VTEX - VTEX: Europe And The U.S. Expansion Is Very Positive

2023-06-23 10:58:53 ET

Summary

• VTEX is expanding its e-commerce software as a service platform into the US and Europe, targeting a combined market worth over $1.5 trillion.
• Entry into these markets is still in early stages, and it may take time for VTEX to establish its presence and see a boost in revenue.
• Risks for VTEX include foreign exchange fluctuations and the need to maintain technological innovation to remain competitive.

Investment thesis

In the realm of e-commerce, VTEX ( VTEX ) is a Brazilian tech firm that provides a software as a service platform to both small businesses and multinational corporations. The company provides a wide variety of market entry strategies, giving its customers extensive options for personalization and rapid product launch. I reiterate a hold rating for VTEX as I await evidence of success in entering the US and Europe.

Gross margin

It is generally not a good thing to see gross margin compression (sequentially) as it suggests lack of pricing power to pass through cost of goods sold. However, in this case, I believe it is a matter of mix for VTEX and a decision to invest. Subscription revenue gross margin were largely flat vs. previous quarter but service revenue gross margin fell to -65% vs -25% last quarter. Note that service revenue only represents about 6% of revenue, as such the overall impact is not huge. That said, my sense is that management is investing in new geographies (discussed below), and some expenses needed to be front loaded first before revenue can kick in. However, this gross margin weakness could linger for a few quarters as it takes time to set things up, and we do not know how much all these will cost. Bear in mind the markets that VTEX is entering are huge - US and Europe - as such, I expect VTEX to spend more than usual in some key implementations in the US and Europe, to ensure a successful process.

International expansion

I am all for VTEX to venture into international grounds as the TAM is insanely huge, specifically the US and Europe. Various estimates are available on the internet, and if we use Digital Commerce 360 figures as a benchmark the US TAM reached more than $1 trillion in 2022, and EcommerceDB estimated Europe TAM to be in the range of $500+ billion. Cumulatively, these markets represent a market that is north of $1.5 trillion, which is close to 10x the TAM of Latin America where VTEX has a strong position. Given the sheer size of the market, I believe there are still plenty of ecommerce channels or retailers still using legacy platforms that are inflexible and have difficulties to meet current demands such as omnichannel. As such, I see plenty of opportunities for VTEX to capture growth here. According to management estimates, they believe around 20 to 30% of US ecommerce GMV is still based on legacy platforms, and a similar range for Europe. Suppose the right figure is 20%, this means there is a low-hanging fruit TAM of ~$300 billion which VTEX should go for first as they are not an existing solution provider to compete against. In my opinion, these low-hanging fruits will provide VTEX the necessary operating experience in this new market and pivot its solution to better fit the market before going out to compete head-to-head (win market share) against larger incumbents like Shopify.

With all the optimism, I note that entry into US and Europe is still in the early stages. Entry into new markets typically takes a long time before results can be seen as VTEX needs to relearn the market and conduct several trials and errors on the best GTM strategy. All these takes time to implement and also to gather feedback. Therefore, it is unlikely we will see any topline boost from these new markets, in contrast, we might see periods of margins volatility as VTEX needs to keep reinvesting into these new markets.

Valuation

I believe VTEX has the potential to be worth a lot more than what it is today if it is able to succeed in gaining a foothold in the US and Europe. The sheer size of the TAM would allow VTEX to continue growing for a very long time and likely at a very fast rate at the onset as it faces easy comps (US and Europe starts from a small base). Also, I think VTEX's entrance into the US and Europe markets will increase its exposure and awareness to a larger group of the investor base, which will definitely help from a stock sentiment perspective.

Risks

FX

The problem with operating in LATAM is the huge FX risk that the business face. In this case for VTEX, the Argentine Peso is a case in point, which has continued to depreciate against the USD. Argentina's contribution to revenue is in the range of high single digit to low teens, while not the majority, it could still cause damage to the headline numbers if the currency continues to depreciate.

Technological evolution

Management failing to adequately maintain and support customer-facing services, systems, and platforms, or failing to promptly address quality issues and release product updates, could have a negative impact on the company's revenue and reputation given the importance of technology and innovation to the company's success.

Conclusion

I think there is a path for the stock to be worth a lot if it can establish a proper presence in the US and Europe markets. Until then, I am reiterating my previous recommendation for a hold rating as the valuation is not exciting enough yet (refer to my previous model).

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