Blue Apron Becomes the Latest Unicorn to Pursue an IPO

Meal kit delivery company Blue Apron is making headlines after filing for an initial public offering.

In this episode of Industry Focus: Consumer Goods, Motley Fool analyst Vincent Shen and senior Fool.com contributor Asit Sharma do a deep dive on the multi-billion dollar unicorn start-up. Find out what investors should know before thinking about buying shares, including the business model, important metrics, financial performance, and competitive landscape.

A full transcript follows the video.

This video was recorded on June 6, 2017.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and it's Tuesday, June 6th. Super excited to talk about a hot new IPO that was filed last week. It's not too often that we get unicorns in the consumer and retail space going public. A unicorn, of course, is the amusing title given to private start-ups with valuations of $1 billion or more. Dylan over in the tech world usually gets to claim these unicorn IPOs but not today, thanks to Blue Apron. Joining me via Skype to share his thoughts on the company is senior Fool.com contributor Asit Sharma. Asit, thank you for joining us. Did you ever subscribe to one of these meal delivery services before?

Asit Sharma: I haven't, Vince. I consider myself something of a foodie, so I have my hands full with going and getting my own ingredients and constantly experimenting. But I'm very interested in the model. I've followed Blue Apron and some of its competitors, so I'm quite familiar with the service, and excited to talk about it today. How about you? Have you tried one of these services yet?

Shen: Yeah, I've tried a few of them. I generally really like the clear, clear instructions, how everything is portioned out for me. I think that's the magic behind this, where you get everything in the box. I'll explain more to listeners, but as a preview of our discussion, Asit and I will first cover a little bit of the history of the company and its management team before we move on to the business model, some of the financials, and the bigger-picture context for investors, such as risks for the company, what the competitive landscape looks like, also the size of the market depending on how much time we have left.

If you're unfamiliar with what Blue Apron is, it's a meal delivery service. What that means is, you sign up with a company by choosing one of its two meal plans. One is catered for two people with about three meals per week at a cost of approximately $60. The other is catered for a family of four with either two or four meals per week, which will come in at $70 or $140. So once you've signed up with one of these meal plans, you receive your meals in a refrigerated box, and all the key ingredients for these various recipes are prepackaged, portioned out, and there's detailed instructions on how you prepare your food. It could include some pretty interesting dishes like tomato saffron risotto or summer squash enchiladas. All in all, it's a simple but compelling business model and I'm kind of surprised that no one has tried to pursue previously.

Asit, before we get too hungry here, can you give us a quick overview of how the company got its start?

Sharma: Sure. The company was started a few years ago in 2012 when its founders were trying to cook at home with their families. Per the overview provided in the S-1, it has a really good description of how the company launched, they found the grocery shopping and menu planning tiresome. To me, that's actually the fun part of putting a meal together. But when you're pressed for time, you can see how for anyone, that can take the joy out of the meal. So the founders had the first delivery in 2012 to the box with three recipes -- seared hanger steak, barbecue Cornish game hen, and lemongrass shrimp with soba noodles. That sounds so good, just from that first meal I can see why the company has succeeded so wildly. And to your point about your own consumption, Vince, the focus was on pre-proportioned ingredients. The company established a template for further meals. Since then, they have scaled the business, working with small farmers, building a supply chain, putting in technology which helps them manage inventory. According to their filings for their public offerings, which is upcoming from inception through March 31st, 2017, that's the end of their most recent quarter, they delivered over 159 million meals to households. They claimed that represents approximately 25 million paid orders. That's basically, in a nutshell, how the company started and built up its business.

Shen: I'll add that the three co-founders -- Matthew Salzberg, Ilia Papas, and Matthew Wadiak -- now make up a pretty decent portion of the executive suite of this company. In that order, the CEO, the CTO, and the COO. As early as 2015, there was private venture funding for this company. It placed the valuation for Blue Apron at about $2 billion. With the growth that the company has seen in the past two years since then, IPO valuation should place it far higher since revenue has just about doubled since then. Asit, you and I dug into the S-1 filing. It's a very early rough draft for the prospectus, but we have some information here on company financials and other details shared about the business. The first thing I want to touch on is, how has some of this impressive growth that you mentioned, about 160 million meals delivered since inception, their run rate back in late 2014 was about a million meals per month and they're now at 8 million meals per month, how has that growth panned out in terms of the top line?

Sharma: Growth has been very interesting, amazing, actually. I was looking at their revenue figures. 2014 to 2015, the company did about $341 million in revenue, and that was a 338% year over year gain. Accompanying that, it had a loss of $46.9 million. Listeners who are experienced in investing in growth companies have seen this narrative before -- a fast-growing company that's more focused on grabbing market share than anything else. From 2015 to 2016, the company did almost $800 million in business. Growth slowed to a paltry 133% year over year. Interestingly, that year, 2015 to 2016, the company lost $55 million. Now remember, I said on basically half the revenue of the year before, it lost about $47 million. So, within that year, the company was able to put systems into place to lower its cost of goods sold. As I said earlier, they work with a number of small farmers and are building out a supply chain which is very technologically advanced, trying to build a framework to fend off future entrants into this space. In their most recent quarter, which again, is from January 1st to March 31st, the company grew 44% year over year, versus that first quarter in 2016. And turned a small profit of $3 million. So, you can see the trend lines. Growth is exceedingly rapid, but the company is learning as it evolves how to make money with the service. Not a lot. Just now, we see them on pace to do maybe $1 billion of business this year, may still end up with a slight loss. But maybe what differentiates this company from other growth companies you'll see is, they're on path to profitability. That's very interesting, to keep your eye on as a potential investor, seeing its S-1 statement, they may make money and be profitable in the next two or three years.

Shen: Thanks, Asit. I will add that 99% of this company's revenue is generated from this meal delivery business, but the company has expanded into some other complementary areas, including a wine service, and also some kitchen tools and accessories that are sold through their e-commerce platform. So obviously it's clear, the 338% growth and 133% growth in 2016, really a lot of progress for Blue Apron as they scale up this business. The company says outright that there's some seasonality that they face. The first part of the year is generally their strongest for engagement, but then as the summer season creeps in and the holiday months come about, their customers see more irregular schedules and thus often reduce order activity. Let's turn to the bottom line, and some of their expenses. In this kind of business, it seems that their increased scale should be a major tailwind for the company. But, how is their actual profitability, not just in terms of some of the numbers you mentioned, but, what are some of the main things they're looking at in terms of their cost structure?

Sharma: The cost structure depends on efficiency with handling materials. You can think about this company, they're in the business of moving raw materials. And some of these are truly raw. Vince, you've used this service. There's raw vegetables. But, at the same time, Blue Apron ships proteins. It's refrigerated. So they have tacked on some additional costs in basically forming a product which hasn't been on the market before. You can get a complete meal, cook it from scratch with the ingredients in the box, and don't have to supply your own proteins. There have been versions of this type of service before but not so comprehensive. I think Blue Apron is a pioneer along with these smaller competitors at completing the whole system. The cost that it looks at, the product cost that it has to move, it also has third party delivery costs, which hit its bottom line. It has to have the meals delivered.

Now, on the revenue side, it's a subscription-based service. This means that you subscribe for a certain number of meals, and like any other company, many of our listeners invest in tech companies, you have to worry about your subscriber churn. You are familiar with this model if you invested in companies which rely on subscription. Intuit is a great one with QuickBooks Online. They always have to worry about adding new customers and keeping existing customers from leaving. So far, they seem to be doing a pretty decent job with reducing churn. But I will say, in the S-1, one thing that stood out to me is that Blue Apron actually measures its active customers by people who have ordered with them at any time in the past. If you have ordered from Blue Apron, let's say two years ago, and then order again today, you are considered an active customer, whereas in the tech industry, which is one of the only things we have to compare this to, usually people have to have a couple transactions in a single year. So this might affect the visibility of those churn numbers. But to wrap this up, in terms of their bottom line, their cost of goods sold, which is basically, they exclude some non-cash items like depreciation and amortization, they were able to decrease that from 93% in 2014 when the company was first getting off the ground to 67% last year. That's why, I was talking earlier about the profitability, you saw some profit in the first quarter, they're getting better at handling their basic materials. 

Shen: Thanks, Asit. A few other things that I want to touch on that you mentioned is this idea for a subscription model, how important it is to consistently grow your customer base. I think that bears out in terms of their marketing expense. That's a very significant line item for the company. They're burning through quite a bit of money in both acquiring and retaining their customers, like many start-ups. So the company is going to put its pedal to the metal to drive that high growth, help boost its valuation as well. Just to give you an idea of what we're looking at here, the marketing expenses in 2016 were about $144 million. That's about 18% of revenue for that year. And if you look at the most recent quarter, the first quarter of 2017, that was up to 25% of revenue for the first quarter. So actually going up as a percentage of the top line. And management has noted that because this first quarter is the period of highest customer engagement, they expect marketing expenses to decline throughout the rest of the year. 

But even if you take the marketing spend from the first quarter of 2015 and 2016, it's about 17% of the annual total spend, and you apply that to 2017 for an annual run rate, we're looking at almost $360 million for the full year, which is massive. I think with the company marketing through not only online and traditional media, they also have its referral program, where basically, existing members spread the word on Blue Apron, introduce new users with a free meal to try and hook them into the system. Referrals also account for over 30% of their new customer acquisitions. But what it comes down to is, if you take their marketing spend, divide that by the number of customer acquisitions that they saw, Blue Apron is spending about $94 acquiring each customer. The way that has trended upwards for the first quarter, we also saw that in terms of cost of goods sold that you mentioned, Asit, gross margin has definitely expanded significantly. But we saw a little bit of a reversal for the first quarter.

And another big line item for them is their product, technology, general, and administrative expenses were up from about 21% of revenue in 2016 to over 25% of the top line for the most recent period. I think that's from the company ramping up the investments they make in the infrastructure to support its very rapid expansion. We usually hope to see these young companies get closer to profitability as they grow more mature. It seems like Blue Apron is taking the steps toward that. But at the same time, some of these expenses are blowing up for them in their first quarter, their busiest quarter. 

There are some red flags there for me. Beyond some of the line items that we covered so far, you also brought up the repeat customers, and how they count those based on if they've ever placed an order in the past. Some other metrics that the company looks at that were interesting, they also have their average order value. In the first quarter of 2016, the average order value was at $59.28. That's declined slightly for the most recent period to $57.23. Another bit of a red flag is also, their orders per customer went from 4.5 in that prior-year period to 4.1 for this period, and the average revenue per customer going from $265 to $236. So I guess I'm seeing a lot of numbers here, despite the growth that they're enjoying, trending in the wrong direction. 

But when it comes down to it, I think there are a lot of other bigger picture things to like about this kind of business. I want to cover some things that we're bullish on. Blue Apron is the biggest name in the meal delivery world. I think it's curated a pretty compelling brand and image. That comes through in certain qualitative ways such as, you see the way that customers interact and share their cooking experiences on social media, but also in quantitative ways in that 90% of the revenue is coming from repeat orders. That seems to be a strong indicator of a sticky product, and bodes well if it can continue to expand its customer base. The power of some of the additional growth it hopes to see, the company will also be expanding the number of plan options it offers, not only how many meals customers can receive per week but also the number of recipes available to choose from, which could increase its appeal to more people. Asit, what else do you like, in general, about this kind of business or this industry, or some of the financials?

Sharma: I love that the product itself appeals to millennials, who have shown a disinclination to eat in casual restaurants. That industry is getting burned up by millennials' preference to stay at home and cook. So there's a market there. I think almost 40% of Blue Apron's customers right now can be classified as millennials. So they have a strong base that loves to learn. And Blue Apron sees itself as a company that learns with its customers. They have a new menu every week. They solicit feedback from customers and they try to keep it interesting to keep that space engaged, as we said. What I like about their balance sheet is that, really, management has been very savvy in funding this company, keeping it going as they reach this stage where they can go public and get public investment.

I will add another red flag onto some of the nice ones that you listed, Vince. If you read the proceeds section, so how are they going to use these funds, basically the company has a working capital deficit of about $84 million. That means they don't have enough of their current assets on hands to fund obligations that are coming up. So they're going to use most of the proceeds to fund that. They also have a revolving credit line, which, even after the period that they were reported on in the first set of financials within their statement, there's always a section called subsequent events, they've tapped their credit lines. The credit line now that they have, they've used $125 million out of $175 million. I've seen different figures for how much will be raised in this IPO. But pretty much, the company is saying, "We're going to use almost all of our proceeds to pump cash in, because we're sort of underwater on a current basis, and then we're going to pay off on this revolving line." There's not much else that the proceeds will be used for, so if you're thinking, "I'm going to buy shares and they're going to use my funds and other people's funds for more of this product innovation, marketing, which Vince talked about," that won't happen in this offering. 

One more red flag to put in there -- the company, as I said, good side, smart management has raised a lot to fund the company. The bad side, if you're an incoming investor, they tend to like convertible preferred stock and convertible promissory notes. So there's about $260 million on the balance sheet, $63 million of that which doesn't show up, again, until a subsequent event, just happened last month in raising money which can later be converted into shares. That will dilute this first tranche of investors coming in on the IPO. Bottom line is, if you're thinking of buying into Blue Apron, just know that they are probably going to follow this up with another offering. Typical time frame is one to three years. They'll go to the markets again, and you'll get diluted. 

But there's some appreciation potential in here as well. They're a market leader. As Vince said, there's a lot to like. If you have some risk tolerance, you can take an investment now and hold on, and you may be compensated for that risk of dilution by an appreciating stock. They do have a competitive advantage right now. Competition, I'll let Vince talk a little bit about that, isn't so fierce. But I do worry about a larger competitor like an Amazon eventually coming in. Do we have any more time, Vince, to talk about their competition?

Shen: Yeah, I think that's a good segue. In my view, this is really not a market with high barriers to entry. If you can just look at the story of how Blue Apron was founded, three guys, New York City apartments, putting together these meal kits themselves. It's not too surprising, then, that there are about a dozen or more other start-ups that are competing with the company. Some of the direct competitors include companies like Plated, Home Chef, Green Chef, HelloFresh. And then some of their competitors are specializing on certain niche customers, or changing the model. You have Purple Carrot, which is all plant-based recipes for vegetarians, there's Chef'd, which has no subscription required, unlike Blue Apron, you just order the recipes you like.

But I think, actually, the biggest threat beyond these direct competitors is, it wouldn't take that much for bigger companies that are already currently setting up their capabilities for grocery delivery or already have it in place to expand their service offerings to something that competes directly with Blue Apron. A lot of grocery chains are actually stocking meal kits, so you can purchase them in the store. The question becomes, what can stop a Walmart from putting these kits on their shelves, and also making them available for the curbside pickup service. Then, Amazon is another example where they partnered with Tyson Foods last fall to sell Tyson Tastemakers meal kits. They offer those online. They also offer their Martha Stewart meal kits as well. So it's quite easy, the idea to include these in your weekly AmazonFresh order, along with the rest of your shopping list. So what you mentioned in terms of some of the bigger competitors posing a more significant threat, I definitely agree there.

But another issue that comes through in terms of challenges that this company faces also comes with their pricing power. I looked over many of the competing services. Blue Apron charges about $10 per meal, similar to most of its competition. If it raises its prices, some of the stickiness that you would hope from people having a good relationship and ties to the brand. But customers can ultimately look elsewhere for similar services. There are plenty of promotions and free meals to try out there considering the marketing budgets that are being employed in this industry. That means, again, it comes back to our point, the idea that growth can really only come with more customers. I question a little bit how mainstream meal kits will actually become, because we've seen with even giant retailers like Walmart and Amazon, they struggle to build up their standard grocery delivery businesses. So whether these meal kit delivery services will reach a certain scale that we'd like to see is not so certain. But I'd like to close out with any final takeaway thoughts from you, Asit, for this IPO, and what maybe investors can expect, or any other thoughts you might have.

Sharma: I think that Blue Aprons is an extremely interesting company. My thought is that investors should watch rather than leap into this IPO and have a few quarters pass, examine the financials, look at the stats that Vince was talking about earlier, the customer retention rates, customer additions, it'll be very prominent and easy to read in those quarterly reports. Really wait this one out. There's so much in terms of competition, and even within its own subscriber base. I'll end with a quote which actually shows you the flip side of this. This is from a writer from The Atlantic whom I follow on Twitter who writes often about food and health, Olga Khazan. She said, "The most dystopian thing about Blue Apron is that you're eating the same exact meal on the same night as thousands of other people." So this is a very interesting risk for the company -- 40% of customers are millennials. What happens when they wake up and figure out that they've learned how to cook through this great service, and they're ready to move on? So that's why I say proceed with caution. But it is an interesting company with a lot of potential. Right now, it's dominating the market. I'm not trying to diss it or persuade someone not to invest. I think, just take some time. You won't miss out too much on a few quarters of observation.

Shen: Thanks, Asit. I, too, will take a much more cautious tone. I think this company kind of reminds me of Fitbit, frankly. You have an early mover with a compelling product, a growing industry or category, and a very strong brand, but there's also lots of competition, few barriers to entry, and I think the financials are pretty challenging, as we've seen with the massive marketing spend to acquire and retain new customers, various metrics trending the wrong way that we've talked about.

So with this initial filing, the IPO will not occur for another six months or more, so you won't be able to get your hands on Blue Apron stock for some time, assuming that we haven't scared you off of it at this point. But when the deal happens, we'll be sure to revisit with any updates. On a final note, the stock is expected to trade under the ticker APRN.

Thanks, Asit, for the fun discussion, and thanks to everyone for tuning in. You can reach out to us and the rest of the Industry Focus crew via Twitter @MFIndustryFocus, or send any questions to [email protected]. Don't forget to check out the other podcasts at podcasts.fool.com. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program.