[CHUBA/K – CommerceHub] A Skeptical Take

Investors are once again genuflecting before the altar of Malone.  Here’s the bull case: to combat Amazon, traditional retailers are increasingly pursuing omnichannel strategies (selling their products online for delivery or customer pickup + bric & mortar) and adopting drop-shipping solutions as part of their online fulfillment process.  Drop-shipping allows products ordered by a retailer’s customers to ship directly from the manufacturer or distributor to the customer, sparing the retailer from having to store inventory for online orders, expand distribution centers, and manage the shipping logistics.  Suppliers who participate in drop shipping will often slap the retailer’s sticker on the cardboard box so that the customer thinks her order has come straight from the retailer.  [Drop shipping is not to be confused with Electronic Data Interchange (EDI), a process by which retailers electronically (rather than via paper/fax/phone) send purchase orders to their suppliers, who ship those goods to the retailers’ warehouses, not to the customer directly].

CHUBA is a Liberty spin-off that conceives of itself as the digital “hub” that connects retailers and marketplaces (“demand channels” or digital properties where consumers buy things) on one side and consumer brands/manufacturers/distributors (“suppliers”) on the other to enable drop-shipping, collecting usage fees (2/3 of revenue) based on the volume of customer activity.  Mid-teens e-commerce growth (although, interestingly, according to Slice Intelligence, an estimated 43%(!) of US e-commerce sales in 2016 was Amazon; so if the US e-commerce category is growing by 15% and Amazon’s GMV is growing by ~25%, that implies non-AMZN e-commerce is only growing by about 7%) + drop-shipping penetration within existing and new e-commerce retailers/marketplaces = 20%+ CommerceHub annual GMV and revenue growth.  CHUBA captures value because of putative network effects: retail customers have their suppliers plug into the company’s hub, which hub becomes more attractive for other retailers to join as the number of participating suppliers grows.

That last part is critical, so it’s worth examining whether the flywheel is as real as it seems on the surface.  Network effects are characterized by a self-feedback mechanism in which adoption by each platform participant spurs further adoption by other constituents.  In CHUB’s case, this should mean that each incremental on-boarded retailer brings on more suppliers (who want access to those retailers), which in turn spurs more retailers (who want access to suppliers), and so on.  But what’s actually happening is far more straightforward: retailers want to drop-ship some of their SKUs and so they are asking the suppliers of those SKUs to plug into CHUB’s hub.

Just to be clear, I’m distinguishing between drop-shipping as a solution (which I agree, has legs) and network effects as a moat in this instance (which is debatable, in my opinion).  That a whole bunch of suppliers are connected to Commerce Hub is not, in itself, compelling retailers to plug in; nor is the presence of retailers, in itself, pushing suppliers to join.  Retailers are not transversing the hub to connect to other suppliers it doesn’t otherwise have access to.  Suppliers are not aggregating onto the platform organically; they are being “asked” by large retailers to join.

Platform structure often yields clues as to the presence of a real flywheel.  Usually, these two-sided platforms are characterized by a “many-to-many” ecosystem – think Uber (drivers/passengers), AirBnB (hosts/guests), and Priceline (hotels/travelers).  CHUB, on the other hand, is a “many-to-few” ecosystem, with many suppliers on one side (~10k) and a few, powerful retailers (3 customers = 30% of revenue in 2015; QVC, a 7%-8% customer, is having revenue growth challenges) on the other, which matters because the whole profit-maximizing point of running a platform is being able to extract a tax on all transacting constituents, who by virtue of being small and insignificant in relation to the platform, have no leverage to wield against the platform operator.

The other concern I have is that while drop-shipping is sensible for the long tail of low-turning SKUs – you’re not going to waste internal logistics resources for an item that only sells sporadically – or for spillover capacity during the holidays, retailers will keep high-velocity SKUs (and pull SKUs from drop ship if they become high-velocity) and take all the margin for themselves.  Also, in January 2015 CHUB acquired an unprofitable e-commerce marketing services company called Mercent.  This business has no identifiable competitive advantages, and positioning it as somehow synergistic to the drop-shipping hub feels forced.  Finally, there’s always the looming threat of Fulfillment by Amazon, part of a true flywheel that I suspect will continue taking e-commerce share.

Of course, you can still have a decent business as a SaaS mediator of drop-shipping solutions.  Coordinating the shipping logistics of who-knows-how-many SKUs from thousands of suppliers to 10s or 100s(?) of thousands of customers is certainly no easy task (in comparison, an EDI enabler like SPS Commerce moves product in larger and steadier batches from supplier to retailer).  But still, from a customer capture and captivity standpoint, that’s not nearly as powerful a proposition as being the one platform all drop-shipping adopters must attach themselves to.

CHUB’s enterprise value is ~$750mn (includes 5mn of anti-dilutive shares), trailing EBITDA is about $32mn (taking the company’s adjusted EBITDA guidance, adding back separation costs, and subtracting my estimate of normalized stock comp of ~$12mn), so ~23x EBITDA.  This could still be cheap given the robust end-market growth if you believe in the platform dynamic, which I don’t.  The dream here is that with, say, 20% revenue growth (in comparison, usage revenue grew by ~13% YTD 2016, well above non-Amazon e-commerce growth rates, but below the 17% organic growth rate posted in 2015) at 50% contribution margins, CHUB gets an incremental ~$70mn EBITDA in 5 years, so call it $100mn in year-5 EBITDA…and of course, some cash is building along the way.  The cynic in me suspects that the cost structure will continue to creep higher as it bloats with recurring growth-related “one-timers” and the implied margin expansion from 50%+ drop-downs will prove elusive – just a hunch, perhaps an unfair one.