Mr. Market Is Way Far Off On Wayfair

I’ve been really intrigued by Wayfair (W) recently.

It started with the purchase of a sleeper sofa last year.

Furniture shopping sucks. Showcase stores are enormous but still have fairly limited inventory, just because of the sheer size of the product. I had a pretty specific idea of what I wanted. The room was painted and carpeted, and was designed around a particular theme that I wanted to fit into. It was also pretty small, so I needed something with very specific dimensions.

To find what I was looking for at a store would have been really difficult and time consuming.

Online seemed like a better option, but I was apprehensive. Amazon doesn’t really do furniture very well. Physical store’s online presences are a mixed bag. Shipping costs are prohibitive.

This was before I found Wayfair. Wow! Huge selection, detailed descriptions and measurements, plenty of reviews, and… free shipping?! I ordered a sofa, it came 3 days later, fit into the room perfectly. It was a GREAT experience, and I would definitely buy from there again.

So I was curious when I saw the stock show up in the Quality Growth Spell recently. I was even curious-er when I saw the company’s revenue growth rates trending at 75-80% year-over-year. And then when I saw the stock carrying just a 1.3 price-to-sales ratio… That seemed quite low to me given the growth and market opportunity.

On the flip side, we’ve got a vocal short contingent on Wayfair, including well-known short-side outfit Citron Research and hedge fund media personality Whitney Tilson, fresh off his successful short attack on Lumber Liquidators (LL).

So who has a better case, and what is a decent price for Wayfair’s stock? Let’s review.

The Business

First, let’s look at Wayfair’s business model.

Wayfair does not own enormous warehouses full of furniture that it ships from. Its business model is more like that of Amazon Marketplace, where 3rd parties use Wayfair’s websites as a platform for selling their goods. That lets Wayfair offer over 7 million products (!) from over 7,000 suppliers.

This has 2 advantages. One, it allows Wayfair to boast of easily the largest selection of any furniture retailer – anywhere. And two, since there is no inventory, cash flow is excellent. Even though Wayfair has posted GAAP losses on the earnings front, the company has been free cash flow positive.

This “matchmaker” business model has proven highly successful in the online world. It is a model used by a number of successful companies such as eBay (EBAY), Priceline (PCLN), Alibaba (BABA), Uber, and many others.

In addition to the two advantages listed above, the model also creates a strong network effect. Small home goods retailers want to sell on Wayfair to leverage its investments in technology, brand building, and advertising. Customers want to buy on Wayfair for its massive selection, convenience, and free shipping. This creates a large network that is extremely hard for new competitors to replicate or compete against.