Retail stocks are getting blasted this year, especially those specializing in e-commerce, as the global consumer returns to in-person shopping experiences after a couple years of heavy online activity. Farfetch (FTCH -5.26%) is among them. The online luxury platform's growth has slowed this year, and shares are down some 87% from all-time highs reached in 2021.
This leader in online fashion has been busy, though, and recently concocted a big deal that could be a game-changer in the next few years. Is it time to buy Farfetch?
A strong dollar beats up Farfetch's earnings
As has been the case with all multinational companies this year, Farfetch's financial results are getting clobbered by a historic run in the U.S. dollar. Total revenue in Q2 2022 was up 10.7% year-over-year, but excluding the effects of the dollar's strength versus most other currencies, revenue would have risen 20.7%. Ouch!
The reason for this is that over half of Farfetch's digital platform sales are transacted in currencies other than the dollar. All of the brand platform sales are collected in euros. With the dollar on the rise, exchanging these overseas sales for U.S. reporting equated to a big hit to revenue.
Other headwinds included the suspension of business in Russia, as well as COVID-19 lockdowns in China -- the world's largest market for luxury goods. While the company slimmed down on expenses, currency exchange rates and other issues flowed through to the bottom line and resulted in Farfetch's adjusted EBITDA margin coming in at negative 4.9% in Q2 2022 versus negative 4.7% last year.
The good news is that Farfetch still has a fairly strong balance sheet with $675 million in cash and short-term investments at the end of June, offset by debt of $537 million.
The company has a complex business structure
The biggest news, though, was the announcement that Farfetch will be acquiring a 47.5% stake in Italian fashion retailer Yoox Net-a-Porter (YNAP) from luxury conglomerate Richemont. In addition, YNAP will adopt Farfetch's digital platform solutions, as will Richemonts maisons like Cartier and Buccellati. The deal is expected to close by the end of 2023.
Richemont has had a difficult time gaining traction with YNAP's own hybrid digital and in-person shopping services. Nevertheless, YNAP is a valuable asset, with reportedly over four million customers every year. Combining forces with Farfetch will be a significant consolidation of efforts to create an undisputed leader in digital luxury shopping.
However, a big ding against Farfetch has always been its complicated business model. The e-commerce company has a toolkit of various digital and media solutions for luxury brands, as well as a small collection of wholly-owned luxury brands like Off-White and Palm Angels. To illustrate some of the complexities of what's going on under the hood, Richemont and Alibaba (NYSE: BABA) both invested in Farfetch via convertible debt in late 2020, and additionally contributed $250 million each to the joint venture Farfetch China.
This present deal for YNAP won't make understanding things much easier. In the initial stage of the agreement, Richemont will receive new Farfetch stock worth 10% to 11% of Farfetch's fully diluted share count in exchange for the 47.5% equity stake. A third investor, Mohamed Alabbar (founder of Emaar Properties, lead developer of the Burj Khalifa tower in Dubai), will acquire 3.2% of YNAP to keep the platform neutral with no controlling shareholder. On the fifth anniversary of the deal, Richemont will receive another $250 million-worth of Farfetch stock.
Additionally, Richemont and Farfetch will have options at their disposal in which Farfetch would acquire the rest of YNAP before the fifth anniversary of the deal. Besides potentially combining with YNAP, a significant aspect of this deal is that Richemont's luxury brand portfolio will start using Farfetch's e-commerce and in-store technology solutions.
But here's the thing: If all of this sounds confusing, you might consider passing on this stock. With so many moving parts at Farfetch -- and with more moving parts getting added into the mix with the YNAP-Richemont-Alabbar deal -- there is a risk that Farfetch shareholders won't realize any real value from the initial share dilution that will occur by late 2023.
There's value here, but there's also risk
In the meantime, Farfetch shares could be really cheap at just 1.5 times enterprise value to trailing 12-month sales. Given the company's ongoing expansion in spite of currency exchange rate headwinds and other macroeconomic problems, there could be tremendous value here if the company keeps growing and makes progress toward turning a profit.
The luxury retail market is huge, and the opportunity for e-commerce and hybrid digital shopping experiences is significant. Farfetch's deal with Richemont to bring together two leaders on this front could go a long way toward helping Farfetch continue its growth streak. Management also believes its operations in China will return to growth in 2023 as well. This beaten-down stock could simply be too cheap to ignore.
But share dilution could be a problem, as could the pesky issue of operating losses and a convoluted business structure. If high-risk but potentially high-reward stocks aren't your thing, stay away from Farfetch at this juncture. There are other e-commerce stocks out there. But if you're looking for an e-commerce leader that has been left for dead by many investors this year, Farfetch is worth a look right now.
