow have been a large reason behind the aggressive fall but on my numbers the Company can get to end of FY17 on the current burn-rate…but this is a very harsh bear case given they have already seen a pickup in sales momentum post January.  

Furthermore, there are now some major cost benefits to be recognised this year, including acquisition integration related headcount savings of 25% (on FY16 group salaries of $12m = $3m), $1.5m revised CAPEX savings, scaling down from 5 warehouses to 2 saves another $1m (leases are expiring so can consolidate as part of ZIZO and Milan integration), and last but not least, large operational efficiencies of at least $1m should be realised from centralising the three businesses operating platforms (means they only need one purchasing team, one technology team and one marketing team).  Add all of this up and you get $6.5m…for context, these savings represent almost half of the conservatively guided -$14m FY16 EBITDA number.  

Let’s look at an end of CY16 scenario where they hit $76m of sales (representing growth of just 10% from the the low end of the revised FY16 guidance, essentially a 6-month lag to hitting the prospectus number), assume GP margins revert to 40% (half way between the 38% H1FY16 number and the 42% prospectus number), deduct Wages+Selling+Admin expenses of $40m, then assume that they realise the aforementioned cost savings and add back the $6.5m…this would put EBITDA at just -$3m and have TPW well on track for breakeven in FY18 if not by the end of FY17. None of this is in the current share price!

Long story short…the Company isn’t going broke and at this valuation it is a gift!”

Any thoughts on the above would be much appreciated, perhaps retail investors see something the institutions do not.