July 29, 2014 2:30PM
What Would You Do? Josh Burwick Imagine that you are head of Sonys online product group. You need to have a presence for your thousands of SKUs (stock-keeping units) on all the major websites/marketplaces such as Amazon, Newegg, and eBay. You also need to monitor the search engines and comparison shopping sites such as Microsoft Bing, Nextag, and Google. Not to mention emerging channels such as Groupon, Living Social, Twitter and Facebook. How about selling in high-growth markets such as China? How would you manage prices and inventory? Before you answer, keep in mind that these channels all have their own product listing requirements and they are ever-changing. If your head is spinning trying to figure out how to balance all of these very different channels, dont worry you are not alone. You desperately need a ChannelAdvisor a partner to help sort through everything. Luckily, there is a company that will handle all the details in an easy-to-use SAAS solution. Meet ChannelAdvisor (ECOM), the best kept secret in online commerce. What is ChannelAdvisor? ChannelAdvisor is a SaaS (Software as a service) provider targeting retailers and manufacturers whose software platform allows them to integrate, manage, and optimize their merchandise across the wide spectrum of ever-changing channels. Brand-name companies such as Dell, Sony, Lenovo, Under Armor, and Ann Taylor have all standardized on the ChannelAdvisor platform. (Insert Logos of these top customers- Dell, Sony, Lenovo, Under Armor, Ann Taylor, etc) As of December 31, 2013, ChannelAdvisor has amassed 2,400 customers, representing 27% of the Top 500 US Internet Retailers. Those companies processed $4.4 billion in Gross Merchandise Volume (GMV) and managed 150 million SKUs (stock keeping units) on the platform. ECOMs Total Addressable Market (TAM) represents 110,000 retailers who account for $540 billion in GMV vs. the current total market, which only consists of 4,400 customers and $4.4 billion in GMV. In other words, ECOM has penetrated merely 1-2% of its total opportunity. ChannelAdvisor sells software modules that correspond to specific channels (a channel being marketplaces or search engines or comparison shopping engines, etc.) So, if you are a retailer evaluating ChannelAdvisor you may start by buying the marketplace module. After being impressed with the results, you can expand into the paid search or comparison shopping modules The value of ChannelAdvisors solution increases with every module added, as it integrates the channels into a single feed. For many retailers (small and large), the ChannelAdvisor platform serves as their entire back office and pseudo-marketing department. Product Listings across Multi Channels Solved A major pain point for retailers revolves around listing products on an increasing number of channels. There are many more channels than Amazon Marketplaces. Other channels include comparison shopping websites and search engines. In the not too distant future, platforms such as Facebook and Twitter will be included as well. Product listings need to be customized for each individual channel because there is no standardization among the various channels for SKUs. Moreover, channels are constantly changing the rules and requirements for listings. If you are a clothing manufacturer like Ann Taylor, you might refer to a sweater as Cranberry. However, Amazon may call it Dark Red and eBay may call it Burgundyand the specific term could change at any time. Its a full time job to keep up with the ever-changing definitions while extending your reach by branching out to additional channels. The majority of retailers who dont use ChannelAdvisor do these things internally and are not doing it well. Single Inventory Feed Another problem is inventory management. A retailer can get in trouble if it lists a popular product on the eBay Marketplace while an influx of orders on the Amazon Marketplace causes inventory to be depleted. The retailer has to notify the unfortunate buyers that their order will not be met and likely suffers their wrath with a lost sale, a negative review, and the possibility of sanctions by the marketplace. Its obvious that retailers need a way to gain a single view of inventory that dynamically changes across all channels. To do this, a retailer either needs to employ dedicated people to manage the inventoryor they use ChannelAdvisors Inventory Juggler. With Inventory Juggler a retailer can post the same inventory on a multitude of websites without fear of overselling. The software automatically adjusts and updates inventory immediately. As a result, a retailer can maximize exposure and manage inventory across multiple channels. Revenue Optimization One of the biggest pain points of retailers is constantly adjusting prices in the new Amazon-dominated world, where dynamic pricing is expected. If a competitor cuts its price by 20%, youre doomed if you dont respond. With ChannelAdvisors Repricer you can set rule-based price adjustments. The software also allows a retailer to change prices with pre-set profit margins in mind. So, a retailer may respond to a competitors 20% price cut by cutting prices on select merchandise in situations where it will still lead to an acceptable minimum operating margin. ChannelAdvisor also offers analytics, so Chief Marketing Officers can maximize channel relationships and make quick decisions. The 360 Dashboard allows a retailer to view and act on all metrics that influence their online seller reputation. The Cross Channel Dashboard details transactional data daily, weekly, monthly, etc, while the Inventory Velocity Report enables a retailer to anticipate inventory needs based on prior inventory / sales trends. A Play on Marketplace Growth with a Massive TAM Marketplaces are increasingly important in the U.S., but more so internationally where they represent 80% of ecommerce (vs. 30% in the U.S.). In China, marketplaces represent 90% of ecommerce. While it is unlikely that the U.S. will get to 90%, the trend is clearly growing, with Google, Wal-Mart, Twitter and Facebook all likely to establish their own marketplaces. Managing product and inventory on marketplaces is enormously complex. As this channel grows in size, it only becomes more complicated to manage. One of the primary demand-drivers for marketplaces comes from SMB (Small- and Medium-sized Business) retailers, who can use marketplaces to tap areas well outside of their domain especially overseas. The sweet spot for ChannelAdvisor is the retailer who generates $1-10 million GMV on third party marketplaces. Stock Sell-off Largely VC Selling that is 90%+ Complete I think the stock represent a great opportunity right now. A persistent overhang for the stock has been VCs, who have been selling since the company went public last year. VCs entry point(s) range from angel rounds to Series A, B, C, D, etc. The ultimate payout for a VC is when one of its early stage investments makes it to IPO and beyond. At that point, liquidity is present and the VCs, similar to parents when their children go off to college, feel they have done all they can. Thus VCs will typically look to cash out at IPO and in subsequent rounds and/or through open market transactions. Small-cap stocks with low average daily volume (like ECOM) can be overwhelmed by large sellers. This is especially on days when high-growth tech stocks sell off. The good news is that the VCs have largely pared their stakes, from over 7 million shares early in 2014 to well under 1 million shares currently (based on a recent note from Deutsche Bank, which recently spent time with the CFO marketing the company). We should see the VCs finish their selling soon, if not done already, which will provide an enormous boost to the stock as supply dries up. Growth Pillars ECOM has two major factors that will drive its continued growth: ECOMs growing sales force reaches an inflection point ECOM has pressed the accelerator on sales force hiring since going public. ECOM plans to grow its sales force by 50% in FY 2014, similar to its growth rate of the past two years. Typically, new sales people tend to be assigned to new accounts. When new accounts sign up, they usually start with a basic module (modules are associated with different channels such as Marketplaces, search engines or Comparison Shopping), which is usually in the $10,000-15,000 range annually per account. Steadily, the retailer increases the Gross Merchandise Volume (GMV) they run on the platform and eventually buy additional modules. As a result, the revenue per customer increases considerably from the $10-15k initial sale to the $30-40k range when in a mature state. Because the average revenue for new accounts is low, the average revenue per customer across the entire company has been artificially depressed, decelerating from 13.6% in Q113 to 8.2% in Q413. We should expect to see a couple more quarters of lower revenue per customer, caused by a high number of new-customer additions. In addition as an account matures, their GMV increases and ECOM has direct exposure as it takes a certain percentage of customers GMV above a minimum threshold. This variable piece accounts for 30-35% of revenue, lower end of the range now as new customers have increased and have relatively low GM on the platform. The companys average revenue per customer on a trailing twelve months basis as of last quarter was $30,670 up 9.4% year over year (which is down from the 17% growth last year and 13% in first half of 2013). This deceleration is emblematic of the dramatic growth in new customer additions, which accelerated each quarter in 2013, from 14% in Q1 to 26% in Q4. This was led by new-customer adds, growing an extraordinary 130% for the year, including an astounding 344% in Q413. The customer growth acceleration is dramatic as it reflects the newer salespeople signing up new customers. Prior to the second half of 2012 when sales headcount really ramped, customer count grew by low to high single digits. Over the last four quarters, the customer count has broken out accelerating to 21% and 26% the last two quarters, respectively. Moreover, some of the recent sales headcount additions are in China where partners are trying out the ChannelAdvisor product and sampling the T-Mall integration (more on that later). Suffice it to say when these salespeople are productive (i.e. meeting quota), growth will further accelerate. With sales headcount growing in the 40-50% range and explosive triple digit new account growth, salesforce productivity has declined precipitously as many salespeople simply are not productive until they have been on the job for a good year. In Q312 when the salesforce headcount acceleration started in earnest, the size of the salesforce increased 30% year over year and productivity (revenue per salesperson on a TTM basis) declined from $298,000 in Q312 to $269,000 precisely one year later in Q313. As the initial new crop of Q312 sales hires start to achieve quota in Q413, the salesforce productivity will start to increase. Currently, as the binge in hiring has cycled through the worst of the impacts is behind us. Overall, revenue-growth accelerated in 2013 to 29% from 26% in 2012. I expect growth will continue to accelerate in 2014 to 40%. Now the ChannelAdvisor model is poised to see the full effects of 40% increase in salesforce hiring which should be 40% growth when productivity gets back to the $300k+ level. Note the Street is not modeling an acceleration close to 40%, in fact sell side analysts are modeling a deceleration in revenue growth to mid-20%s, illogical and a perfect setup to be long into beat and raise estimates for several quarters to come. Geographic Expansion International revenue represents just ~20% of ECOMs revenue, but its the most promising area for the company. ChannelAdvisor is one of the few U.S.-based players in this market to gain a foothold in the massive Chinese market. This has started with its expansion into Amazon China. Forrester estimates that the Chinese ecommerce market will grow at an 18% annual rate through 2018 (to $672 billion). The real kicker came when ECOM announced (at their Channel conference) that they are integrating with T-Mall. T-Mall holds a 50% share of the China marketplace market, with a massive 400 million annual customer base larger than that of Amazon for perspective. This relationship is still young and analysts are massively underestimating T-Malls potential contribution. In fact, no one is modeling it to have an impact on results in 2014, 2015, or beyond. Part of ECOMs ramp in sales headcount comes from aggressive international expansion, especially China. Given the fact that Chinese ecommerce is much more marketplace driven (i.e. 90%) than in the U.S. (30%), the demand for ChannelAdvisors solution should be commensurately higher in demand. Its not much of a stretch to believe that the Chinese market could contribute 10-20% incremental growth or $20 million in 2015 more than enough to help ECOM to meet / beat overall Wall Street estimates. FYI, the Street has yet to include any contribution from the partnership because management has not provided any specific guidance for any impact. Stock without a Proper Home Part of the misunderstanding with ECOM is that sell side analysts who cover it are generally Internet or small cap software analysts so the result is two-fold: (1) lack of strong analyst coverage and (2) no comparable peer group. ChannelAdvisor is a 40% long term grower providing the basic software platform for retailers and manufacturers of all sizes. ECOM is a direct beneficiary of major secular themes like marketplace proliferation, increased channel complexity, and China-as-a-consumer. Small retailers with $1-10 million in GMV to major brands such as Under Armor, Sony, and Dell are standardizing on ECOMs platform. ECOM has 27% of the Internet Retailer top 500 under contract with the balance on the radar. The Street has not done the work of digging into the salesforce additions and understanding that there is an inflection point at hand as previously hired salespeople are just now becoming productive after the typical one year adjustment/learning phase is over. My model has salespeople continuing to grow slightly under 40% in 2014 decelerating to low 30% growth in 2015. As the salespersons tenure increases, his annual contribution increases from $150k when they start to $300k+ 1 year into their tenure as they reach productivity. I also model a 10% increase in productivity annually. Two items will likely provide upside to ECOMs model but are very tough to predict and hence model: One is the emergence of new marketplaces (such as Google, Facebook, Twitter, and other social media that have yet to emerge). The more channels that retailers need to address the higher the need for a ChannelAdvisor to help them navigate. The second (and possible game changer) is the data analytics angle. ChannelAdvisor is working on an analytics engine whereby it can predict trends from all sorts of data, benchmark vs. peers, etc. The analytics engine will provide an increasingly compelling value proposition that will allow salespeople to upsell into the account base based on weaknesses in the analytics. For instance, a company that scores extremely low in sales via marketplaces vs. peers would be an easy target to upsell the marketplaces module. Or a company performing poorly vs. peers in comparison shopping would be stubborn not to at least try the comparison shopping module. Now is an ideal time to enter the stock after VC divestitures and a 50% sell-off (sparked by being lumped in with overvalued momentum stocks). ChannelAdvisor is on the brink of an inflection point in their model amidst their salesforce ramp and major catalysts like China and analytics (which have not even been factored in, yet). ECOM has a historical renewal rate of 100%. Thus, once they have penetrated a sizable portion (60-70% versus 27% today) of the top 500 Internet retailers, the company will be the de facto standard in a market where customers will steadily add modules and increase their GMV as they renew, enabling growth along multiple dimensions. My 12-18 month price target of $60 is based on 7x 2016 revenues (which will be the estimate analysts use at that point). At that point, $60 will be a fair valuation for a 40% grower which will be generating 30% FCF margins once they transition from their sales force investment phase into a phase of customer monetization. The $60 price point also represents the DCF value I arrived at using rather conservative assumptions.