Financial Analysis

WeWork Debacle Changes the Gig Economy Game; Public Direct Sellers Continue to Slow.

 

WEWORK IMPLOSION SIGNALS THE END TO BLANK CHECK FINANCING FOR GIG ECONOMY

For the past several years, growth in the U.S. Direct Selling market has appeared to plateau after decades of posting mostly consistent, mid-single-digit kind of growth rates, even during mildly recessionary times. We think it is more than coincidence that this is also the period where some of the bigger Gig Economy concepts had really gained traction as well as critical mass, offering the workforce micro-entrepreneurial opportunities with workplace flexibility. This has always been the hallmark appeal of direct selling.

Many of these Gig concepts, particularly the ones that support their own independent contractor infrastructures, have been bleeding cash in order to achieve very rapid growth rates. However, they also had a seemingly bottomless pit of private equity financing to burn through. This gave them a huge advantage over the more traditional direct sellers, who tend to finance growth through internal cash generation.

But a funny thing happened to the Gig explosion this year: the public equity markets started yelling, “stop the madness!” to the private equity markets. It started with the rideshare unicorns Lyft and Uber seeing their recent IPOs trade underwater almost immediately, and they both remain so now with each carrying a market value about 1/3 less than at their respective IPO prices as of early December. Press reports indicate that Uber carried private market valuations as high as $72 billion pre-IPO. Today, its equity market capitalization is $49 billion. Lyft currently carries an equity market capitalization of $14 billion, below its last private market capital raise of $15 billion in the summer of 2018. But this was just the shot across the bow.

The game-changer was the dramatic rise and fall of the WeWork IPO in the Q3 of this year. WeWork is not technically a Gig concept, but it is a by-product of the Gig revolution in that it offers shared workspaces, which accommodate the emerging independent workforce.

At its last private equity capital raise in January 2019, a $2 billion investment from Japanese conglomerate Softbank, the company was valued at $47 billion. Press reports indicate that bulge bracket investment banks dangled valuations for its IPO in the $63 to $96 billion range. When the IPO prospectus was finally filed in August, investors and the media were taken aback by the shoddy corporate governance and the trail of red ink with no end in sight. With the immense pushback, by mid-September, the bankers were considering an IPO with a valuation of $10-$12 billion, about one-quarter of the private market valuation just eight months earlier. By late September the IPO was postponed and the CEO/founder was forced out due to erratic behavior in a sweetheart deal that further enraged investors. Without the IPO proceeds, WeWork was now cash-strapped and had to be bailed out by Softbank at a valuation reported to be $7-8 billion in October. Finally, the company laid off 20 percent of its global workforce in November.

Since then, food delivery service Postmates has laid off dozens of workers, closed its Mexico City office, pulled its planned IPO, and is reportedly looking for a buyer. Homesharer Airbnb and food deliverer Doordash have decided to forgo a traditional IPO and pursue a direct listing, which will create a public market for the stock but will not raise additional capital for the companies.

Therefore, while Lyft and Uber continue to be cash-rich from their recent respective IPOs, it appears that with the financing spigots turned off there is now a finish line with regard to being self-funding as they burn through their existing cash balances. It appears that with the recent souring on money-losing Gig concepts, coupled with the Theranos fraud earlier in the decade, the days of throwing unlimited cash at anything coming out of
Silicon Valley appear to be behind us, at least for now.

 

LYFT REGULATORS ARE ALSO CATCHING UP WITH THE GIG ECONOMY

Along with a tighter wallet from Wall Street, regulators and voters are also reining in the freewheeling Gig players.

  • Recently passed AB5 in California threatens to force Uber and Lyft to classify its drivers as employees rather than independent contractors.  Headlines read, “California’s AB5 will kill the Gig economy.”
  • Spanish courts have also ruled that Deliveroo riders are employees, not self-employed.
  •  Voters in Jersey City, NJ, voted to impose severe restrictions on Airbnb’s ability to operate there. In early December, Airbnb had to pull thousands of listings in Boston as a result of a new regulation requiring it to apply to register all of its listings there.
  •  NYC-based ride app Juno recently went bankrupt and blamed the wage laws there.
  •  Doordash is being sued by the D.C. attorney general for misleading customers and pocketing driver tips.
  •  Our guess is that after a decade of explosive growth, 2019 may mark an important inflection point in the Gig Economy’s life cycle, with growth going forward becoming a little more restrained.

 

GROWTH CONTINUES TO SLOW; STOCKS CONTINUE TO LAG

While the overall market continues to power upward this year driven by sharp multiple expansions in this declining interest rate environment, direct selling stocks are experiencing the double whammy of having lower multiples applied to reduced earnings, as growth has slowed markedly for the group this year.

Our index of Direct Selling stocks was down (22 percent) so far this year through the end of November versus gains of +25 percent for the market as measured by the S&P 500. Since mid-year, Direct Sellers have declined (19 percent) vs gains of +7 percent for the market.

The drivers are easy to delineate:

  •  For the market, prospective 12-months earnings forecasts have been virtually unchanged all year while the prospective P/E ratio has gone from 14.4x at the beginning of the year to 16.8x at mid-year to 17.9x as of the end of November. Declining global interest rates have pushed investors into riskier assets.
  • For the Direct Sellers, prospective earnings didn’t start to decline until mid-year, but as is usually the case, investors anticipated trouble beforehand and multiples began to contract as early as the 2018 Q4. Therefore, while prospective earnings actually increased by +4 percent in the 2019 first half, the prospective P/E ratio  went from 15.9x at the beginning of the year to 12.3x at mid-year. Since mid-year, prospective earnings are down (17 percent) and the prospective P/E ratio dropped further to 11.9x.

Stepping back, our index is now down (35 percent) since its recent September 2018 peak, and is discounting earnings levels that go back to late 2017; all the earnings growth the Direct Sellers benefited from in 2018 has now been given back.

As the graph above illustrates, organic sales gains decelerated further in the Q3 for the 4th straight quarter since peaking in the 2018 Q3. The low-single digits average growth rates for the group in the Q3 is the slowest since the 2017 Q2. Each company showed decelerating sequential growth trends with the exception of HLF, where global growth ticked up a point to +2 percent in the Q3 from +1 percent in the Q2, and USNA, where sales declines lessened by a point to (10 percent) in the Q3 from (11 percent) in the Q2.

Optavia (MED) once again led the pack with a strong +40 percent organic growth increase in the Q3, but that is expected to slow markedly, at least in the near term, as the company has been forced to deal with unexpected disruptions to its business as a result of credit card fraud, delayed ERP system implementation and supply chain issues arising from its recent rapid growth rates.

Double-digit organic sales declines at NUS and USNA continue to be driven primarily due to the recent adverse media and regulatory environment in China, although we note that in both cases there has been system-wide softness, so we do not believe China alone is impeding growth at either company.

The double-digit declines at TUP do not appear to be driven by any single factor, and with no solutions imminently visible to stem the declines, the board there decided a change in leadership was required to take the company in a new direction. In early December, the interim CEO outlined a
vision of leveraging Tupperware’s iconic global brand name in channels outside of direct selling. We wish the company well but are pressed to think of a case where a multi-channel approach provided any benefit to the direct selling sales force. In fact, it’s usually the opposite.


DOUGLAS M. LANE, CFA, IS A SECURITIES ANALYST WITH MORE THAN 20 YEARS OF EXPERIENCE COVERING COMPANIES THAT EMPLOY A DIRECT TO CONSUMER BUSINESS MODEL. HE LEADS A BOUTIQUE EQUITY RESEARCH FIRM, LANE RESEARCH, FOCUSING ON THOSE COMPANIES. PLEASE VISIT WWW.LANERES.COM. HE CAN BE REACHED AT DOUG@LANERES.COM.