The 2013 IPO Bubble Is Here, And Companies Are Lining Up Quickly Before The Window Closes

From Yahoo! Finance:

Zulily, Inc. operates as an online flash sale retailer in the United States, Canada, the United Kingdom, and internationally. It provides various merchandise products to moms purchasing for their children, themselves, and their homes, including children’s apparel; women’s apparel; children’s apparel products comprising infant gear, sports equipment, toys, and books; and other merchandise, such as kitchen accessories, home decor, entertainment, electronics, and pet accessories.”

Yes, Zulily (ZU). One of the latest hot initial public offerings. The company description above might sound fancy, but it’s a shopping site targeted at moms. Think of it as a specialty boutique store, with just an online presence. I don’t mean to minimize it, but there is no special sauce here. It’s a retailer, plain and simple. And a very popular one at that. For the first nine months of 2013, the company’s sales totaled $439 million, which generated $29 million of positive cash flow (7% cash flow margins).

So, how much is Zulily worth? $5 billion. And I’m not joking. The company went public last Friday at $22 per share and now trades at around $37. The initial expected price range for the IPO was set at $16-$18 but investors were willing to pay more than 35% above that before the stock even began trading. After it opened, the price was bid up another 70% on the first day.

Zulily is the perfect example of why the current IPO frenzy has gotten out of hand (and likely won’t last too much longer). The company is targeting what is likely an under-served niche within specialty retail (moms), and it has been very successful thus far. In fact, they are based here in Seattle and I hope they continue to make their customers happy. But the price of the stock makes no sense. And that’s where the IPO market, and many retail investors who are gobbling up any newly issued stock they can, will wind up having a problem.

There is nothing new here in terms of Zulily’s business model (at least with Twitter (TWTR) you can argue they created something new and were a first-mover, so perhaps they will be a unique case). They are a retailer. We have a good idea of how that business works and what kind of profit margins one can expect. Accordingly, we should be able to determine what kind of market valuation makes sense. We might not be able to pinpoint it exactly, because Zulily is growing very fast (2013 sales are running double those recorded in 2012) and its exact growth trajectory is difficult to predict, but at this point they are simply taking market share from existing retailers, both online and off. Moms across the country aren’t all of the sudden dramatically spending more on their children. There is not a retailing renaissance more generally throughout the U.S. The consumer economy has not suddenly taken off. Zulily, if they continue to execute well in the marketplace, will see its growth rate slow over the next few years and then find itself just like any other retailer vying for consumers’ discretionary dollars.

And that is why the company should not trade at 150 times cash flow. The business model at it currently stands does not justify a $5 billion valuation. Heck, even Amazon (AMZN) trades at 34 times cash flow and it is one of the few companies that can barely turn a profit (7% profit margins on a cash flow basis — same as Zulily’s interestingly enough) and not face any objections by investors. Is every dollar of sales generated by Amazon really worth 75% less than a dollar of sales booked by Zulily? That is what the market is saying right now.

And because of that other internet start-ups are preparing to test the IPO waters. Just in the e-commerce space we have heard rumblings that Gilt.com, Wayfair.com, and Fab.com are itching to cash in, and I don’t blame them. So I would caution everyone to stick to a valuation discipline when you pick stocks for your portfolio. The last time we had companies being valued based on a multiple of sales (not profits), or saw P/E ratios reach triple digits, or saw analysts justifying prices by using financial projections five years into the future, was the late 1990’s. And we all know how that turned out.

Full Disclosure: No positions in the stocks mentioned, but positions may change at any time

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