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3 Stocks That Can Grow Without Raising Capital

By Mark Lin – Jul 17, 2014 at 9:00AM

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A company with negative working capital is an attractive business, with suppliers funding a large portion of capital that most growing businesses need, resulting in high returns and strong growth.

Source: FTD Companies

One of the biggest risks surrounding companies relates to financing, or the lack thereof. Companies that are unable to raise funds don't have the ability to capitalize on growth opportunities. Even companies that obtain the necessary financing for future growth often pay a high price in terms of either high interest costs or significant equity dilution.

The better alternative for investors is to choose companies that are able to grow with their own internally generated cash. Examples include companies such as FTD Companies (FTD), Blue Nile (NILE), and Zulily (NASDAQ: ZU), all of which leverage their negative working capital model to grow.

Brokering model
Unlike your neighborhood florist, FTD Companies acts more like a real estate broker by managing a network of retail florists. It basically just takes orders from customers and coordinates the fulfillment process between consumers and its member florists. FTD Companies rarely owns any goods on its balance sheet, and only holds any limited inventories for an average of seven days.

More importantly, FTD Companies is paid by consumers before it has to pay its network of members for fulfillment. In fact, it collects payment from customers in 15 days on average, while suppliers get paid by FTD Companies in approximately 50 days; this is a classic case of negative working capital.

FTD Companies' revenues comprise 20% of its gross order proceeds, a 7% clearinghouse fee, and a fixed transmission fee on a per-order basis. It's able to expand its operations with limited upfront investment as it purely links up buyers (consumers) and sellers (member florists). FTD Companies has expanded its revenues by a decent 4% CAGR from 2010 to 2013 in a slow-growth floral industry.

More impressively, it has delivered free cash flow in excess of $40 million in each of the past four years, while committing to less than $10 million in annual capital expenditures and operating on a negative working capital model.

The beauty of the negative working capital model is that FTD Companies doesn't have to set up new stores or hire more workers to handle a higher volume of sales. Going forward, FTD Companies should continue to grow by adding more member florists without incurring significant capital investments or securing external financing.

Source: Blue Nile

Unique diamond sales model
Most jewelers typically have to pay the suppliers for the diamonds they display in their stores before they can collect cash from paying customers. Blue Nile, an online retailer of engagement diamond rings, is one notable exception. Its strong relationships with specific suppliers allow it to showcase diamonds on its website without putting up any cash upfront.

Instead, Blue Nile only purchases diamonds from its suppliers upon customer order. This is reflected in its working capital metrics. Blue Nile literally has no accounts receivable as its customers pay almost immediately during the online transaction. In contrast, it takes approximately four months for Blue Nile to pay its suppliers. In addition, the company holds the diamonds it purchases on its books for only a month, roughly the time taken for the goods to be delivered from suppliers to customers.

Since Blue Nile's customers pay in advance (before Blue Nile procures what the customer has agreed to buy), it has been able to grow rapidly with minimal investment. It has increased its revenues at a CAGR of 13.3% between 2004 and 2013, but this growth has been largely financed with internally generated cash flow.

Blue Nile has a negligible gearing of 2%, and its number of shares outstanding has steadily declined from 19 million in 2005 to 13 million in 2013. This is the strongest indication that Blue Nile didn't have to rely on external financing to grow.

Looking ahead, Blue Nile has plans to expand into the non-engagement diamond market. In the U.S. non-engagement diamond market, Blue Nile has a mere 0.2% market share, compared with a much more significant 3.9% share of the engagement ring market as of June 2013. Blue Nile's negative working capital model will be critical to its future asset-light growth.

Source: Zulily

Flash sales model
A lot of retailers go out of business because they overstock on inventories which they can't sell. Zulily, a mom-focused online retailer, mitigates this risk of inventory obsolescence with its flash sales model, where it sells a limited quantity of its products for a limited time. This helps to drive rapid inventory turnover because Zulily can sell more stuff in less time.

Its suppliers are also typically paid after the goods are sold. The suppliers' inventories stay with Zulily for not more than seven days, though the suppliers are paid roughly a month later.

More importantly, there's another benefit associated with the flash sales business model. Scarcity drives demand, and the fact that what Zulily sells will be gone in hours makes the products more valuable in the eyes of consumers. The numbers speak for themselves. It has increased its number of customers by more than 90% year-over-year every quarter.

Zulily grew its top line by 93% year-over-year in the first quarter of 2014, and it shouldn't have problems remaining debt-free as it targets to cross the $1 billion sales mark in the full year.

Foolish final thoughts
Any company that is reliant on capital markets for financing is bound to suffer in an economic downturn. In contrast, negative working capital companies like FTD Companies, Blue Nile, and Zulily are among the safest bets to survive any crisis. Their capital-light business models and strong balance sheets remain the best defense.

Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Blue Nile. The Motley Fool owns shares of FTD Companies. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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