Farfetch Limited (FTCH 9.40%) may not be well-known to U.S. investors, since the company is based in London and run by a visionary founder-CEO from Portugal. However, there's a lot to like about this e-commerce platform, which appears to be consolidating the online market for global luxury goods.
Last month, Farfetch made a transformative deal that may be underappreciated by the market. Against the backdrop of a 70% fall in its share price this year, this beaten-down tech stock could be a big opportunity. That's why it was the only new stock to make it into my portfolio last month.
What Farfetch does
Farfetch was founded and run by José Neves, a Portuguese owner-operator now based in London. Neves has a unique combination of skills: mastery of both software engineering and the unique quirks of the global luxury-goods industry.
Luxury brands are mostly family-owned businesses, historically skeptical of technology, with unique concerns that may go beyond maximizing this year's financials. But Neves' unique background both as a software engineer and a luxury-clothing designer (one of his prior businesses even won a British Fashion Award in the Retailer category in 2006) enabled him to gain the trust of luxury brands where others couldn't.
Starting Farfetch on the eve of the 2008 financial crisis was also lucky, as the recession helped nudged brands and retailers to adopt its marketplace to expand their reach. The pandemic that began in 2020 was another catalyst to build supply on Farfetch and further strengthen its network effects, as e-commerce sales went from just 9% of the $350 billion luxury-goods market in 2017 to roughly 22% today.
A combination of Amazon and Shopify
Farfetch is essentially three different, highly attractive businesses.
First is the Farfetch marketplace. As with Amazon's third-party seller business, Farfetch doesn't take possession of inventory; rather, it connects inventory from suppliers' stores across the globe, in an attractive asset-light model helped along by a rising advertising business.
Second, Farfetch Platform Solutions (FPS) is the Shopify to the luxury industry; Farfetch's API-based software powers luxury brands' and retailers' direct-to-consumer websites.
Third, Farfetch has bought its own brick-and-mortar retailers and luxury brands, beginning with London-based department store Browns in 2015. In 2019, Farfetch acquired Stadium Goods, a high-end sneaker platform, for $250 million, and New Guards Group, a platform for incubating luxury brands, for $675 million.
While it may seem counterintuitive for investors who would like a "pure play" e-commerce stock, these acquisitions have many benefits. With Browns, Farfetch bought a very cheap asset, and it has expanded sales some 20-fold since 2015 through the use of technology. Farfetch also uses Browns to experiment with its "augmented retail" vision, which combines online and in-store connected technology.
Stadium Goods and New Guards are growth businesses themselves. They provide valuable data that help inform Farfetch's software, while also providing the company an opportunity to acquire the next big luxury brand. For instance, Farfetch acquired Palm Angels, one of New Guards' brands, in 2021. It also acquired beauty retailer Violet Grey in 2022, and is just beginning to offer a curated selection of beauty products on its marketplace.
A perfect storm in 2022
The recent discount has arisen because Farfetch is enduring a perfect storm in 2022. Russia was its third-largest market, but is now zero. China, the second-largest market, has had sales drop 30% to 40% this year due to both destruction of demand, and supply constraints caused by COVID lockdowns. (Farfetch gets other international revenue, but reports in U.S. dollars, so the strong dollar is keeping a lid on top-line figures.) Meanwhile, Apple's Identifier for Advertisers (IDFA) privacy changes have driven up marketing expenses, compressing margins.
With all these headwinds, Farfetch projects gross merchandise volume (GMV) growth of just zero to 5% this year, after 33% GMV growth in 2021 and 49% growth in 2020. Encouragingly, Farfetch is still targeting adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to break even, thanks to a reorganization and restructuring that's currently underway.
However, since the company will be lapping the closing of the Russia business and the Chinese recession next year, those headwinds could turn into tailwinds for growth comparisons in 2023. For his part, Neves expects the company to return to his 30% growth target next year and beyond.
A big fashion deal
Farfetch should bounce back not only because of macroeconomic factors, but also because it consummated a transformational deal in August that could turbocharge results next year.
The company will acquire 47.5% of rival e-commerce platform Yoox Net-a-Porter (YNAP) from luxury giant and Cartier parent Richemont (CFRUY 1.28%), with an option to buy the rest in five years should YNAP reach certain profitability metrics. Richemont had already invested in Farfetch's China Joint Venture with Alibaba in 2020; Richemont's CEO Johann Rupert has said publicly that Alibaba's tech team told him even they couldn't replicate what Farfetch has built, calling its software "truly remarkable" technology.
In the YNAP deal, Richemont will take a 10%-11% stake in Farfetch, potentially rising to 15%-16% if the acquisition goes through. The big part of the deal for Farfetch is that Richemont will bring its luxury "maisons" (subsidiary businesses) onto the Farfetch marketplace, while also implementing FPS for its maisons' direct-to-consumer websites. Richemont had more than $3 billion in digital GMV in 2021, nearly as much as Farfetch's 2021 total, so this could nearly double Farfetch's business in short order. If Farfetch manages to turn around YNAP, so much the better. If YNAP's turnaround doesn't succeed, Farfetch can offload it to a strategic buyer or hold an initial public offering.
The important takeaway is that Farfetch has acquired a major competitor, and seems to have reached escape velocity in consolidating the luxury e-commerce market for itself.
Low valuation, room for growth
Farfetch is currently trading at just 2 times sales and 1 times GMV.
With its 2021 GMV of $4.2 billion amounting to less than 2% of the luxury market and roughly 5% of the luxury e-commerce market, Farfetch still has a lot of growth potential. And with a solid contribution margin (gross margin minus demand-generation marketing expense) of 31.7%, the company should be highly profitable once it scales on top of its corporate infrastructure.
Along with those turnaround catalysts for 2023, its beaten-down valuation and multibagger potential are why Farfetch was the only new name to make it into my portfolio last month.