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Is Shoe Company Allbirds' IPO Worth a Look?

By Asit Sharma – Sep 27, 2021 at 11:00AM

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This sustainable footwear brand with a cult following is getting ready to go public.

In this episode of Industry Focus: Consumer Goods, Motley Fool analysts Asit Sharma and Emily Flippen take a look through Allbird's S-1 to determine if the business has staying power beyond its high-end brand.

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 stocks. A full transcript follows the video.

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This video was recorded on September 21, 2021.

Emily Flippen: Welcome to Industry Focus. My name is Emily Flippen and I will be joined by Asit Sharma today as we could take a dive into the world of sustainable shoes and talk about Allbirds. We're actually pre-recording today's episode but if you're listening, that means today is September 21st and the good news is, is that next week we will be back to recording our consumer goods podcast on our normal schedule after our little record-a-palooza here. Asit, thanks for joining!

Asit Sharma: Emily, great to be here as always.

Flippen: Before we start talking about Allbirds, which by the way, is not a business that is public quite yet. They will trade under the Nasdaq, under the ticker BIRDS, which is a great ticker within itself but before we start, I have to ask Asit, how many pairs of shoes do you own?

Sharma: Well this was surprising to me and we actually went to my closet to answer this question. I used to be the kind of person who owned a lot of shoes, but here's what I've got in my closet well, in my closet and what's on my feet right now. I'm wearing a pair of bright red Chuck Taylors. Emily, I know you still don't know what these are, but maybe at some point on a podcast we'll break down the Chuck Taylor shoes. The company that makes them is owned by Nike. I've got a pair of Nike Running shoes well-worn in. I have one pair of SIMMS Fishing waders. They're not what they sound. They've got like a low cut-off. These are not high-top shoes. They looked like hiking boots. This is a really long story, this is like an expensive pair of wading shoes. You can fly fish with these. I don't have time on this podcast to explain how they ended up in my closet and why I'm using them, but I'm using them for hikes and I have one pair of spiffy, shiny, black dress shoes. This is pretty slim for me compared to what it had a few years ago, which I'm guessing is about 10 different pairs of shoes and I will admit to before the pandemic rolled around, trolling some boutique men's sites for some really cool like calf boots and shoes that were going to just make my image and then we stopped going places. So [laughs] I'm headed the other direction but is this anywhere close to what the average person wears these days?

Flippen: If you had asked me before, I did this research into Allbirds, I would say yes. I know that I tend to be less of a clothing purchaser than the average person but I, myself, owned probably six pairs of shoes, maybe seven if I'm including that one pair of heels that I have to wear if I'm going out to an event. But the thing that stood out to me the most in Allbirds S-1 here and what I think really makes the critical thesis for this business, is that apparently the average American buys around seven pairs of shoes every year. So in 2018, the average American bought an additional seven pairs of shoes and that same report said that they actually bought 68 different pieces of clothing which within itself is just mind boggling to me. Where are people keeping all of these shoes? Are their closets just 10 times the size of mine? I can't wrap my head around this number.

Sharma: That's a crazy number. I seem to remember when I was very young, going through tons of sneakers. It makes sense if you think about the average American family which may have kids that are growing. So you've got to replace shoes a couple of times a year and then kids need all types of sport shoes, dress shoes, shoes to look casual in at school but I question the accuracy of that number. It just seems extreme that you'd replace seven pairs of shoes each year on average. However, if it's true, it proves a big market out there.

Flippen: That's exactly what I was going to say. Again, if people are buying shoes at a much higher rate than what I would've expected, it does make sense, I suppose why Allbirds is looking to go public and tapping into this market. Their shoe business, I mentioned this at the off start, they recently got into apparel, but they actually got started only a few years ago in 2014, they started a kick-starter campaign, raised more than $120,000 in just three days and then they sold their first pair of shoes in 2016 and by January 2018, Allbirds had sold more than one million shoes. This is a really interesting start-up story.

Sharma: It is. I have to make a comment here. This is now going to, I think join my Hall of Fame pantheon of small brands that just exploded. So I want to remind viewers that the Dollar Shave Club and Halo Top ice cream both started in similar fashion with an idea, just a teeny bit of capital, a very localized strategy. It proves this growing proposition that now anybody can participate in the ground world of consumer goods products and challenge the big giants. Emily, you and I could do that if we had even a smidgen of brand acumen, if we had just a bit of marketing-savvy.

Flippen: But there is a reason why I'm sitting behind a podcast talking about businesses instead of starting my own. I lack the creative willpower necessary to come up with such an ingenious idea.

Sharma: Me, the same, but hey, what about technology? This is just amazing what you can do if you've got an idea and it also proves out why so many big conglomerates are very interested in acquiring smaller brands and how there is a clear path for companies like Allbirds to go from Kickstarter to public offering within just seven years.

Flippen: It's truly an incredible story. I'm just amazed by how quickly they have managed to ramp up production. Allbirds, part of the reason why they got this cult following, I could say, is because they are what they call a purpose native business. They really want to allow customers to buy footwear and apparel without having to compromise on their sense of responsibility, what the business calls doing good. They actually have a really lofty goal aiming to reverse climate change through better business by empowering people to make better, more conscious decisions for themselves and the planet and in that same goal, they are a Certified B Corporation, a public benefit corporation. So they definitely have a big mission underpinning their business. I do think it's part of the reason why they attracted so many purchasers that and in addition to the fact that I believe it was in 2015, the New York Times called the Allbirds shoe, the world's most comfortable shoe and certainly that does build up a little bit of press.

Sharma: That can help. I mentioned to you, I think last week when we were looking at planning this episode out, that those Nike's which are well-worn, need to be replaced so I was examining pairs of Allbirds online. They look very comfortable. They do have this aesthetically pleasing component about them, but I have a bad track record of mentioning on this podcast items that I'm thinking of trying but don't end up trying. I think I mentioned the Sactional, I haven't replaced the couches yet. [laughs] I want to say we talked Home Depot. I haven't bought the new fridge. I think we talked Sleep Number and we still haven't purchased the bed. Ask me in a few months, "Did you buy those Allbirds Asit?"

Because I probably will say, you know what, I'm still using those Nike, I'm going to get a few miles out of them. Again, I am not the norm here, obviously. They're doing pretty well through this mission empowered, and we'll get to this in a bit, direct model of selling to customers. I want to quickly point out here though, that this combination of certified B-corp and public benefit corporation tilts the scale. It's really great for investors who want to invest with a conscious mission in mind. But it also means that management sometimes is going to make decisions that balance out financial objectives with those that have to do with public benefit. In this case, environmental goals as well. You know that up front because they're telling you. But for those of us who want the best of both worlds, there's always some trade-offs somewhere you have to be able to roll with the management company that's balancing both the economic objective with the bigger social mission.

Flippen: I will say, I think my skepticism came in here a little bit for exactly that reason. I always think to myself, is this a good business or is this a good business to invest in? I think there's no denying that Allbirds is a good business. There is a reason why it has a net promoter score of over 85, the customers love it. But I always think, is the market opportunity for footwear big enough? I don't know why I think that because when I look at the businesses that have amazing brand that has succeeded in this space, obviously Nike is the big one, but you can even expand it even further. We can think about Lululemon or Yeti, which is an example that we pull out often on the show. Businesses that may not feel like they have the biggest market opportunity behind them, but grab more than their fair share of the industry simply because they are so well executing on their brand and they have these loyal followers. I can see Allbirds falling into the same grouping. When you reached out to me about this offering, it reminded me of my former roommate in Connecticut. He was quite the shoe person, a shoe aficionado, if you will, and he was obsessed with Allbirds. I think you come in with this group of people that are niche loyal purchasers, these brand enthusiasts, who then spread the love for Allbirds in such a way that it keeps their marketing costs low and expands the brand image to just let it grow exponentially. While Allbirds has a long way to go to reach that exponential growth, it is certainly well on its way.

Sharma: Presumably, they'll use some capital as they go forward being a publicly traded company, whatever they raise in this and subsequent rounds if they have them to further that mission and market in a way that's efficient for them and keep grabbing bit-by-bit share of this sneaker, which is essentially a sneaker marketplace. I'm with you there, Emily, we both know this is a cutthroat business and you've got companies like Dick's Sporting Goods, which are rolling out their own private label of shoe lines. It's really hard to succeed long-term. You're up against the Adidas' and the Nike's and the Lululemon's, so many companies that have these really huge distribution footprints and very efficient build models for the shoes, lots of R&D being port-in. But let us not underestimate the power of brand. We've vowed to do that in 2021, not [laughs] too short shrift brand. We got to pay attention to it here. Part of that brand is in the narrative of the founding of this company. Talk just a bit about this. This company was founded by two pretty interesting guys, a guy named Tim Brown, who's a native of New Zealand, who apparently was a great football, that's in the European sense, we call it soccer, soccer player nearly made it onto their national team. Also really was not happy with the type of footwear that he used to receive when he played, which was really great in terms of logos, but not so comfortable. He was an inveterate tinker with shoes. He also, being from New Zealand, grew up in a country in which sheep outnumber humans, six to one. He would often wonder to himself, why isn't Merino wool used in shoe production, especially sneaker production? Now, that is an amazing question to ponder. I could live many lives and never come up with that question or even hit my radar screen.

But we see how the environment really builds up our curiosity about certain things. He needed a way to put this idea into motion, how to design a better shoe? Being a soccer player himself, he teamed up with another gentleman named Joey Zwillinger. Now, Joey Zwillinger's wife and Tim Brown's wife went to college together, they were college roommates. They both knew their husbands were these creative guys with big ideas and decided to put them in touch. They got together and decided that with Joey Zwillinger's background, he is an engineer and he is also an expert in renewables. With his background, combined with the insights that Tim Brown had on shoe production, they could come up with this company that would sell direct-to-consumers, be sustainable, incorporate crazy materials like wool, which Emily, you will point out a little bit later, it has maybe a downside associated with it as well. But thus began the phenomenal idea of an [...], in my opinion. Nonetheless, that's catching a little bit of fire. I think it's important to understand that because it's such a colorful story and it's part of the narrative that they build when you visit their website. It's part and parcel of this whole brand presentation and I think it's a good one. We see a lot of these. I can see how people would become enamored, not just at the shoe, but the story behind it and the fact that these two young guys look like they're trying to do a lot of good out in the world.

Flippen: I might be falling into that same trap that you fallen into Asit, saying, "I need to experience this, I need to make the purchase myself." I have a pair of running shoes that I have had quite literally since I was, I believe 16 years old and they've lasted, I'll give credit to them. I'm not sure if they're Nike's or what they are, but they have lasted a long time. But I'm certainly in need of a new running shoe and the most popular shoe that Allbirds sells is what they call their wool runner. But repeat customers which make up more than 50 percent of sales, by the way, actually come back for different types of products. There's a funnel that exists with Allbirds right now where you come in for that original wool runner shoe, you have a great experience. Apparently, you love to feeling of the Merino wool on your feet maybe, maybe the shoe's really comfortable. Then you come back to the site and you purchase different pairs of shoes or even apparel which they just recently rolled out last year. But to talk some numbers here, nearly 90 percent of sales do come digital, so when we talk about happening direct-to-consumer, vast majority of their sales spreading all across the world are happening on our digital site. But they have expanded into some retail stores, which they see as these brand builders for Allbirds. They have 27 stores representing the other 11 percent of sales. I like the small retail footprint, the conscious retail footprint. I do think there is value in having brand exposure, especially in heavily trafficked areas, especially when you're trying to be a premium sustainable brand like Allbirds is.

Sharma: Absolutely. You can provide a bit of an experiential pre-sale for someone who's strolling by a store and sees other people trying them on, just walks in, picks up a shoe and feels it and buys it later. It's important in that sense, and the balance is good. In-store sales, as you point out, just 11 percent, nearly 90 percent are digital sales. They're cutting out that traditional wholesaler middlemen in, I'll call it the real-world, which is this big, bad competitive world of athletic shoe selling. At the same time, that's a boundary toward faster growth. It's controlled growth. Allbirds is essentially saying, we think we can get exponential, but it's more of spreading the brand. We could turn on that spigot, but we don't want to because we lose control of profits. I think also they feel that that might cause some brand dilution if they grew too quickly. There's a really purposeful thought behind the way they distribute their product. This thing you mentioned about the repeat customers is also very interesting to me, Emily because they've got this nice cadence of repurchasing. I'm using rough numbers here, but it's something like 50 percent of customers will purchase again in year 2. Out of that cohort, roughly 50 percent will purchase again in year 3. I think it goes on one more year, now those percentages might be slightly less, they might start to decline. But if you can think of it as around half of each initial cohort repurchasing over a four-year period. You can see how powerful that is to the business model. I'd like to talk about the value of the customers, Emily. But before we do, I have to ask you about this net promoter score you mentioned, just 86. Net promoter score we mentioned sometimes this is a way for a company to score itself on its preponderance of supporters and advocates versus detractors. A score of 70 is generally recognized as world-class. 86 is unheard of. It almost gives me pause because there is a point, and there have been a few papers on this, there is a point where too high of a net promoter score means a company potentially is trying too hard to please its customers and that can lead to bad data in what a company needs to do to move forward. It can almost lead to a state of trying to please everyone, rather than focusing on presenting your product with its merits and demerits and your customer service as such. I have rarely seen a score this high. I almost begin to wonder, is this what those theoretical papers were talking about when the net promoter score first came about that there's a point where you don't want to optimize it. I was blown away by that number.

Flippen: That's really interesting. I, to be completely frank, never thought about that. But as somebody who is a people pleaser myself, I know firsthand that there is a point where you have to come that you say, "In order to run this business, in order to get done what I need to get done. I have to recognize that some people are going to be unhappy with that work." 86% is the largest that I remember seeing and it did stand out to me, although not in a negative fashion. It'll be interesting to watch. I will say, I was expecting the financials to be better than they were, and I wonder if some of this as a result of trying to people please customers, especially as it comes to their product innovation pipeline a bit more. They have a pretty generous, say, refund policy, these sorts of things that can pose risks to investors. They're pretty generous, they are great for consumers, maybe not the best for shareholders. But with only $220 million in revenue, this is a relatively small business. I recognize that it's much larger than many other small players, but for Allbirds it's relatively small. What concerns me is that I don't see improvements on their bottom line, this is an unprofitable business. They lost $26 million in 2020, nearly $15 million in 2019 in terms of their net income, which was 11.5 percent of revenue in 2019, and 11.8 percent of revenue in 2020. We don't have a ton of numbers here. Again, this is a recent IPO or going to be an upcoming IPO. I should clarify, but it concerns me that I don't see the net loss as a percentage of revenue shrinking. To your point about maybe overextending themselves, making decisions that are not necessarily great for the business in terms of profitability, for the sake of the brand image. At what point does that become too expensive to pursue?

Sharma: Emily, it's a very interesting point you bring up. Something in their presentation really stood out to me. They say that 100 percent of all cohorts have contribution profits in excess of customer acquisition costs within the initial month of purchase. This has everything to do with what you're pointing out. What they're saying here, to translate this out of accounting speak into more real-world speak. They're saying that for every yearly cohort of people who buy their initial set of shoes, for each of those, that contribution profits, so what each sale contributes to the rest of that business is in excess of what it costs to acquire each of those customers. On average, if I buy a pair of shoes, the contribution margin of that shoe is higher than what it costs to acquire me, for me to come onboard, become a customer. Now that's due to their great word-of-mouth. Easy to understand, yet they don't really mention what the actual gross profit percentage in contribution is versus that cost to acquire the customer. That may be because they are including their return component or that warranty component within gross profit, when you factor in that particular item, the numbers don't look so good. Impressive on the surface, but I always say CFOs and other people who are in charge of allocating what actually hits cost of sales and what doesn't and for those of you who are newer to accounting, there's a lot of latitude in what you can characterize as your cost of sales versus what hits below the line, your fixed costs. Because you can allocate people's salaries, you can allocate certain expenditures as you see fit. That cost of sales is often a variable number. What always shows though, is the bottom line, if you're confused, looking at one company's gross margin versus another, even though they do the same thing, they are operating the same industry. It's helpful to look in the annual report and see what's being put in the cost of sales. It doesn't always turn out to be apples and apples between two companies. At the end of the day though, despite whatever twist or spin a company puts on its gross profitability, it's got to show up in the bottom line at some point. Emily, what you're saying is, "Hey, I'm looking for my operating leverage here. I don't see it. I see the revenue growth. But what's going on here under the hood?" That's something that we might get more insight into when the company goes public and we can listen to analysts, ask management pointed questions about their gross profits, but I was a little bit concerned by that too. Now, we should say here the net losses really aren't that huge in dollar terms versus their sales level. As Emily pointed out, they're a little high as a percentage of sales. We should also point out that the balance sheet is fairly decent here, they don't have any long-term debt and they probably have enough on their balance sheet even before their IPO to run for a year or two without having to worry too much about their finances. But we should see some profits start to hit that income statement at some point.

Flippen: I love that. To your point, what stood out to me was also something that I think initially looked good, but then there's maybe a little bit more concern as I got a little under the hood, and that was how they broke down the lifetime value of their cohorts. They say that their most loyal and engaged customers that's their top 25 percent of customers, have a lifetime value of nearly $450, which again at face value sounds really great. I wondered why they didn't break down the lifetime value for all of their cohorts. I think it's a more holistic picture when you look at the money that you're spending to acquire all your customers, not just your most loyal and engaged customers. I wish that I had had more information there, it would give me a better sense about whether or not they can move toward profitability. To bring up Chewy as an example of a business that did that. It looked unprofitable at the bottom line, but they gave great detailed breakdown about the lifetime value of all of their cohorts. Which paid a very clear picture that, "Hey, 'we're actually making a ton of cash off of the customers that we acquire. We don't retain everyone, but for the people who do retain, they generate enough capital to make up for that loss." I don't see that happening with Allbirds right now. I don't want to be too harsh on them again, this is not even a business that is public yet, so we will get more information over time, but that did stand out to me.

Sharma: Absolutely. Emily, we should exit here with some risks. As I mentioned before, you had some interesting, but I think pertinent risks to talk about here. What's on your mind when you look at what might go wrong with this thesis.

Flippen: Well, the first thing, which I'm not sure if it's something that could go wrong, but it's a risk in my mind because as an investor, I have no clue what the supply chain looks like for the raw materials that Allbirds use. I'm not even sure how to quantify the risks that exists and their unique process of shoe creation. They use recycled products to make their shoes, so they need things like tree fiber, obviously that wool, that you mentioned earlier, sugarcane, recycled bottles, all these things to make products. It could be no risk at all. I mean, these could be things that they easily have access and supply to or it could be something that is as a commodity driven by a cyclical nature that I'm completely unaware of. Maybe the sheep go away one day and suddenly it's very, very hard to get this specific type of wool that Allbirds needs to create their shoes. Because of that, I classify it as a risk. One that, I suppose if I wanted to devote another week, month however long, to really understand the wool supply chain, I could do so, but do I think Allbirds is worth it at this point? Probably not the best use of my time.

Sharma: True. We can take some big picture numbers though to your point. I believe that ratio of sheep to people in New Zealand used to be a 10-1, only a few years ago.

Flippen: Oh, no. [laughs]

Sharma: There's something here to consider and we know that climate change also is affecting the various harvest of specialized commodities. If you look at just one of these, you mentioned sugarcane, I wonder about that. Is that supply intact? But of course, we would have to really want to invest in this company to probe that further. Right now, I think for me, absolutely a radar screen, consumer goods company, a fun one to see how they evolve as they go along over the next few quarters, waiting to hear some insights for management. They'll probably answer some of the questions we've posed in the next couple of quarters. Another risk that I think is ever present in this industry is just the possibility that one of the bigger players takes a look over its shoulder and decides, "We can do that and we can do it in an underhanded fashion." I don't mean underhanded in a pejorative sense here, I just mean a low-profile fashion. We can launch a brand not under the Nike name, for example, mentioned Converse shoes at the top of this hour, the maker of Chuck Taylors, not a lot of people know that they are actually owned by Nike. There you go, you can fund a smaller company. What if Converse decides to come up with some really interesting materials and show a more sustainable shoe, and then put their marketing power behind that. That's an ever-present risk in this industry. But all-in-all, it's great to see a company that is so focused on sustainability and the environment. They're trying to do good and make a profit at the same time, you can't knock them for that. That has to be applauded, I think. As for the investment case, not hugely persuasive yet, but I'm going to watch it. It's a fun company I think to keep up with.

Flippen: As always we come away with the same conclusion here. We need to take different stands at one point. If we're better about, I guess, preplanning our shows, we could do a bull versus bear case, but I have a hard time, I think, really getting behind this business without seeing how it looks after at least a few quarters as a publicly traded company. For that reason, I agree, as always.

Sharma: We agree way too much on investment theses. But I think the fun thing to agree on is that we got to educate ourselves more about brands and this has a lot of brand strength. We're not going to forget about this one because we did this once independently, we traced back to a single point in time, I think within a month. For those of you who haven't heard this story, ad nauseam, and we both penned Yeti, and look how that worked out. Yeti's done quite well. [laughs]

Flippen: Listeners that does it for this episode of Industry Focus. If you have any questions or want to reach out to say, hey, shoot us an email at [email protected] or tweet us @MFIndustryFocus. As always, people on the program may own companies discussed on the show. The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I'm Emily Flippen, thanks for listening and Fool on!

Emily Flippen owns shares of Sleep Number Corp. The Motley Fool owns shares of and recommends Nike. The Motley Fool recommends Sleep Number Corp. The Motley Fool has a disclosure policy.

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