NEGG - Newegg Commerce: Financial Collapse And Further Headwinds Ahead

2024-01-05 07:00:00 ET

Summary

• NEGG’s revenue growth has been completely derailed, with a persistent decline on a quarterly basis despite lower comparables.
• The company is now loss-making and has negative FCF on an LTM basis. We do think an improvement is possible, but with headwinds ahead, we see further pain.
• We do not see sufficient business model development to warrant a change in fortune, leaving the company vulnerable to an economic downturn.
• NEGG is trading at a recessionary valuation but given the circumstances and lack of long-term upside, we are not wholly against this.

Investment thesis

Our current investment thesis is:

• NEGG has historically punched above its weight and really has no reason to exist in a world that has Amazon (AMZN) and Best Buy (BBY). Despite this, it has succeeded but following a series of small missteps, the business is in a major negative spiral that we do not think it can escape.
• Its growth is negative and has limited scope for outperformance, while its margins are now negative and inventory will need to be liquidated to generate cash. With economic headwinds ahead, 2024 could still be its worst year yet.

Company description

Newegg Commerce (NEGG) is an e-retailer specializing in electronics products in North America. It offers a wide range of products including computers and accessories.

NEGG's share price performance since 2021 has been disastrous, losing over 90% of its value and significantly underperforming the wider market and its directly comparable peers. As illustrated by its cohort, a material degree of the negative impact is market/economy related, although there is also much criticism that can be levied on Management and weaknesses in its fundamental business model. We have covered NEGG twice previously, and detail much of this there ( here and here ).

Financial analysis

Presented above are NEGG's financial results.

Revenue & Commercial Factors

NEGG's recent performance has been highly negative, with the business seemingly unable to reach a "bottom". Revenue per quarter has declined from >$500m to ~$300m, with a decline of (35)%, (24)%, (19)%, and (9)% in its last four reported quarters.

The primary reason for this decline is the current macroeconomic environment. With an extended period of heightened inflation and the corresponding increase in interest rates, consumers have suffered from a cost of living crisis. This has contributed to reduced discretionary spending, a key component of NEGG's target market, given its association with the gaming industry. As the following illustrates, US Retail sales have broadly stagnated, with this inherently overstated by the impact of inflation.

Compounding this is the impact of the pandemic period. Consumers, flush with stimulus checks, spent heavily on retail, which involved the purchase of consumer electronics. These products are still in use currently, contributing to a deep-down cycle as the need for goods is depressed. Computing stocks are seeing analyst ratings upgraded as a PC market recovery is expected to begin in 2024, potentially representing the end of the down cycle for NEGG.

Looking ahead, we do concur with the view that an upcycle is imminent given the deep decline the industry has experienced. This said, economic conditions could represent an offsetting factor in the coming 12 months. The US recession probability indicator has exceeded 50% for the first time, despite the indication that rates will decline in 2024. Realistically, rates should step down, which lends itself to a "soft landing" in our view. Nevertheless, prudent consumers will likely defer purchases as sentiment declines.

NEGG's actions to offset the impact of this have been underwhelming in our view. We do not necessarily see this as a criticism of Management, as its peers have equally struggled, and it's an inherent weakness of the company.

Management has aggressively expanded its sales channels and revenue generation potential, including a partnership with Walmart has deals on the most-wanted gifts ( WMT ) and TikTok Shop. Despite these new revenue channels, revenue is still declining. This is likely due to a degree of cannibalization, as well as the low-quality nature of these additional revenue streams.

Further, Management has implemented operational improvements to drive down S&A costs, such as the use of autonomous robots in its factories and cutting non-core costs. The impact of this has not been sufficient despite S&A costs declining, with EBITDA-M increasing in negativity to (5)%. Realistically, the company will only reach positive profitability if revenue grows sufficiently, as far too much of its cost base is fixed.

Fundamentals

NEGG is one of the leading electronics retailers in the US and unlike many of its peers, namely Best Buy, it is a pure-play online offering with an asset-light model. This has allowed the company to gain significant scale through a broad SKU approach, amassing over 3.5m active customers and a loyal customer base.

The electronics industry is quite attractive despite its cyclicality due to the natural tailwinds associated with societal development. Technology is increasingly spreading across all facets of society, contributing to higher ongoing demand through replacement and uptake.

NEGG's trajectory was derailed by a change in approach as Management sought to maintain growth. Just as Icarus flew too close to the sun, NEGG's strategy was a step too far for its customer base, alienating its core base and diluting its differentiation to new customers. The company increasingly allowed and encouraged retailers to market their products on its services, contributing to an influx of Far East producers and a lower relative number of highly-regarded brands. This contributed to an increase in quality and reliability issues. NEGG has been unable to revitalize its brand and remains committed to the Marketplace / Marketing Services revenue streams.

Balance sheet & Cash Flows

Despite the financial issues experienced by NEGG, there are no imminent solvency concerns. The company has no debt and ~$54m in cash. This said, it is now burning cash and so the concern is that the business needs to raise financing, which the debt markets likely will not provide. Its RR cash burn was ~$17m in the LTM period. NEGG does have ~$142m in inventory that it can liquidate, but this would come with further damage to the company.

Outlook

We are forecasting (5)%-0% revenue growth in FY24, primarily due to the low comparable period. In conjunction with this, EBITDA-M will likely remain negative in Q1/Q2, with scope for improvement dependent on an improvement in conditions in the second half of the year.

We see limited scope for outperformance, particularly given the degree to which NEGG has struggled thus far and the lack of options available to Management.

Industry analysis

Presented above is a comparison of NEGG's growth and profitability to the average of its industry, as defined by Seeking Alpha (6 companies).

NEGG's performance relative to its peers is poor, with lower growth and margins. This is illustrative of its market share loss following the misstep in strategy, as its customers lose loyalty and competition increases.

Further, its decline in margins has been more extreme, particularly given it is burning cash while peers have still been able to liquidate stock sufficiently.

The most important factor is not reflected here, however, which is the quality of the business model. We are bearish on NEGG's long-term staying power following recent developments. The likes of Best Buy and Amazon are taking market share in droves, and NEGG lacks sufficient differentiation to protect its position.

Valuation

NEGG is currently trading at 0.3x LTM Revenue and 0.3x NTM Revenue. This is a discount to its historical average.

NEGG is trading at a deep discount to its historical average, reflecting the significant decline in financial and commercial capabilities. We concur with a discount, although the extent is fairly substantial.

Further, NEGG is trading at a ~106% discount to its peers on an LTM Revenue basis, a smaller delta reflecting the industry tailwinds experienced. This is warranted, in our view, owing to market share loss and the negative future outlook we have.

Overall, a 0.3x multiple is reflective of a hopeless, recessionary valuation. NEGG is not necessarily there yet but appears to be on the road to this point. We have seen almost no tangible improvement since our first paper in early 2023, and economic conditions are only worsening now.

Key risks with our thesis

The key risk to our thesis is a potential takeover. NEGG is loss-making and its business model is now broken in our view, although its brand, website traffic and assets, and industry relationships still have value. At 0.3x revenue, the company could be approaching a territory where a party such as Amazon considers NEGG attractive.

Final thoughts

NEGG is a struggling business, which by virtue of its size and overachieving nature means it must be perfect in order to succeed. Unfortunately, Management has not been, and now the company is on a downward spiral to failure. We do think it could maintain its niche in the high-end PC segment, but will involve another fundamental shift in its business model and the willingness to forego growth.

In the near term, however, we only see pain ahead and no reason for share price appreciation. With the risk of a recession now exceeding 50%, we continue to maintain our sell rating.

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