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There are companies you would like to invest in because of the huge promise they hold, but they are just too risky. That’s where we find ourselves at with Boxed (NYSE:BOXD). It has a great business model, what appears to be good market-product fit since its customers say they love the service, and a lot of growth potential, but the financials are just too ugly.
We see the Boxed business model as a combination of the business models of Amazon and Costco. Just like Costco, there is a lot of use of high-quality private labels that offer a lot of value to the customer, while at the same time increasing the gross margin for the company.
Boxed Investor Presentation
And just like Amazon, the company is ultra focused on providing a delightful experience and putting the customer first. Their customer satisfaction is top notch, with a lot of positive reviews. According to a third party consulting firm that surveyed customers, online customer satisfaction is as high as with beloved brands such as Chewey, and higher than Costco and Amazon Fresh.
Another business model similarity with Amazon is that the company sells ads on its marketplace. This currently brings less than 1% of GMV as revenue, but the company is targeting at least 4%+. We think it is a smart way to increase monetization of their platform, but it is not going to move the needle much in the short/medium term. The company is also letting external sellers into the marketplace. Currently around 1% of GMV, and with a target of more than a quarter of GMV coming from third party sellers by 2026. Finally, the company is trying to monetize its technology platform as a SaaS offering too, already having one big customer, Aeon, an $80 billion global retailer. This too is not expected to bring much in the form of revenue soon, but is an interesting opportunity to grow long-term.
Boxed Investor Presentation
The most important feature of Boxed’s business model, however, is the cost flywheel that Costco has used so successfully. Basically the idea is that as volumes grow the company is able to purchase products more cheaply, passing this price reductions to customers, which in turn respond by buying more, so the company can get even lower prices, and so on. The only problem with this strategy is that it needs to achieve a certain critical mass for the flywheel to get going, and Boxed is not there yet.
So far Boxed has managed to improve gross margins to the ~13-14% level, but this is not enough to make the company sustainably profitable. Boxed believes that with improved vendor negotiations, ad-tech monetization, improved customer retention with loyalty programs, and supply chain optimization, that it can approximately increase gross margins by ~10%. A key to this plan being successful is a significant increase in sales, and that is why, as we’ll see, Boxed is being so aggressive with its sales & marketing expenditures.
Boxed Investor Presentation
While sales have been increasing, they are still far from what we believe to be the necessary critical mass for Boxed’s business model to become self-sustaining and profitable.
The company seems to understand the need to attain this critical mass, and has been investing heavily in sales & marketing, and general & administrative.
Unfortunately this heavy spending has resulted in negative operating leverage, with operating margins being reported at an awful -52%.
With these margins it is not surprising to see that the company has very significant negative cash from operations (i.e. “cash burn”). We worry that if the company does not manage to achieve the necessary scale to make the business model flywheel sustainable with higher gross profit margins soon, that it risks running out of cash.
So far the losses have been getting worse due to heavy investing. As can be seen in the extract from the recent 10-Q for the company, for the three months ended March 31st 2021 the company lost $14.2 million, but for the same quarter in 2022 the loss increased to $36.2 million.
Unfortunately the company does not have that significant cash reserves to finance continuing losses. Its cash and equivalents stood at $69.94 million at the end of the most recent quarter, and it carries some debt as well. We believe the company will have to raise some capital soon, or restructure the business to reduce the losses significantly.
The company is planning on increasing spending on marketing, opening new fulfillment centers, and its R&D expense to be able to generate SaaS revenue. We see the value of these planned investments, for example the additional fulfillment centers are expected to grow capacity 2.7x and provide 10-15% cost savings, what we worry is where they will get the funding to make these investments.
If they succeed in making the flywheel reach critical mass, they see net revenue of ~$1 billion in 2026 (around 33% CAGR), with gross margins ~30%.
The company is currently trading with a market cap of ~$639 million, which appears reasonable given the size of the opportunity. However, we worry if the company has enough funds to finance its business plan until profitability.
Since the company does not yet have earnings, we have to value it using revenues. It is currently trading with an EV/Revenues multiple of ~3x. If the company succeeds in reaching profitability, the current valuation could be seen in hindsight like a bargain. But that is a big IF, and we are not yet convinced that the company can attain the critical mass needed.
As we’ve mentioned throughout the article, despite liking the company and its business model, we see multiple risks. First, we don’t believe its cash & equivalents are sufficient to execute on its business model to 2026, so we expect the company will have to dilute shareholders at some point in the future. Second, we are worried by the significant increases in sales & marketing and G&A expenses, which will make the runway offered by the current cash levels even shorter. Third, we don’t think the balance sheet is strong enough with debt and a negative Altman Z-score. As a reminder, companies with an Altman Z-score below 3 are considered to have non-negligible risk of bankruptcy. Finally, analysts are not projecting profitability for at least the next three years, according to estimates compiled by Seeking Alpha.
Boxed is a company we like, just as its customers appear to like it, too. It has a creative and powerful business model that we believe can work if the company manages to reach the necessary scale. What we worry is that the company might not have sufficient funds to finance the business plan to 2026, and that it might have to significantly dilute shareholders. We also worry that the company has debt and negative operating cash flows. Until we see the company get closer to profitability, and sustainable scale, we are not buyers of the shares.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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