Don't Buy – or Even Rent – This Stock

In late October, an early startup unicorn finally made its way to an initial public offering ('IPO')... Readers might remember Rent the Runway (RENT) as one of the companies most associated with the sharing economy. Sharing economy companies look to displace the need to own things... and instead, offer products and services for use on […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] Don't Buy – or Even Rent – This Stock By Berna Barshay In late October, an early startup unicorn finally made its way to an initial public offering ('IPO')... Readers might remember Rent the Runway (RENT) as one of the companies most associated with the sharing economy. [Sharing economy]( companies look to displace the need to own things... and instead, offer products and services for use on demand. Think of ride-hailing apps Uber (UBER) and Lyft (LYFT) and their promise to displace car ownership... home rental exchange Airbnb (ABNB) eliminating the need to buy a vacation home... or co-working space provider WeWork (WE) making traditional office leases obsolete for startups. Most sharing economy companies got hit pretty badly when the pandemic struck. While a portion of Rent the Runway users did keep using the service during the pandemic – some to do things like [wear ballgowns to clean their bathroom and post about it on Instagram during lockdown]( – Rent the Runway's business took a serious step back during the pandemic. Rent the Runway allows users to rent clothing and accessories for single-use occasion wear... like for a wedding or casual party, either on an a la carte or subscription basis. Users can also choose to hold onto items for weeks – if they want to incorporate an item into their seasonal wardrobe. With few people going into work and so many group gatherings canceled, the use case for fashion and the special occasion wear that Rent the Runway excels in plummeted. Revenue dropped about 40% to $158 million in 2020, and losses expanded from $154 million in 2019 to $171 million in 2020. In recent years, Rent the Runway has been trying to steer consumers into its subscription programs... because who doesn't like recurring subscription revenue? It's kind of like software as a service... but make it fashion! Not too surprisingly, subscriber counts, however, tanked in 2020, dropping 36% to 95,000. But in the six months ending July 2021, subscribers rebounded to 127,000 – 86% of the 148,000 subscribers that Rent the Runway had in 2019, pre-pandemic. --------------------------------------------------------------- Recommended Links: [Woman gets revenge after 401(k) falls nearly 50%]( Jilted by her broker, a Connecticut woman builds website to expose which stocks could soon be rated a "buy" and triples her savings. [Details here](. --------------------------------------------------------------- [The Big Electric Vehicle Story Everyone's Missing]( While investors are obsessed with Tesla's surge, legendary investor Whitney Tilson says an even bigger EV story will provide the highest gains. [Click here to learn more](. --------------------------------------------------------------- Optimism about the bounce back in subscribers and the need for people to refresh their wardrobes allowed the IPO to finally get done, despite the setbacks of the pandemic... Investors looked past weakness that extended well into 2021, despite reopening being in full effect from coast to coast this year. Despite the better backdrop, revenue at Rent the Runway was still down 10% in the first six months of its fiscal 2022, running from February through July 2021... although, in fairness, the company did have to comp the pre-pandemic month of February 2020 in these results. Stepping back to look at the service that Rent the Runway offers its customers... The value proposition to the Rent the Runway user is multifold. It's a way to experience or trial a new brand or style at a lower cost than committing to buying an item would be. It saves users money... why spend $400 buying a gown for a wedding that you might never wear again when you can rent one for $80? Or even better, for no incremental cost as part of a subscription? The company offers lots of choices, including 18,000 different styles from 750 brands. It also allows subscription customers to experience constant newness in their wardrobe with less waste. Rent the Runway invests a lot in cleaning and fabric preservation technology. With proper care, it claims that its clothing items can circulate for years among different users, supplanting the need for fashionistas obsessed with newness to buy things that they then throw quickly into a landfill. This is a very environmentally friendly business concept, and Rent the Runway encourages users to "buy less, wear more." And it does seem like it could be a good deal for fashionistas who crave the latest trends or women with very active social lives, attending many events. For eventgoers, heavy social media posters, and aspiring or actual social media influencers who have concerns about being seen or photographed in the same outfit twice, Rent the Runway can be a pathway to affordable and constant wardrobe newness. Monthly subscriptions start at $89 to rent four items per month and go up to $199 to rent 16 items per month. However, surcharges for damage apply. For example, $25 per spot on clothing when you return it... so don't spill that red wine! If a customer doesn't like what she ordered, or it doesn't fit, she can swap it for a new item within her plan for between $25 and $39. Once a company focusing just on a la carte rentals, subscriptions now make up more than 80% of revenue at Rent the Runway. It's a better business model with more visibility – and I'm sure that's something that buyers of the IPO latched onto. Rent the Runway, like all fashion companies with a tech component – from [Stitch Fix (SFIX)]( to [Revolve (RVLV)]( – claim that "data powers everything we do." Rent the Runway uses data not only to suggest styles to customers and keep them happy but also to share data with the brands it sells. This data helps vendors learn about their end customers, the reception of their products, and figure out how to attract new or younger customers. Rent the Runway touts its strong brand relationships and boasts it has retained 100% of its partner brands since 2009. There are so many reasons I want to root for this stock... First, it's built for women by women. Rent the Runway is the first U.S. company to go public with a female CEO, chief operating officer, and chief financial officer. The two co-founders were section mates at Harvard Business School, which I attended about a decade before them, and they cooked up the idea for Rent the Runway while they were students. Rent the Runway is also a NYC-based company, one of our best-known consumer startups. And it's an eco-friendly company... the planet would be better off if more of us rented our fashion. The addressable market of "women who wear clothes" is extremely large... but the million-dollar question is how many want to subscribe to a rental service. Rent the Runway claims 2.5 million customers have used the service in the last 12 years, yet the total subscriber base peaked at just 148,000 in 2019. The company, however, says it is just getting started when it comes to building a subscriber base. There's no question that the subscription service is of great value for fashion enthusiasts who use it actively. The average current subscriber rents 83 items per year, which means she's accessing clothes with a retail value of tens of thousands of dollars for less than $2,000 per year in subscription fees. The company also touts a diverse customer base covering 74% of U.S. zip codes, with two-thirds of subscribers living outside major cities, dispelling the misconception that Rent the Runway may only be a New York and Los Angeles thing. Around for 12 years already, I wonder why the company doesn't have more subscribers by now. The company touts that it has acquired 88% of customers through word of mouth... but with such a small subscriber base, maybe it should try more formal advertising programs? It's great to have a low cost of customer acquisition ("CAC")... but this company seems too small to support the hefty infrastructure it has in place, including two complex distribution centers, its data infrastructure, website and app, customer service, vendor relations, and other expenses. But can it afford to advertise? This company has never actually made money and doesn't look like it will anytime soon, although it is slowly moving in the right direction, as you can see in this graphic...  Source: Chatr Renting clothes could prove very profitable... at least in theory. Rent the Runway thinks it can get 20 uses out of a garment. With the average rental clocking in at $27 of revenue, the company could take in as much as $540 in revenue on a garment that costs about $100 to buy. That leaves $440 in product margin to cover the cost of shipping, cleaning, and other handling. If Rent the Runway can get these costs down to $10 per rental... this will be a very profitable business as 20 rentals would cost $200 total to process. Add on $100 for buying the product, and you still have $240 in profits on the garment if rented 20 times. However, if roundtrip processing of an item costs $20, the business doesn't look so hot. Shipping and handling costs would be $400 for 20 rentals... Add on $100 for the initial purchase, and you only have $40 of gross profit to cover corporate overhead, IT investments, marketing, and site maintenance. And that assumes that every item rents 20 times... sometimes, products will just turn out to be unpopular duds. Or a renter will damage an item too early in its lifecycle... Rent the Runway has two obvious routes to profitability... The first path requires attracting more subscribers so that the company gets scale benefits. An alternate path centers on driving shipping and handling costs down per rental. Starting with the cost side – we know shipping costs are going up, as are the wages for unskilled labor. It seems like this will be a tough time to drive these costs down. As for growing the subscriber base... reopening should help, but it may be that the low-hanging fruit has already been picked in terms of women who want this service. After all, this company has been around since 2009. Rent the Runway may have to spend more marketing dollars on educating and recruiting new customers to accelerate subscriber growth. Such spending would also accelerate losses in the short term. This is a cool company, and I would like to try its subscription service just to check it out. But its long-term margin guidance seems completely disconnected from reality... Rent the Runway targets a long-term earnings before interest, taxes, depreciation, and amortization ("EBITDA") margin rate of 30% to 35%, much like a Software as a Service ("SaaS") company. Rent the Runway might have a subscription model... but unlike a software company, it needs to deliver physical goods in the physical world, which is expensive. Rent the Runway's peak EBITDA margin after 12 years in the business is negative 7%. A 30% to 35% EBITDA margin seems like a pie in the sky target, and it didn't explain how it was going to get there in the roadshow. I wish I could be more optimistic about Rent the Runway... but I'm sad to say you should avoid RENT shares, which are down about 16% since the IPO. They could go a lot lower. And if you need one more reason to stay away from this company, look how overvalued it is on enterprise value per subscriber versus other e-commerce consumer subscription businesses, courtesy of NYU professor Scott Galloway...  Source: Scott Galloway This is just one more company taking advantage of a [frothy market for IPOs]( that isn't ready for primetime. In the mailbag, a timely reader e-mail on the topic of evaluating unprofitable companies for investment... Would you ever subscribe to a fashion rental service like Rent the Runway? Would you wear preowned clothes? Are there certain things that are too intimate, and you wouldn't want to rent? How do you approach evaluating an investment in an unprofitable company? Share your thoughts in an e-mail by clicking [here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Berna). "Berna, For your question: 'How do you evaluate high-growth tech companies that aren't earning money when you are considering them? Do you think valuation even matters at all when it comes to high-tech growth investing?' "I've always found this a very curious problem to solve. For a high-growth company bleeding operating cash flow, I would like to know who is continually funding the bleed. What financial institutions are providing the funding that keeps the lights on even though the company is practically bleeding out? Furthermore, I would like to know which financial institutions are financing the bleed without capturing the equity of the founders in exchange for money. This would indicate that there is a lot of confidence in the founder and in the business model. "Take Netflix (NFLX), for example. If Netflix burned through $10.8 billion in cash for six years, then who was providing that cash? Furthermore, Reed Hastings was left with 2.28% of the company, even though he provided most of the startup capital for the company to begin with. Jeff Bezos is another. Amazon (AMZN) was burning cash flow as well. Who was providing the funding, and why did Bezos' stake stabilize at 25% or so? Why did the financial institutions not drive a harder bargain and dilute his ownership even more? Tracking these institutions and the compensation of the founders appears pretty important. "I also discovered a figure in the balance sheet of the financial statement called 'Number of common shareholders.' You can see this at finviz.com [here](. Search for shareholders under the balance sheet." – O.P. Berna comment: Interesting point about founder incentives being a possible tell on companies that will hit it big. Most successful aggressive growth investors I know do, in fact, put a ton of weight on the quality of top management and visionary leaders-founders in their investment process. Regards, Berna Barshay November 8, 2021 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2021 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. [Unsubscribe from all future e-mails](