5 Red Flags for Wish's Future

ContextLogic (WISH 15.73%), the parent company of the e-commerce marketplace Wish, posted its fourth-quarter earnings report on March 1.

Its revenue declined 64% year over year to $289 million, missing analysts estimates by $21 million and marking its third straight quarter of declining revenue. But, it still narrowed its net loss from $569 million to $58 million, or $0.09 per share, which beat expectations by a penny. On an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) basis, Wish narrowed its loss from $118 million to $23 million.

Image source: Getty Images.

Wish's stock remains more than 90% below its IPO price of $24. However, some value-seeking investors will likely point out that with a market cap of about $1.3 billion, Wish trades at less than one times its trailing sales and only a bit more than its $1.2 billion in cash, cash equivalents, and marketable securities it held at the end of Q4.

Unfortunately, a deeper dive into Wish's earnings report reveals that it's dirt cheap for obvious reasons. These five red flags indicate it's a value trap.

1. Ongoing loss of active users

At the end of 2020, Wish served 107 million monthly active users (MAUs). But it bled MAUs throughout 2021, and it ended Q4 with only 44 million MAUs -- representing a 58% drop from a year earlier. It served 64 million last-12-month (LTM) buyers at the end of 2020, but that figure plunged 41% year over year to 38 million in Q4.

Data source: ContextLogic. YOY = Year-over-year.

2. Murky plans for the future

Wish mainly attributes its loss of active shoppers to an ongoing reduction of its sales and marketing expenses, which declined 35% for the full year. Fewer ad purchases reduced its brand visibility, but Wish thought it was necessary to focus on retaining its higher-quality customers instead of gaining new ones.

Reining in that ad spending frees up more cash for the expansion of its logistics network as well as shipping subsidies, discounts, and other perks for merchants who receive high customer reviews. To block sales of low-quality goods, Wish also recently became an invite-only platform for new sellers. All those improvements could address the two most common complaints about Wish: its sluggish shipping times and sales of low-quality and fake products.

Unfortunately, that strategic shift won't change the fact that Wish is still simply a cross-border marketplace that mainly helps Chinese merchants sell cheap products to overseas buyers. Amazon already reaches the same market with its third-party sellers in China, while Alibaba serves cross-border shoppers with AliExpress.

So as Wish cedes shoppers to bigger competitors, it's also curbing in its ad spending and exacerbating its own slowdown. It also plans to lay off about 190 employees, or 15% of its global workforce, to "right-size" its spending to "match the current size and scope" of its business. That vicious cycle of slowing growth and cost-cutting measures will likely end badly for Wish.

3. Crumbling gross margins

Generally speaking, a company that is reining in its operating expenses should have stable or expanding gross margins. That way, its net income will improve as its operating expenses stop chipping away its gross profits.

But that isn't happening at Wish: its gross margin declined from 76.7% in 2019 to 62.7% in 2020, then dropped again to 53.1% in 2021. Wish mainly attributes that ongoing decline to higher logistics costs -- which continue to overwhelm its revenues even as it reduces its sales and marketing expenses.

4. Negative free cash flow

Wish's $1.2 billion in liquidity might buy its new CEO, Foot Locker's Vijay Talwar -- who succeeded CEO and founder Piotr Szulczewski in February -- a few more quarters to turn things around. Its low debt-to-equity ratio of 0.6 also indicates it still has room to take on more debt.

However, Wish ended 2021 with a negative free cash flow (FCF) of $953 million -- compared to a negative FCF of just $2 million in 2020. That staggering cash burn rate could accelerate as it loses more shoppers.

5. A lack of insider confidence

In addition to a new CEO, Wish recently hired a new chief financial officer, chief technology officer, and chief product officer to orchestrate its turnaround efforts. It also claims it will "experiment, incubate, and invest in exciting features, products, and services" to "greatly improve" its customer experience throughout 2022.

That all sounds promising, but Wish's insiders still sold more than twice as many shares as they purchased over the past three months. That lack of insider confidence -- especially at these valuations -- raises a bright red flag.

Limited downside, limited upside

Wish's price-to-sales ratio and cash position might limit its downside potential at these bargain-basement levels. However, its lack of top-line growth, its ongoing losses, and its deteriorating gross margins will also limit its growth potential. Therefore, I expect Wish's stock to stagnate throughout 2022 -- and it probably won't catch a break until its new management team stabilizes its loss of active shoppers and meaningfully widens its moat.