Luxury marketplace platform Farfetch has had a long courtship with JD, Alibaba and Chinese consumers. In the next update, I’ll go into my thoughts on Farfetch as a stand-alone company (basically, not good). But the more interesting questions for investors are:
- Is Farfetch going to get bought?
- What is the private market value to Chinese acquirers?
Some Background on Farfetch
British-Portuguese Farfetch was founded in 2007 and has evolved into a marketplace platform for cross-border luxury goods sales. So lots of shoes, clothes, handbags, accessories, and jewelry for women. But also, to a lesser degree, for men and kids. And Farfetch has all the luxury brand names you would expect – Gucci, Prada, Burberry, Valentino and so on.
But Farfetch has two aspects that really strike me as interesting:
- It has approximately 3,400 brands from 1,200 luxury sellers in 50 countries.
- It has 2.1M active consumers in 190 countries.
So it is inherently cross -border, and there are lots of smaller, less known luxury brands. It turns out both luxury sellers and buyers are fragmented across the globe. So the company has, in theory, a global marketplace platform with highly fragmented and differentiated products. That is generally great in terms of platforms. And the main user groups (luxury consumers and creators / designers) have unique needs that might not be well served by a mass market retailer.
All of that makes Farfetch interesting as a digital platform. And, at first pass, the company is showing rapid growth in users, GMV and revenue.
- GMV grew from $375M in 2015 to $1.9B in 2019
- Revenue grew from $142M in 2015 to $1.0B in 2019.
The gross profits have been relatively stable 45-50%. And there are fairly minimal operational and logistics requirements for an ecommerce player. In 2019, the company had 4,530 employees in 14 cities.
That, however, is about all I really like about the company. Most everything else makes me nervous. Especially the ongoing losses and possibility that it is ultimately subscale as a marketplace, financially non-viable and not competitive against larger ecommerce companies. I’ll go into all that in the next update.
That doesn’t mean there isn’t an opportunity here. Because I keep wondering if this company is going to get bought at a healthy premium by a strategic Chinese buyer.
The Luxury World Is Increasingly Centered in China
According to Statista, the global personal luxury goods market was $341B in 2019. And this is part of a fairly steady upward trend. It was $140B in 2000. Within this trend, China’s share has grown rapidly, with Bain now predicting that half of global luxury spending will come from Chinese consumers by 2025.
Unsurprisingly, the major luxury brands are increasingly focused on Chinese consumers, both in China and while traveling. And this has forced them to do something they have long avoided, moving their businesses online. Because Chinese consumers are digital-first in their behavior. They learn about companies, products and luxury on their smartphones. This includes shopping, watching videos and chatting. Although it is important to note that most luxury purchases happen in person. Luxury is not going online. It is going towards online-merge-offline – and is being driven by Chinese consumers.
The other important players in this “luxury moves to China” dynamic are the ecommerce giants Alibaba and JD. And, to a lesser degree, luxury ecommerce specialist Secoo. Within the last 2-3 years, Alibaba and JD have launched major initiatives in fashion and luxury. You can’t go a month without hearing Alibaba anounce another major brand is joining the Tmall Luxury Pavilion. JD has been more unpredictable, with their biggest initiative the launch of TopLife and its white glove delivery service (you order a luxury product online and a driver delivers in special car wearing white gloves).
And within all of this, Farfetch keeps popping up over and over again.
Farfetch’s Ongoing Deals in China
From JD media relations in June 2017:
“E-commerce giant JD.com (Nasdaq:JD), China’s largest retailer and Farfetch, the leading global e-commerce platform for the fashion industry, today announced a strategic partnership that will create the premier platform for luxury e-commerce across China, opening a gateway to an $80bn market.
The strategic partnership between JD.com and Farfetch leverages JD’s unparalleled logistics, Internet finance and technology capabilities and social media resources, including its WeChat partnership, with Farfetch’s leadership in global luxury, to create a frictionless and seamless brand experience. Farfetch has well-established operations in China and is already the partner of choice for 200 luxury brands and more than 500 multi-brand retailers. JD will help drive further brand awareness, traffic and sales for Farfetch in the market.
As part of this partnership, JD.com will become one of the largest shareholders of Farfetch, investing $397 million, and Richard Liu, JD.com’s founder and CEO, will join the Farfetch board. JD and Farfetch will partner on marketing, logistics and technology solutions to build the brand in China, while Farfetch will continue to be the customer-facing brand.
The combined strength of the Farfetch-JD partnership will benefit all 700 brands and boutiques that are part of the Farfetch community, enabling them to take advantage of the vast resources of this new gateway to China’s luxury market.
Leveraging JD Luxury Express, JD’s recently launched white glove service, Farfetch will be able to offer customers a premium level of service befitting the world-class brands sold on the site. For Chinese consumers, this combination of Farfetch’s luxury know-how, and JD’s blazing same-day delivery speeds and highly professional service, will provide an unparalleled luxury proposition.”
From CNN (hi Sherisse) in October 2018:
“The luxury retailer wants to sell a lot more of that kind of fashion item in the growing Chinese market, and it has tapped the country’s biggest e-commerce company, Alibaba, to do so.
Yoox Net-a-Porter and Alibaba (BABA) are establishing a joint venture to launch two mobile apps for Chinese customers, one for Net-a-Porter which caters to women, and one for Mr. Porter which sells men’s fashion.
Net-a-Porter and Mr. Porter will also launch online stores on Alibaba’s shopping website Tmall. The companies didn’t say when the apps or the online stores would go live.”
From JingDaily in February 2019:
“JD, China’s second-largest e-commerce platform, sold its luxury portal, TopLife, to Farfetch for a reported US$50 million in cash today. TopLife will merge into Farfetch’s already existing Farfetch China business, with the transition overseen by Judy Liu, Managing Director at Farfetch China. The strategic move is perhaps one of many necessary moves to deal with the increasingly tougher economic environment that JD is facing in China.
The new deal, based on the two parties’ relationship since July 2017, will give Farfetch a “Level 1” entry point on the app of JD. In exchange, JD will gain access to Farfetch’s network of more than 1,000 luxury brands and boutique partners. Previously, Farfetch has been benefitted from JD’s logistics capabilities in China.”
And, most recently, from MarketWatch on Nov 6, 2020:
- “Farfetch will launch shopping channels on Tmall Luxury Pavilion, Tmall Global and Luxury Soho, reaching 757 million consumers.
- Alibaba and Richemont will invest $300 million apiece in Farfetch. The investment will be through the purchase of 0% convertible senior notes due 2030 issued by Farfetch. Alibaba and Richemont may require Farfetch to repurchase all or some of the notes on June 30, 2026 at full price.
- Alibaba and Richemont will also each invest $250 million in a new joint venture, Farfetch China, taking a combined 25% stake. The two companies will also have the option to take another combined 24% stake in the venture after the third year.”
“All of the companies will join their efforts to further the Luxury New Retail initiative, which will create solutions including e-commerce websites and apps for luxury brands.
“The growth potential of luxury e-commerce has never been so promising, and the importance of China for the luxury industry is only becoming more obvious every day,” Pinault said in a statement.”
Note the use of “new retail” in the article. That’s basically the online-merge-offline phenomenon I have been talking about.
So is a Chinese ecommerce company or other major Chinese player going to buy Farfetch? Which brings me to private market value (PMV).
Intro to Mario Gabelli and Private Market Value (PMV)
Many of you are familiar with Private Market Value (PMV) and its creator and biggest proponent Mario Gabelli. But for those who aren’t, here is a basic introduction.
Mario Gabelli is founder, Chairman, and CEO of Gabelli Asset Management Company Investors (i.e., GAMCO). He is a billionaire based in Rye, New York and his company GAMCO had US$41.3 billion in assets under management in 2017.
Some fun factoids:
- He was trained as classic value investor (analyzing companies based on cash flow, not earnings) at Columbia Business School. CBS is the home of Warren Buffett and Ben Graham.
- His first break came while he was researching an auto-painting and body repair service provider. He noticed that the repair facilities were located in downtown locations and the real value of the real estate holdings was not recorded on the company’s financial statements.
- In 1976, he started his own firm, an institutional brokerage, with borrowed money and some of his own cash – “with one employee – myself.” His focus was institutional research at a time when few wanted equities.
Over time, Gabelli became known as a specialist in identifying companies that were going to be taken private. This had a lot to do with the LBO and take-over boom of that time. By the mid 1980’s, he was managing $350M and making (reportedly) over 35%. His focus was on companies going private.
He began talking about the idea of Private Market Value, which he defined as what a “knowledgeable industrialist would pay for an entire company”. It is the idea that companies are actually worth more depending who owns them. And that investors would pay more for them in this situation. Private market value is usually above stand-alone intrinsic value – because:
- You can buy the whole company. That gets you control.
- You can extract synergies.
- You can use debt, which also enables them to pay a higher price.
PMV is a type of enterprise value. It’s a buy-out or take-over price. Gabelli is its primary thought-leader. He describes it as a type of valuation. But I would argue it is more a type of market price.
I think PMV raises interesting questions:
- Does who owns a company change its value? Is there more value if it is owned by the right private buyer? And won’t they pay more?
- Does control matter? If they have control, can’t they sell parts and other things?
- When would this collapse the price to a higher private market value quickly?
My Assessment of How Gamco Calculates PMV
So if a Chinese company is going to buy Farfetch? What would they pay? What is its PMV? From my reading about Gamco, I think their process is the following:
Step 1: Search for companies based on list of catalysts
- Buy-out candidates.
- Lots of cash on balance sheet.
- Underlying assets like land.
- Strategic acquisition candidates.
- Spin-off candidates.
Step 2: Calculate PMV
- Project cash flow 3-5 years out.
- Do financial study. Call customers and competitors.
- Compares to other transactions as a check.
- Calculates PMV from multiple of cash flow today, and 3-5 years out.
Step 3: Calculate Margin of Safety.
- The goal is a discount to PMV. (margin of safety) of 30-50%
Step 4: Check Catalyst. Look at industry and company events going back 18 months.
The goal is to find $2 (PMV) selling for $1 (current price) and the $2 is growing faster than inflation. With a catalyst in next 2-3 years to collapse current price to PMV.
Ok. That’s it for today. I’m going to send my assessment of Farfetch as a digital platform in the next update. But I think the most interesting opportunity is to determine whether it might get bought and at what price (regardless of company quality).
Concepts for this class.
- Digital Platforms: Marketplaces for Products and Services. This is on the right side of the pyramid below.
- Network Effects. This is under competitive advantage below (dark green).
- Private Market Value (PMV)
Companies for this class:
- #33: More on Marketplace Platforms
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