Stitch Fix valuation

It's Friday night 11:00 pm and I just read Turner's take on Stitch fix. He is optimistic that Stitch fix is a $100B+ business in 10 years. I don't think that’ll be the case.

Here’s his take:

Turner Novak @TurnerNovak

Stitch Fix is likely a $100b company within 10 years. Quick thread:

Turner is amazing at social apps and commerce businesses and I respect his analysis (and have read them multiple times) but I have a different take on this one. I had analyzed Stitch fix myself, invested, and then sold the stock as I didn't see consistent long-term growth. Huge respect for Katrina Lake - one of the best founders of the last decade.

Here's my version and some thoughts:

Stitch Fix is an online women clothing business (now men and kids). The core idea is to use data analytics to find clothes that fit well and look good. And they are good at it. They have done a great job of getting providing great styles and a fresh shopping experience (using proprietary data analytics.)

Stitch Fix was launched in 2011 from Katrina's apartment at Harvard and grew rapidly. She took the company public after raising only $42M in funding. Early investors include Baseline Ventures, Lightspeed, and Benchmark capital.

I was blown away by the value created with so little venture capital.

Now, Stitch Fix is a phenomenal business but I don't think it'll be worth $100B in the next 10 years.

Stitch Fix revenue comes from 2 major sources:

1. Styling fee

2. Selling Clothes

It is primarily focused on women but recently started men and kids.

The key metric for them is “Number of active customers.”

Customer growth has slowed in the past 2 years:

Q2 2018: 32%

Q2 2019: 16%

Q2 2020: 17%

I don't expect customer growth to pick up significantly in the next few years. In fact, I think it'll slow down further.

In the most recent quarter ending on May 2, 2020, that number stayed flat to 3.4M. They consider a household as one customer - so total customers may have grown but not by a big number.

Stitch Fix is in a competitive category and women have other options. If Stitch Fix messes up a couple of times, women may stop using the service completely. Because customers are not the ones making choices and paying every time they don't buy anything, it may turn off some customers. I also don't expect that a large part of their customer base is buying clothes every month which is reflected in their net revenue per active customer.

Stitch Fix defines an active customer as someone who purchased at least an item in the preceding 52 weeks. Net Revenue per customer:

Q2 2018: $437

Q2 2019: $463

Q2 2020: $501

Average revenue per month (using Q2 2020): $41.75 - this includes a $20 styling fee (charged if customers don't buy anything.) A $21.75 revenue net of styling fee means that Stitch Fix is not driving significant monthly purchases per customer.

E-commerce has exploded in the last 6 months but even during the pandemic, their customers have not grown at a faster rate. This is surprising.

Capital Efficiency:

Stitch Fix is strong at capital efficiency and has a negative cash cycle. This is a big positive for the business. But in the past, Stitch Fix hasn't been able to convert this cash to better products aside from expanding their services for men and kids.

The average order size for men and kids is expected to be lower than that of women. I'd expect men’s and kids’ spend to be 20%-25% of women's spend.

Improving the average order size:

There is a limit to how many clothes women can buy each month. Stitch Fix will have to expand to other categories or bring new products to increase revenue per customer.

We should remember that Stitch Fix is competing with a lot of other players here - existing retailers, e-commerce companies, new DTC brands, and others. It is not just about the fit or style, people also buy from brands who they identify with and those will also continue to grow.

It will be naïve for us to assume that if Stitch Fix can sell clothes, they will also be able to sell other household products. It is not simple to expand to other categories. The market is extremely competitive for each category and acquiring customers is difficult.

The shipping costs, unit economics, and preferences completely change as they move from clothes to other items. My best guess is that they have tried but found limited interest from customers for other products.

The best analogy here is for fintech companies that try to expand by offering different products. A neobank good at checking account faces tough competition as they try to offer a credit card. It turns out that people like the existing credit cards and it's difficult to compete with dollars.

Valuation:

The best case for Stitch Fix is 15% annualized growth for the next 10 years (but I don't think the market will value 5x-6x LTM revenue.) I think they should get a 2.5x-3x multiple and with a $6B-$7B revenue, it can get to $15B-$20B market cap.

Let me know if you agree or disagree with this analysis. I’m always looking to learn from other perspectives.

Feel free to reach out if I missed anything, if you don’t agree with my thoughts here, or just want to discuss. I love this stuff and can do this all day long. Always looking to learn more.

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