Whirly lollipop on orange background.

On Monday May 5th the Wall Street Journal ran an article entitled “Zulily’s Secret to Profit Means Slow Deliveries” (here is a link to the WSJ online version )which pointed out the company is profitable but at the expense of longer delivery times. While the article points out some facts about the company and the service it misses the broader context of retail and how it’s evolving.

Zulily is less about retail distribution and more about consumer discovering and merchandising. Amazon is fantastic at hunting down a product you want and getting it to you fast at low cost. Discovery and personalization on Amazon is rudimentary however. Amazon also has some “flash sale” types of offerings with their Daily Deals and with their acquisition of Woot which by the way offers deals that tend to take longer than usual to receive versus typical Amazon Prime service.Screenshot 2014-05-05 12.18.14

Investors might want to refer back to the original IPO roadshow slides for Zulily to review their stated strategy. Zulily has better personalization and mobile technology offerings for merchandising than most of the other companies in consumer retail, including Amazon.

The big question for Zulily is how to deal with back-end infrastructure which is not their secret sauce versus their personalization and merchandizing technology. The financials and cash flow are attractive since consumers pay up front but the conversion cycle isn’t as fast as customers and investors might like.

From 30,000 feet the combination of front end technology like Zulily with back end processing from QVC or Amazon.com would be a big win for both sides.
Girding the strong case for a QVC/Zulily combination is the fast that the chief target market for Zulily is women with children. There’s a strong overlap between the QVC and Zulily customer profiles and production categories.

Intrinsic Valuation

In terms of valuation ZU is trading at a $6B market capitalization with just over $300M in cash. (As of this writing Google Finance shows the market capitalization as $12B which is in error.) Revenues have been doubling every year and are estimated to top $1B in 2014. We put a quick intrinsic valuation together for ZU that suggests a $36 stock price in 2014 with an increase to $48 in 2015. At the moment the consensus price target is $56.

2014-05-05_12-26-55
Like most rapidly growing companies at the beginning of profitability small changes in the assumptions driving the model can make a big difference in terms of stock price. Our IV model lines up pretty well with both consensus and company guidance. We chose a 35x multiple which reflects a sustainable medium-term growth rate.

Conclusion

By all indications Zulily is doing well but is facing some normal growing pains as they scale up. They are on course to more than triple revenue this year from the $330M they did in 2012. But the stock valuation is high enough that any resetting of expectations, which seem likely, at least on the margin side of the business, won’t be received well by investors. All other things being equal we’d be far more interested in this stock closer to our 2014 IV of $36 or at least a major discount to the 2015 IV of $48.

The company is scheduled to report earnings on Tuesday, May 6th and we’ve no reason to suspect results won’t be good and at least in line with expectations. The WSJ article stirs the pot regarding their model and analysts may be forced to bring these questions to management in this public forum. Their responses in the Q&A will shape near-term investor perceptions.

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