Lessons from the Temple & Webster IPO

One of my favourite books in recent years is What I learned losing a million dollars. The lesson is a very simple one and in short there’s a million ways to make money but only a couple of ways to lose money. Hence it’s more important to learn how not to lose money.

In this context, performing post mortems on investments that go wrong is extremely valuable as you are essentially getting a free investing lesson without having to pay for it.

The lessons from the Temple & Webster IPO will be filed accordingly.

Temple & Webster’s shares crash 80%+ less than 3 short months after IPO

From a metrics perspective, the online retailing game is actually very very simple. Underneath it all, the equation that needs to hold true is that your customer acquisition cost is less than your customer lifetime value.  If this equation holds true, then you have potentially a very good business that scales. If it doesn’t, then you don’t have a business.

So let’s take a look at the operating metrics that were disclosed in the Temple & Webster prospectus.  Temple & Webster disclosed its customer acquisition costs as follows:

Total marketing spend on each online platform has increased over time, but the average acquisition cost per customer across the Group’s three online platforms has ranged between approximately $40 and $60 since the beginning of CY13.

Two months after the IPO however, the company releases a massive earnings downgrade along with its 1H FY2016 results. What is fundamentally most worrying in this release is that Temple & Webster’s operating metrics are going completely the wrong direction with customer acquisitions costs spiking upwards but the number of first time customers actually going downwards:

An average cost per customer acquisition of between approximately $40 and $60 obviously represents a very different set of economics to $100 per customer. Additionally, Temple & Webster’s number of first time customers is actually decreasing. The fundamentals of the business has shifted spectacularly two short months after the IPO.

What is astounding is that you can see these numbers heading the wrong direction during 1Q16, way before Temple & Webster’s prospectus was lodged on the 6th of November.

Given Temple & Webster listed more than 2 months after the end of 1Q16, there are only 2 reasons I can think of for the 1Q16 metrics not to be disclosed:

• the company knew, but chose not to disclose it; or
• the company didn’t know.

Both reasons would make me very upset had I bought into this IPO. Rightfully, the market has absolutely belted Temple & Webster for this.

Lessons learnt from the Temple & Webster IPO

Firstly, be very wary of companies that IPO under the notion of capital raising for an acquisition (i.e. going to the market with signed sale and purchase agreements and pro forma financials). You are essentially buying a company with no track records.  The company you are buying does not currently exist and, despite what investment bankers might tell you, adding two P&Ls together and sprinkling in a bit of synergies does create a new company. In this case, I suspect Temple & Webster did not have a firm grasp of what they were acquiring in Milan Direct.

Secondly, ask why you’ve been given the specific privilege to invest. The reality is that there is no shortage of capital out there looking for a home. If this a good deal, then there are a plenty of trade players and financial investors that would love to write a cheque (especially at this ticket size).  The catch is though, any of these trade players or financial investors would by definition be sophisticated investors and would know what they’re buying much better than you do. As an example, there would be absolute no chance that these guys would complete the deal without seeing Temple & Webster’s 1Q16 numbers.

As a general rule, it is much easier to sell shares to a lot of small uninformed investors than one large sophisticated investor. Make sure you are not being sold shares on this basis.

What is next for Temple & Webster?

Temple & Webster currently trades at a market capitalisation of $22m, roughly equal to the net cash on its balance sheet ($27.7m of net cash as at 31st December 2015, less cash-burn since). In other words, the company is no longer valued as a going concern.

As a value oriented investor though, at the right price any investment is worth looking at, and I actually quite like the risk-return profile on offer at sub $0.20 (far below replacement cost for the assets). The fact that the company has no debt means there are no financing risks, removing one of the biggest risks in a play like this.

The worst case scenario I can see is where Temple & Webster:

1. does nothing to stem the cash outflow; and
2. its customer metrics continue to deteriorate.

This means the company runs out of cash by the end of the financial year (note with the payables on its balance sheet, Temple & Webster could go into administration before the cash runs out).

Conversely though, if either (1) or (2) doesn’t hold true, then Temple & Webster will have a future as a going concern, and if it get re-rated accordingly, tremendous returns are on offer.

Note: The above blog post constitutes the author’s personal views only and is not to be construed as investment advice. Being obviously passionate about the art of investing, the author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this blog post.