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Zooplus When Good Management Meets Bad Business – a Structural Short-Selling Opportunity…

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Zooplus When Good Management Meets Bad Business – a Structural Short-Selling Opportunity… Zooplus When Good Management Meets Bad Business – A Structural Short-Selling Opportunity… 15 February 2019 Disclaimer This presentation and the information contained herein are provided solely for information and illustration purposes, and are not to be construed as a solicitation of an offer to buy or sell any securities or other financial instruments any jurisdiction, including without limitation, Switzerland and the United States, or as an inducement to enter into investment activity. No investment decision relating to securities or other financial instruments should be made on the basis of this document. All information has been prepared in good faith. However, no representation or warranty is made or implied by Burggraben, and Burggraben does not assume any responsibility, concerning the accuracy, completeness, fairness, reliability or comparability of the information contained herein relating to third parties, which is based on publicly available information. Burggraben is under no obligation to revise or update the information contained herein. Nothing contained herein should be deemed to be a prediction or projection of future performance of any security or other financial instrument. Certain information contained in this presentation constitutes "forward-looking statements," which can be identified by the use of forward-looking terminology such as "may", "will", "should", "expect", "anticipate", "target", "project", "estimate", "intend", "continue" or "believe" or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of any security or other financial instrument may differ materially from those reflected or contemplated in such forward-looking statements. 2 Source: Burggraben Holding AG 15/02/2019 BURGGRABEN HOLDING AG “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” Warren Buffett 3 15/02/2019 BURGGRABEN HOLDING AG Snapshot Basics Share Price Development (in Euro/share) • Online only: Established in 1999, Zooplus is Europe’s largest 250 pure-play pet supplies online platform with a footprint in 30 202 countries. 200 • Rapid Growth: Between 2010 and 2017, the company grew 150 revenues by 27% on average per annum. As at year-end 2018, 112.5 the company reported €1.3bn in sales from approx. 7 million 100 customers. 50 • Niche Category: Pet supplies are well suited for online retail as they are standardised products, with a regular & repeat demand 0 pattern while offering high-convenience home delivery in Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan 17 Jan 18 Jan 19 Europe; • Products: Today, the company offers 8,000 articles across all sub- Capitalisation & Market Valuation categories of pet supplies on its webstores. However, 83% of sales are food orders with an average basket size of €54 25/01/2019 and an annual turnover of €250-€290 per customer. In essence, Share Price Euro 112.5 Zooplus is really about ordering food for your cat & dog from Number of shares million 7.2 branded goods such as whiskas or Frolic. _______ • Zero Moat: Zooplus, like most eCommerce retailers, does not Market cap Euro mio 805.6 have switching cost to the consumer. Instead, a customer can Net Debt (cash) Euro mio (19.1) _______ purchase the exact same product at Amazon if this means to get Enterprise Value Euro mio 786.5 a better bargain or have more convenient shopping experience _______ or delivery time. • Margin Compression: This constant threat of client migration Sales 2018 Euro mio 1,342 makes pet supplies retailers compete on price. The result is steadily compressing margins. EV/Sales x 0.59 4 Source: Burggraben analysis 15/02/2019 BURGGRABEN HOLDING AG Executive Summary Zooplus is substantially over-valued and makes for a compelling structural short-selling opportunity… • The Business: Founded in 1999 in Munich, Zooplus is Europe’s leading pet supplies online retailer with a market cap of €0.8bn. Over the last 10 years, the company achieved an impressive 27% sales growth per annum. As at year-end 2018, the company reached net sales of €1.3bn from 30 countries. Its typical customer is female, 40 years old and spends €250-€290 annually on cat & dog food with an average basket size of €54. The order pattern has low seasonality, suggesting Zooplus has certain “consumer staple” qualities at first glance. • Zero Moat: A closer look at the company however reveals that it hardly has the free cash flow generating qualities of a defensive stock. Instead, Zooplus cannot differentiate itself from the competition as its core turnover items are one click away from Amazon.com or many other similar pet supplies services. Zooplus is what we like to call a “commodity shopping” experience. Consequently, Zooplus has to match or lower the best price in the market in order to retain existing customers or gain new ones. Otherwise, customers will switch to the competition at basically zero cost. Not surprisingly, the result was steadily compressing gross margins, down from a high of 37% back in 2010 to 24% today. • Zero Economies of Scale: Between 2010-2015, Zooplus was able to compensate for its margin compression by improving its overall efficiency. Recently however, this trend has been reversed as the company has to invest more into new fulfilment centres, marketing or IT in order to improve its logistics costs or simply to keep up with the competition. More importantly, the company has less then 4% fixed cost, leaving little room for it to scale by adding new customers. On the contrary, management’s obsession with growth adds complexity from managing an organisation in 30 countries, in- and outside the EU, in likely more than 20 languages. In our view, after 20 years of efficiency management, Zooplus has “maxed” out its potential for operational excellence. • Illusive Customer Lifetime Value: And yet, management seems to be committed to grow and build a platform at the expense of mid- term profitability. This is because of the belief that “customer retention” has a strongly positive “customer lifetime value” as the repeat order pattern of a customer will lead to incremental sales at stable or decreasing operating cost in the future. Management calculates such a repeat customer to accumulate €164 in contribution over 11 years when assuming steadily increasing sales per customer, 93% sales retention and 9.5% contribution margin. Our work however reveals that a more realistic number is to assume €13 customer lifetime value, subject to no further pricing pressure from the competition, when applying a realistic 3% contribution margin and when discounted to the present value – hardly a “strongly positive contribution” when compared to €19 acquisition cost for each new customer in 2017. 5 Source: Burggraben analysis 15/02/2019 BURGGRABEN HOLDING AG Executive Summary (continued) Zooplus is substantially over-valued and makes for a compelling structural short-selling opportunity… • Competing with Amazon on Price: It gets worse. In 2018, Amazon identified the pet supplies category as a “unique & highly valuable” category. Given its superior service (it has 72 fulfilment centres in the EU versus 11 for Zooplus), scale in combination with captive customers (54% of online shopping starts with Amazon directly) as well as a third party platform to grow the category rapidly without cost or risk, we expect Amazon to compete aggressively on price in order to cross-sell to existing customers as well as to gain access to new ones. But competition does not end with Amazon. Among others, local grocers, DIYs, drugstores as well as specialised pet supplies retailer compete for the same consumer base when being visited at their local store network. Which is why we expect future retention for Zooplus to continue to come at the price of compressing gross margins. • When good management meets bad business: In essence, Zooplus is caught in a commoditised pet supplies market in which growth will most certainly never return its cost of capital. If anything, it will lead to a “strongly negative customer lifetime value”. This is because Zooplus neither has scale nor loyalty. A good captain then won’t save the sinking ship. Rather, Zooplus is a ticket on the Titanic. In other words, it is a great example of an industry with bad economics. In such an industry, as Warren Buffett explained, it is the bad economics that will prevail over a good management team. But this has been true for some time. So what will change shareholders’ perception about the business now and make them accept that Zooplus's eCommerce story of “growing today and monetising tomorrow” is structurally broken? • Catalyst: We are convinced the answer is less sales growth. Our work reveals that ever-increasing marketing cost from expensive AdWords bidding auctions due to increased competition will force the company to slow down customer acquisitions in order to keep breaking even. In turn, we expect a reduction of its past growth target of €2bn by 2020 to a more realistic number of €1.75bn. Alternatively management may opt to incur losses in order to keep its pace of above €300m annual sales growth until 2020. But in the past, management lived within its means. We are thus convinced the team will guide the market lower at its annual session in March, rather than overspend by adding debt to the balance sheet for the sake of vanity. • Structural Short: Such guidance will catch analysts by surprise. Bloomberg’s consensus forecasts assume Zooplus to improve its EBIT from an estimate of zero in 2018 to €20 million come 2020 while every single metric we have reviewed points in the opposite direction. As for revenues, consensus estimate is for Zooplus to achieve €2bn sales come 2020.
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