Gettin’ Head Rover Heels

As a platform for pet services such as dog boarding and cat sitting, Rover has made a name for itself among a growing number of pet parents across the United States. But does this small company have what it takes to make it as a public investment?

In this episode of Industry Focus: Consumer Goods, host Emily Flippen is joined by Motley Fool analyst Asit Sharma to break down this business before it hits markets.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stock. A full transcript follows the video.

This video was recorded on February 23, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, February 23rd, and I'm your host, Emily Flippen. Today, I am joined by Motley Fool Analyst, Asit Sharma, as we talk about the next pet-focused business to hit the market, Rover. Asit, as I said that sentence, it occurred to me that when I heard this business was going public, I immediately jumped on it for Industry Focus without really thinking about whether or not this is a consumer goods company. Would classify Rover as tech or consumer goods? Now I feel like maybe I need to send Dylan an apology note.

Asit Sharma: I think this is absolutely consumer goods, Emily. Something in me has shifted since, let's say last year pre-COVID. There are a lot of companies that are totally consumer-focused, but they come at it with a lot of tech. So I have my own pet name for this category, tech-infused CG. That gives us a little bit of space to blur some boundaries.

Flippen: I was clearly way too excited about pet trend, the continuance of the chewy curb here, if you'll call it that. So hopefully our listeners won't get a second episode over Rover on Friday when Dylan comes on. But even if you do, what I will say is that this is a business that I think deserves two episodes of Industry Focus because it is such an oddity. I think you and I -- I'm basing this opinion off of your notes that I've read -- I think you and I felt differently about this company. We fell on two different ends of the spectrum here. So I'm really interested to talk about it in a bit more detail.

Sharma: Emily, [laughs] you know how to dial up the intrigue because I'm wondering when I conveyed my notes. I think we actually fell in the same side. We're going to find out. I have no idea now and you probably have no idea what I think about this company, so let's do this.

Flippen: I'm so excited. I have to say, before we get into the details, have you ever used Rover before?

Sharma: I haven't, Emily. At the present time, I don't have a cat or a dog, but I spent some time on the platform last night imagining that I needed someone to provide a service on this platform for me today because I was busy in the one o'clock hour while we were going to record Motley Fool Industry Focus. So I became pretty familiar with getting around the platform. Pretty interesting interface. How about you? Have you used Rover?

Flippen: I have, and maybe that is part of the reason why foreshadowing my opinion here. I'm a fan. I've used it a lot in the past. I wouldn't say in their target demographic, which is urban areas. I'm on the outskirts of an urban area, but I travel a decent amount, at least pre-COVID, obviously, I was doing less of that in 2020. But whenever I would travel, I would find people on Rover to come and do daily check-ins on my very spoiled cats. It was always a good experience. It was really smooth. I never had an issue and I realize that's totally anecdotal, everybody will have their own stories. But when I heard that this company was going public, I was like, oh, wow, I've used that before. So I'm excited to talk about it in a bit more detail. What I will say is, with all companies nowadays, this is a company that's going public through a SPAC. We can talk about some of its SPACy details, if I can call it that, before we talk about the business itself because it's always worth mentioning just some of the added risk that exists with buying shares of a SPAC versus a company that is directly listing.

Sharma: Yeah, absolutely. This is one thing that I want to just quickly emphasize here. For those of you who are used to buying IPOs, after they price, maybe you're not able to get in on the action beforehand, which is perfectly OK. Many of us, I think at The Motley Fool, those who are short here on Fool Live have a mantra to not feel that you are going to miss out. You can wait a quarter or two with an IPO before you buy it, see how they perform as soon as they're public in those first couple of quarterly reports. The same with SPACs. I feel they have a lot of buzz at the moment and there are many of them that are going straight up after the mergers happened. But you've got time as investor, and time's on your side, both in terms of a holding period, but then time to evaluate. You should never feel too pressured to get in on what seems like a good deal at the outset.

Flippen: That's a really good point and to further emphasize that, they're bringing public through deal with Nebula Caravel Acquisition Corp. It trades under the ticker NEPC right now. But at announcement, and note that it's up 6% or 7% since announcement, but at announcement, the SPAC had valued Rover at just over $1.5 billion in equity value. While that sounds smaller than a lot of the other SPACs, we'll talk about why it might be slightly more favorable valuation based on the revenue that the businesses doing today. I agree with your assessment there also. Don't feel the need to jump in just because something is getting a lot of hype or a lot of attention. 1.5 billion doesn't sound like a lot, but when you're looking at the business's size, it is already entering the markets, probably [laughs] going to be pretty frothy valued. Although, I guess, that's par for the course these days.

Sharma: Sure.

Flippen: What can you tell us about background and management here? I intended to add notes here, and the only thing I wrote is that their founder came from Microsoft and you very graciously filled in the rest.

Sharma: That's a great point. We have a founder who's an industry veteran of the tech industry. That's important to the story because at the end of the day, I feel that this is a marketplace business. Emily, and we've talked about a few in recent weeks. You want to have a company that has a great interface and has an efficient platform on the tech side, we'll get into that. Aaron Easterly, the founder, had several fund-raising rounds as he brought this company into its present size. This latest iteration happened after COVID. The company hit a rough patch during 2020. Their latest funder comes on the scene, as you mentioned, Nebula Caravel Acquisition Corp. When they merge, it will be called Rover. Rover is actually the acquiring entity. We'll get into the nitty-gritty of how the SPACs work. But at the end of the day, the company, which is Rover now, is going to be the surviving entity and they will have a bigger balance sheet. The people who are backing the blank check company, Nebula Caravel Acquisition Corp, are pretty experienced. They come from a private equity firm, which is called True Wind. The CEO of that company, Adam Clammer, has been in the business for a while. For those of you who are familiar with the cutthroat private equity firm, KKR, he worked in the technology division of that. The the part of KKR that was focused on buying up technology companies. They've got several projects under way that are going to end up the SPACs. They also had a history of funding some companies that have come to market as a technology company. There's a good element of, watch over your financials that's coming from the funder, and Adam Clammer is going to stay on board, with the CEO, Aaron Easterly. He's going to stay on board as a director. After this merger, Easterly, the CEO, is going to have roughly 5% of the company, between 4% and 5%, I think. Close to 5%. Nebula Caravel is going to own between 4% and 5% itself depending on shares that are redeemed. Now, interestingly enough, Emily, you pointed out in our notes that outside investor or current investors are going to own a whopping 80% of the company. That's because several venture capital funds that participated in the early funding rounds of Rover are staying on board, and I think that's a pretty good sign. There are three funds in particular, which each have a stake ranging from 10-16%. That's always positive when your initial funders aren't just trying to have an exit with the IPO. That's a bit of background about the management team and the funders behind them. Emily, what can you tell us about the actual business?

Flippen: I probably should have led with this. I think I started the conversation just talking about how excited I was to find someone to drop it on my cat while I was out of town. But Rover is a platform that offers a variety of services for pet parents, mostly in the United States right now. The services include boarding, house sitting, day care, dog walking, drop-in visits, and they're even testing in-home grooming in some markets. The way it works is you can imagine it like Airbnb, but for pets. That was the analogy that lots of other people have used. I'm not sure if it works quite the same here. But the ideas that the prices are set by the providers themselves. Independent providers sign up on the platform. They say, oh, I want to be a dog walker. Oh, I can have a dog stay at my house over the weekend. That's where the Airbnb aspects comes in [laughs] , I think. Then they set their own prices for what a day or nightly rate would be for different services. Then people who are pet parents come onto the platform, browse through the different providers at they're different price points, and pick someone to serve whatever their need is. The rates really vary based up what service you get. I think the cheapest ones, they are $5-10 on the low-end per visit, or just simple drop-in visits. Somebody coming by your house, checking in that your cat is still alive while [laughs] you're out of town, Emily. Or as high as $70-100 in case of in-home grooming, which is what they're testing in a few markets. So instead of bookings yourself somewhere to stay, you can book your pet somewhere to stay, I guess.

Sharma: Emily, what really surprised me about the platform when I was looking at it last night, it's so user-friendly. Basically, I thought Airbnb is really great example. I also thought about something like Fiverr [laughs] as a platform. Fiverr is the freelance marketplace where freelancers can advertise themselves to buyers who need services. The thing that struck me going through last night is when you put in a search, so putting in search, of course, for today, I needed a dog walker, you get a list of very friendly looking people. The top ones have great reviews and they all look very compassionate. If someone's going to take my dog for a walk, I want to make sure that they look compassionate and friendly. A lot depends on that visual cue, and they've got that in spades. They also promote, I think, well-rated people on their platform. So those return first in the results. The Airbnb aspect is pretty interesting because what you get is a panel on your screen, which shows you the dispersion of map points and you can zoom out and see how close the people on that search are. I think the first set of results you get are the people closest to you. The platform, as I'd mentioned, it's designed to be mobile first, and it is really capital-light. They run this system on Amazon Web Services, that's their technology stack. While they've got cost on their balance sheet that are basically internal software development capitalized costs, meaning they've spent some money to develop software internally, they're not spending on a bunch of servers, and they don't have this high expense to maintain things in-house, which I think is smart because that's really not the function of this business. It's really to unite these buyers and sellers of these pet services. They have a pretty good data team and tech team. Out of roughly 250 employees, 92 of them are data scientists, software programmers, engineers.

You can see that's influence from the CEO coming from Microsoft. He made sure that this would be a really easy to use platform. I think that's probably helped them scale to the size they are. Now, I have to point [laughs] out something that I didn't like. You know what, I'm going to be pointing out a couple, maybe two or three things that I didn't like about this company. I'm surprising myself that I'm interested, actually, I'm interested in potentially investing [laughs] in this. So I'm a little bit of a reveal here. But the offering prospectus didn't have any age, income or sex demographics provided. They do mention that millennials and Gen Zers are leading this movement to higher pet ownership, which will benefit the company in the long run. But this is very unusual for a marketplace business. That's a key focus in the offering document to show for a marketplace. Hey, who are the buyers, who are the sellers? Do they tilt more male? Do they tilt more female? How do we target them? I had to do a little scan of my own. So talk about [laughs] anecdotal and just a little bit of data here. But I looked at several different cities and I did the same search for this time slot. Emily, you can probably speak to this because you use the platform. About 85% in most cities, sometimes 90% of my search results, at least the first 60 or 80 that I looked at were women. There are hardly any men represented, and when they are, they're very friendly looking men. [laughs] I don't know what this says. There's something to be analyzed here. I'm sure the company is utilizing this in how they target what they call providers, the people who are there to walk your dog or to look after your cat. But they didn't really give us good information on what it means to them. This is something that companies like Etsy or Poshmark, we talked about, Fiverr. All these are marketplace businesses excel in their offering documents and in their 10-K annual report, that shown you, who buyers and sellers are, and what it means in terms of age groups or incomes or what not. A first mono quibble here, but is that your experience, Emily, when you look for somebody to take care of your cat? Are most of your results females? They look like to be young females to me.

Flippen: Yeah, this is actually really interesting. I'm happy you pointed it out, because I read through their offering perspectives, their investor presentation. It didn't even occur to me that this was missing. But it would have been such an interesting addition if they had chosen to add it. Because I think I have the same curiosity as you. Even if it were the case, majority of providers or even pet parents did skew female or a certain age, that's valuable ways that we can identify a target market here. But it's funny, my experience was very similar to yours. The first time I used Rover, opened up the app. I was looking for somebody to do drop-in visits on my cat while I was out of town. I knew I'd be handing over my keys to my apartment to whoever I picked. I don't own anything valuable. I'm not a materialistic person, so I wasn't particularly worried. But I did purposely look for somebody who looked compassionate. I picked a young female. I thought it had something to do with the fact that I'm pretty close to the University of Maryland. I figured there was a fair number of college students that were doing this on the side, to make some money while they were studying. I picked a young female I assume, college student who dropped in, I rebooked with her numerous times. Then she moved to Louisiana. The next time I got on the app, I was devastated and I ended up picking another woman, admittedly an older woman this time. But I based it entirely off of reviews, the number of repeat bookings. If you look at their metrics, well, they don't provide demographic metrics, they provide some metrics about performance, I guess from their pet service providers. 87% of bookings on Rover are repeat bookings, and 70% of new customers rebook. So pretty impressive. When somebody is on the platform itself, pretty impressive retention there. 97% of those reviews are five-star reviews. Largely because if you sign up for the platform, it's actually like you're getting graded too, similar to the Airbnb effect. I knew that I wanted this great pet sitter that I had for the first time to want to come back when I was out of town again. I was worried my cat wasn't going to be on its best behavior. She did initial drop-in visit to make sure that the cat wasn't distempered or something, so really interesting. They provided a lot of details about booking metrics, but virtually nothing about the people who are using the platform. That's odd.

Sharma: Yeah, it is. Maybe it's just more of a missed opportunity. It's so interesting because what you just described is something that I thought might be the case that there's going to be a bond that you set immediately, different than transacting. Again, let's go back to Fiverr. You commissioned me, Emily, to do some graphic design. Now, I don't know what graphic design needs you have. I'm terrible at it, but let's just suppose here. It's a great work product. You'd like it, that's all good. Next time I have some need, I will remember that guy, Asit, the freelancer, and I will use them again. But if it's about your pet, this is a person who's coming into your home, as you said. There are all kinds of emotional bonds that are in play here because you want the person to take care of your cat. You feel relieved when they do a good job. They obviously are relieved to find a new customer who is nice and catch relatively easily. It's much different than, let's say, even in Etsy experience where you're buying, selling crafts, good. There's some sellers on Etsy that I really like, that reviews more than once. But this is something that is surprisingly sticky for that reason. That's the strength of the platform, the nature of this business. Take care of my pet, means if it works out the first time for both parties, it's likely to be recurring revenue.

Flippen: I know that you've mentioned the notes a little bit further down about how that is potentially a risk. We'll get to the risks associated with the nature of the services that Rover provides. But before I move on to some of their metrics, I think it's worth breaking out their revenue segments. When you think about the different services that Rover provides, 54% of their revenue actually comes from boarding services. These are presumably people who are dog owners who are leaving town, who don't want to take their dog with them wherever they're going or can't take the dogs with them, but also don't want to leave them at a shelter or not shelter, it's not the right word. I'm not a dog owner clearly. At a boarding house.

Sharma: Kennel.

Flippen: Kennel, that's the word, at a kennel. They want to leave them with somebody who they believe is going to do a good job of taking care of them the same way they would. They find somebody on Rover with great reviews and they board, and that's over 50% of their revenue. But their other aspects are house sitting at 14%. This is somebody coming in, staying in the house, living in that residence, taking care of the animal on-premise for a certain amount of time. 5% for doggy day care, 12% dog walking, and then 14% drop-in visits. So somebody just coming in, checking up, and then leaving. Grooming is less than 1%, but they're only just testing that so that could potentially grow in the future.

Sharma: That grooming is, I'm guessing some of your high-margin service because they described it as being a service relative to the other services, some additional revenue or incremental revenue versus let's say dog walking.

Flippen: Briefly here before we move onto their metrics, or I should say their financials, it's worth taking a look at how they make money. This is one of the things that I thought was really missing from their perspective documents, which was while they charge a fixed fee to both the provider and the pet parents, they're not transparent about what's that fee is. They provide an example inside their investor presentation, that seems to imply it's something like 25% of the gross booking value, of which 75% of that it's being taken from the provider, 25% taken from the pet owner. But there's no implication that, that actually is the case. It's simply an example. It could be an example of what they want to do in the future, it could be an example of what they've done in the past, but there's really no transparency about what that fee is, in terms of boarding, house sitting, day care, how it differs from the different services. That was one of the things that I thought was really missing.

Sharma: It's something that you have to consider as a management team, the first-time you offer documents to the public and then actually in your 10-K annual report, you get an opportunity once during the year to really fix those metrics. If you disclose it, you can fix metrics along the way or add new ones in your quarterly reports. Obviously, you can talk about them on conference calls. But this is important because sometimes companies will hold back a little bit because they know that our fees probably aren't where we should have them so we're just going to message about our fees for now and we'll bump them up and probably disclose them later on. But being transparent is in your interest as a management team because the investor community, be it retail investors like you and me, Emily, or the institutional investors that sit in on the conference calls and ask the questions. Those questions are good for you. They show you where investor sentiment is, what's holding people back from buying more of the stock. It's because you're not giving maybe enough detail or the detail that investors want to be able to make decisions. I wasn't a fan of that, the example was nice. But I'm hopeful that in these first-quarter maybe that's something that they talk about on the calls or start putting into the quarterly and annual reports.

Flippen: One of the things they did want investors to focus on, maybe less though, than what their actual take rate is, is the market opportunity and Rover, as with every pet company that's going public right now, really highlighted what a transformational year 2020 was, especially on the back of a general transformation in the way that people have been treating their pets. While 2020 in particular wasn't great for Rover because people weren't needing to board their pets or walk their pets as often because they're at home. They did still say that there was a huge increase in pet ownership over the course of 2020. So that within itself is potentially interesting. I can't remember the exact number that it grew year-over-year, but it was pretty substantial, and Rover believes that they can really unlock a large amount of value in the market opportunity, raising that from around $9 billion today to over $70 billion, which is a huge increase and we can nitpick that later. But essentially they're saying they can get to $70 billion in yearly market opportunity just off the basis of increasing the number of households with pets, further penetrating the U.S. market as pet households grow, and then also continuing M&A activity in new international markets and expanding there as well. So there's definitely, I think, very real tailwinds that exists for pet businesses right now. I will say they did cite one study, and admittedly it's from the American Pet Products Association, so take it with a grain of salt. But that study found that 32% of dog owners and 28% of cat owners would prioritize their pet's medical needs over their own [laughs]. While that may not directly implicate sales for Rover, I think it does perfectly highlight the trend of pet humanization that has just simply taken the pet industry by storm over the past decade or so.

Sharma: For sure. Anyone who knows a pet owner whose cat or dog has gotten sick or maybe you've been in these shoes yourself, you understand [laughs] that probably the verifiable truth behind that study, I am guessing that's not too far off. I want to say a couple of things really quickly about that opportunity. They don't have control over the percentage of households that are going to increase in terms of having pets. Although they are right to point out there's a growing trend for that and that spearhead by younger people. They also need this catalyst event to get customers. What they talk about in the offering prospectus is that most of the time you're going to reach out first to friends and family when you have a pet care need, do you need a walker or someone to watch your pet overnight. When you can't get that, that's the first time you sort of look out of that boundary. So potentially some sharper marketing and we'll talk about they've got a really nice thing going on with their marketing, we'll get to in just a second. But perhaps some targeted marketing to make sure that that brand awareness, which is, I think pretty big, it keeps growing, so that they don't have to wait for the first time you've got this overnight need. After that, everything breaks open, then you feel comfortable with getting a walker or someone to groom your pet. They need to move beyond the catalyst that's helped them so far.

Flippen: Yeah. Part of the reason why I think Rover is such an interesting play is typically with companies this small, we see them sink a ton of money into marketing expenses. While Rover has certainly spent money on marketing, it wasn't nearly as much as I expected when reading this prospectus largely because of the word of mouth aspect of the business. They're marketing the expense, especially as a percentage of their gross booking value. That may not be the best I guess top number there, we could talk about what gross booking value kind of lacks a little bit later. But the idea being that marketing expenses as the business has grown has come down as a percentage of that revenue over course of time. The result is largely because of people like myself who used Rover and then tried to cat sit her friends cat, had an awful time doing it and then recommended that my friend try Rover next time. It's those sorts of natural marketing experiences that have helped keep this business in a slightly better financial position than I expected heading into this report.

Sharma: For sure, Emily. You know that the expense to market is one of the really big drags on most of these [...] companies that are using technology platforms. You have to acquire customers so if word of mouth is doing on both sides of the platform part of the job for you, that is a path of least resistance, and I was impressed that not only is it from the people who are purchasing the service, but word of mouth spreads to the people who are providing the service. So obviously, if I have a successful couple of outings walking pet, I'm going to tell my friends who are pet lovers too, "Hey, I made $20 an hour doing something I love," and that seems to be another part or advantage of this platform. I will point out that for the business model to work, Rover actually needs an oversupply situation in each metropolitan area it enters. So it needs this dense network of available sitters so that when someone like me takes a look, he is shocked. I was shocked last night, it looked like from the zip-code, I mean, are all my neighbors on this platform because in my zip code I saw so many people coming up that were offering for $15 or $20 bucks to watch my mythical dog or made up dog during The Motley Fool Industry Focused podcast. So they need this. It means that some of those people are going to drop off, without ever getting any work. So they're going to have a lot of churn, if you will, on the provider side. But since the word of mouth is so incredible, they're not spending a ton to draw that part of the platform over. So pretty impressive there.

Flippen: When I look at their financial picture, I think it's worth maybe skipping 2020 as a whole, and we could argue whether or not that's silly, but I think 2020 was such a weird year for pet services, that looking at 2019 numbers is probably more representative of what you can expect a business like Rover to do in the future. So when you look at the 2019 financials for this business... When you look at the 2019 financials for this business, they did just over $400 million in gross booking value, so that's the amount of transactions that happened on their platform, not including cancellations. There is a fair amount of cancellations that aren't included in that number. I think historically, it's hovered around 9%. But they did over $400 million minus 9% in 2019, that was a 31% increase year-over-year and represented over 4 million different bookings, also a 30% increase year-over-year. 2020 was harder, but 2021, it looks like the growth is going to reaccelerate. Although it's worth noting that management still doesn't know what impact COVID is going to have on their long-term need. If people work remotely, 2021, 2022 it could look substantially more like 2020 than 2019. I'm not sure if I'd buy into that quite yet but 2019 by itself in terms of growth and year-over-year numbers, looked pretty solid.

Sharma: It did. They're looking for the travel industry to pick up. That's one of the key indicators for Rover that travel picks up again, so when, Emily starts traveling for business, she is going to obviously use the service more. Going back to that marketing expense that you mentioned earlier, Emily. If we look at the first nine months of 2020, as you said, they are not good nine months to base what the future of this business looks like, revenue nearly got cut in half. But that marketing spend dropped from about $37 million down to less than $14 million, as a consequence, when you look at the bottom line because that expense and some expense control, they actually had a round of layoffs during COVID, they took a PPP loan of about $8 million. But comparing the two bottom lines, the operating loss was not that much different even though revenue, as I said, nearly got cut in half. The operating loss in the first nine months of 2020 was about $45 million versus $40.5 million in 2019. I really like that because it shows the power of that word of mouth. I was going to mention this, and those of you who are watching today on Motley Fool Live can put this in the comments, they probably have a super blog that has millions of unique views every month. It's called The Dog People, and I'm looking at it now. [laughs] It's got a super cute cat with green eyes under a rug just peeking out and it says, this is the lead on the top fold of the website, the article is Why is My Cat Hiding From Me? There's almost a compulsion to click on, read that story about this cute cat so I can see why [laughs] this is another way that they don't have to spend on marketing because the subject matter of this platform has such an emotional pool. I like those numbers. But Emily, let's take just a minute and talk about what's a little iffy on that gross booking volume metric. Maybe you can start and then I'll chime in.

Flippen: Definitely. I know that's what's probably in a lot of people's minds are like, "Okay, we see how much they're doing in gross booking volume, but how does that translate to actual revenue?" In 2019, while they did over $400 million in gross booking volume, they did about 95 million in revenue. If you just took the revenue over gross bookings volume in air value, and you can take that down by 9$, take out for those historical cancellations, you're looking at a take rate between 20-25%. That might make you think this is a business that's able to charge really high fees, but there's actually a time lag between when a service is booked and when Rover recognizes the revenue on its income statement. Revenue is only recognized when the service is actually provided, not when it's booked. There's this weird time lag. If I know I'm going to be out for Christmas this year, maybe I book someone really far ahead of time, while gross bookings value may represent a certain number in booking value that I've made on the platform, revenue is a different story. It can take a few quarters if not longer for investors to see a potential drop-off in things like earnings or things like revenue, like platform growth because of this lag.

Sharma: Absolutely. The little beef I have with this metric, in general, is that it's a good indicator of potential. What they see in their prospectus is that we think this tells us something about our business, the total amount that was booked on our platform, let's say in a business quarter, it means that if no one had canceled, our actual value of dollars transacted would've been X. That's well and good, but it makes it extremely hard to track just what you're talking about Emily. What is the actual take rate? They don't publish that. The gold standard in these types of businesses to me is probably PayPal. They track this metric every quarter, the take rate of what they're making off each transaction. Of course, PayPal's a payments business, not really a marketplace business and they have their gross transaction value. I forget what their acronym is, they're all slightly different. But the concept is you record everything that actually happened on your platform. Don't worry about cancellations, and in many cases, don't include taxes which this company does, but I don't want to quibble any further because I like the company [...] I know I'm sounding like what are they doing? But what you want to do is to show investors here was the gross services value. I would call it service value because it's not merchandise. This is the gross service value, this is every dollar that actually went between credit cards on our platform, and here's our take rate. That's the best-case scenario. The reason is you can trend those two quarter and quarter out, and there are many companies that provide that. If the trend is accelerating, it can work against Rover's favor because investors can't see that growth clearly. They see that the gross booking value is increasing but then they are looking for cancellations percentage and they are uncertain about the future. Better not even to focus on that, just show me the volume, show me the take rate, and then as I see it increase, I'm going to buy more shares. It's another matter of transparency. But I'm not really going to knock on management yet because they're not public, I'm hopeful. Again, first quarter, maybe even during the conference call, they gave the numbers that many investors who are into these marketplace style businesses are going to be looking for.

Flippen: And to your point about maybe not it been wanting to broach this subject of cancellations in terms of metrics, you would think 2020 would be a good reason for them to potentially change their metric focus because cancellations in 2020, were upwards of over 20% of gross booking value. It is an annoying metric for investors to have to breakout. But I always salivate, I get really excited whenever I see a company that breaks down its customer acquisition costs and the lifetime value of its customer and I thought Rover did both those things really well. In fact, I appreciate the fact that they were very upfront about their guidance for payback in terms of the amount of money they spend to acquire a customer versus the amount of money that they get on the customer while they're on the platform and management's internal projections are to keep a 1-2 quarter targets on payback for customer acquisition costs. Even if marketing spend increases, especially as its business tries to move internationally if that is what they decide to do, keeping a narrow focus about what the value of that customer is, I think it's critical. I like the fact that they have these internal metrics that they are holding their teams to. Right now, that is around a four-month payback period for existing customers on average from each of the cohorts that they've tracked. I like the fact that they are pretty on par with their own projections there as well.

Sharma: They have a really nice payback period. Anytime you're under a year, you're in good shape. I like those as well.

Flippen: Although always worth noting that this is an entrenched industry where it's easy for people to slip back to what friends, families, move to different platforms. It's great, although probably not as sticky as say a Chewy [laughs] which admittedly has a much longer payback period, but what I perceive to be a much stickier platform.

Sharma: Sure.

Flippen: You noted something interesting here. Before we move on to the risks in this investment, because as always, there are plenty of risks. You noticed something here that I completely missed that is actually really cool.

Sharma: Yeah. The company has a partnership that they announced in November with Walmart, which I think is going to be really good for them. In this partnership, if you follow Walmart, they're also trying to get it on this premium pet business and pet services business. They actually offer Walmart pet insurance now. They are going to include their version of the new pet sitting service through Rover. They've done this with so many companies. They co-brand the services and basically, they will encourage you to use Rover. They will give you, if you are a Walmart customer, a $20 Walmart Gift Card for your first completed service. If you have five services within six months, you get another $20 Walmart Gift Card. I don't know which of the companies has actually picked up the tab [laughs] for this. I'm guessing it's Walmart, but maybe they are splitting the cost that it wasn't clear in either press release. But this is a really nice tailwind for them on the marketing side. Again, they're leveraging something without having to spend a lot of their own hard dollars and who else would you want to be with but a company that is an every major metropolitan area and has millions and millions of customers. I thought that was pretty neat. They did not put it in their offering prospectus, which was post-November and it really, if you look on their website, they haven't made a big deal about it. It's something that I think I missed too, and I was just pouring the last minute over stuff and I saw it. We'll see. If you happened to be watching today and you've seen this already in play, let us know.

Flippen: When you look at the risks for this business, obviously the partnership with Walmart, it's risk mitigating within itself. When you pull on a big partner like that, you know you at least have some big backing there and this is a business that's been around for a while and has great executives, but it is still a business that's unprofitable. I have a couple of big risks. I'll highlight one that I of course, have to call out at the very beginning because it's making me really question my morals as an investor is that, Rover has material weaknesses in their internal controls. I'm showing a level of hypocrisy here that I try not to show when I look at investments, but I'm almost willing to forgive it because with a lot of these SPACs, these are businesses that never thought they were going to be public companies, especially multi-billion-dollar public companies on such a quick flip of a dime, but when the opportunity exposes itself, I mean, they need time to get their internal controls up to par to be available to retail investors. That being said, I will say [laughs] this might be the worst material weaknesses in internal controls I have ever seen. I manage a Cannabis portfolio, so sometimes I feel like I've seen it all. But they had issues that included no control environment, not enough personnel with accounting knowledge, no formal procedures for financial reporting and no IT controls, which is shocking considering how many IT people they have working at their headquarters. I said it before that I would not buy a company that had substantial material weaknesses. I really like this one. Now I really like it and I don't know, I'm going back and forth with myself here.

Sharma: Well, again, we go back to the idea of waiting for a few quarters. Now that you have to wait Emily, your season than almost everyone listening today, including myself who's participating. Maybe you're the person who could make a judgment and just buy when it becomes public. But for many of us, it could be worth the wait, like I said, a couple of quarters. To give just some interesting notes on the situation. Emily pointed out in our notes, what you're talking about, not enough personnel on the accounting side and really the opposite robust financial procedures when you close out a month and lack of segregation of duties, that's in the internal control. To me, that's a fraud signal. If you don't properly segregate duties, that means I've got access to passwords and user data, but I also have a way to extract something valuable out of that. Or if you're in the accounting department, I have access to paying vendors, but I also have checkbook access and I can create different documents. If you're a small company, you may not have had to deal with this, although I should say, they have the size, they should have had better procedures than this. Reading between the lines on the report, basically, the auditors who came in and did the auditing for the SPAC, they had to do a lot of closeout entries. This is something that's very interesting when a company gets audited, a lot of times the auditors are cleaning up the books and management is signing off on the journal entries. They say that this is not really in an auditable state. You need to have these journal entries to make the balance sheet and income statement workout together. But we've looked at the transaction, we don't see fraud here and we're not going to site it in our report. If you've noticed in their report, they say, management found these [laughs] lack of internal controls and material weaknesses. Well, management's been running the company so what do you mean they found it? [laughs] Because the auditor told them, "Look, you've got to talk about these," and we got to fix them. Emily, they don't have an imminent SEC requirement to fix those, but they do have a Sarbanes Oxley requirements, so they got to hop on it. They noted that we're working on it. We're going to spend a lot of money on this. We're going to try to fix it soon, so let's keep that at the top of the list when you're looking in at that first-quarter, what's happening with work on those internal controls, but yeah, they were ugly, I must say.

Flippen: They were ugly. Honestly your accounting background is so useful. You told me a lot of stuff I did not know there.

Sharma: Yeah. It's so interesting also Emily to find someone who loves this stuff because I know many analysts, just their eyes glaze over when you get to that part of the auditor's report, but you always read it and I'm sure it's going to save you some grief later on by paying attention to that stuff.

Flippen: Well, let's hope so. There have been a number of companies that I passed on because of concerns such as internal controls that have gone on to be amazing investments. But even I have my risk limits, I suppose.

Sharma: I'll go with a quick one here and these are smaller risks and then maybe we'll just alternate and then we'll round out of here. But there is a smaller risk of deplatforming of transactions and what I mean by that, something I alluded to earlier, that emotional bond and someone coming to your house to do the services. It's very easy for two people say, "Look, let's just do this directly that way neither of us will have to pay the fees and I like you, you are really great with our pet. I don't want you to have to pay a fee. I'll pay that $20 directly and vice versa." Rover has developed some algorithms that they think could help them spot providers that are doing this. I'm not sure how they do it, but they then demote those people in search results and try to keep promoting people that are, to them or their algorithms, just using the platform, honestly. But as time goes on, that could be a little bit of a risk. Then I just wanted to go back to my little problem with their gross booking volume metric. That inability to accurately know what the take rate is, and tend to put those things on a trend. Plus what Emily brought up about the revenue recognition not taking place until that service is performing and therefore, what you've got is a situation where the metrics could decline pretty quickly. But you might not necessarily see that. As Emily pointed out on the revenue recognition side for a few quarters, combine that with the lack of visibility into true volume on the platform and a true take rate, I could see a situation where you have two or three quarters, where stuff is really slipping, but you just don't see it when you're looking over those quarterly reports.

Flippen: Before we close out here, I'll highlight a couple of other big concerns that I have. I'd say the first one is just concern that as more people bought pets during the pandemic, I think a lot of people who maybe made that investment were also people who took on a more remote or distributed, more virtual lifestyle that will likely persist even post pandemic. I worry a little bit about the growing need for things like dog walking if somebody's home all day. I think that's somewhat mitigated by the fact that boarding in particular represents over half of Rover's income, were over half of the services that the business provides. Vacations, I don't think those things in particularly are going away. At least that I think they're going to retain. But I wonder a little bit about what true growth looks like, which brings into my biggest risk here, which is, this is a business that did $95 million in revenue in 2019, less in 2020, but let's be generous $95 million in 2019 and is having over $1.5 billion valuation. Management even notes that growth is slowing and that long-term projections have them around 20-25% growth with 30% adjusted EBITDA margins. This is not a really high margin SaaS company. This isn't even a company that's growing 50, 60, 70%. This is a steady but slightly slower grower with a very normal profitability picture. They're not profitable right now, but long-term, hopefully a somewhat normalized profitability picture that I'm not sure justifies the valuation that the SPAC has given it. I hate making calls based off valuation because 99% of the time they're wrong, especially in the market that we're living in today. But this level makes me a little bit concerned.

Sharma: Yeah, it's not cheap. The flipside of that is, if you look at your SPAC-type investments as their own diversified portfolio, here's an interesting company that would be a steady grower and over time I think it's going to have a pretty high return on invested capital. It's debt-free right now. They've got a cash infusion, so they'll have some money to play with. They have been an acquirer, but haven't always bought companies that succeed. I think one of their most recent investments they basically had to sell. I think it was called DogHero. But over time, you can see this business, Emily, creeping up on your results, just sort of stealth [laughs] because it is such a sticky platform. I think that market, while maybe it's not that huge, huge market potential they're talking about, but if it is $7 or $8 billion, right now, international sales are 5% of the business, it's going to take some time for them to expand globally. The other pet markets are slightly different in the U.S., they're going to have to prove their brand. But they've got some definite advantages on their side. So it's odd because I'm liking this. I want to follow it for the next couple of quarters. I could see taking an interest in this company, same way we've talked about some slower growth stocks [laughs] like Dollar General. It's intriguing. I don't know how you ended up liking this company. [laughs]

Flippen: I love the fact that you like it because this is a business that I want to be convinced on. I think I come in from a naturally skeptical place and I like when there is another person I'm talking to, has that higher level of conviction because you're telling me everything I want to hear right now, Asit. But definitely, I'm putting this on my watch list. I hope that in the somewhat near future, by near future, I mean, not the next quarter but with the next four quarters or so this is one that if management executes, if we see some rebound in 2021 in comparison to 2020, that hopefully this one ends up in my portfolio. I'm definitely interested in it.

Sharma: Perfect.

Flippen: Well, Asit, as always, thank you so much for coming on and humoring me while I organized another episode focused on pet trends. I really appreciate it.

Sharma: Emily, this was great fun and I know in the future if I ever want to pitch a business for you to invest in, it's going to have something to do with pets.

Flippen: [laughs] I can't help, but I obviously have a type here [laughs]. But listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out, shoot us an email at [email protected] or tweet at us @MFindustryfocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned. Don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work right behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on!