December 12, 2018

Breakingviews: Stitch Fix models tech’s terminal problem

by Breakingviews.

Will Stitch Fix hit its revenue target for the next quarter? Probably. Do millions of Americans want to receive packages of mystery outfits picked by strangers? That’s harder to say. The latter question is the most important one, though – which explains the terrible performance of the $2 billion retail-tech company’s shares.

Stitch Fix, which listed just over a year ago, reported quarterly earnings late Monday that outgunned consensus forecasts. The snag in Stitch Fix’s stocking, which drove the shares down as much as 29 percent on Tuesday, was that active users increased by 22 percent year-on-year, rather than the 25 percent rate of the previous quarter, and the 23 percent that analysts expected.

That might sound like a trifle – the shortfall was around 20,000 people – but it’s anything but. The biggest slice of Stitch Fix’s value, as for any company, comes not from what happens this year or next, but from the cash flows generated once the business is mature, known as its terminal value. When a business model is as new and speculative as the one founded by tech wunderkind Katrina Lake, tiny changes in trajectory can alter the whole calculus. It’s the same dilemma that has caused Snap’s value to plunge, and that will challenge Uber as the ride-hailing giant seeks to go public at a $100 billion-plus valuation.

Think of a company whose earnings grow 50 percent for the next five years, and just 1 percent from then on until it reaches its 20th year. Plug that into a discounted cash flow model typically used by analysts, and assume a discount value of 10 percent. Almost three-quarters of the company’s value would come from what happens in that latter 15 years. Now say the company only survives for 10 years: its value would fall, all else being equal, by 40 percent.

That explains why investors cling to home-made measures like the growth of active users – the number that disappointed for Stitch Fix this time. The fixation with Twitter’s “monthly active users,” which caused its stock to plunge in July, tells a similar story. For now, Stitch Fix is doing everything right – except convincing investors that its unusual business model will stand the test of time.


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