5 Reasons to Avoid the Wayfair IPO

Online home furnishings retailer Wayfair (W) gained 30% in its first day trading as a public company. But in the days since, Wayfair stock has lost all of those early gains.

wayfair 185Those who bought Wayfair stock at the open October 2 are now down more than 20%, proving exactly why buying an IPO on the first day of trading is generally a bad idea.

Some of that drop is due to jittery markets. However, it’s also clear that Wayfair has its work cut out for it in the world of online retail. Competition is bloodthirsty; although it was able to generate almost $1 billion in revenue in 2013, there’s concern its momentum will stall as a result of its brand anonymity.

There are a lot of reasons to be skeptical about Wayfair stock. Here are five of the biggest.

Wayfair IPO: No Brand Recognition

There’s no question that founders Niraj Shah and Steven Conine have built a significant retail enterprise since opening the first of what would become 240 niche websites. all dedicated to furniture and home decor, in May 2002. From nothing it’s grown into a business with 2013 revenue of $916 million; projected to hit $1.3 billion in 2014.

However, its decision in 2011 to move from 240 websites down to five including its namesake Wayfair.com, could be its undoing. That’s because as well as it’s done getting here, the reality is that hardly anyone knows the Wayfair brand. According to Taryn Luna of the Boston Globe, a survey was done in August that asked women aged 35 to 65 if they’d heard of Wayfair; only 52% said yes.

I’m a glass half-full person but that’s not what you want to hear after a few years of slugging it out in the retail trenches. Furthermore, the company suggests its concept — one-stop shopping for the home — is a relatively new idea for most consumers and is going to take some time catching on.

Frankly, I understand that the U.S. furniture and home decor market is huge — $233 billion in 2013 — but shipping beds can’t be cheap. Why would I order from Wayfair when I can go through Amazon (AMZN) or eBay (EBAY) or even Ikea? The fact that Wayfair has been able to generate almost a billion dollars in revenue from 2.1 million customers means it has had some success persuading people to buy … but doing so while making money is another thing entirely.

Wayfair IPO: Lack of Retail Experience

Look at the prospectus for the Wayfair IPO and you’ll see that there is very little retail experience amongst the named executive officers and directors. There are obviously a bunch of smart people involved but, none have been on the front lines of retail, specifically in the furniture and home decor businesses.

I get that there are people behind the scenes who’ve got retail experience (at least I would hope there is — otherwise I really don’t like Wayfair stock), but you can’t just be a bunch of tech geeks and consultants and expect the world to beat a path to your door.

It might be e-commerce, but it’s still retail, and the first rule of retail is getting customers in the store. You do that through good merchandising, not algorithms.

Wayfair IPO: Power to the Wrong People

Normally I’m actually a fan of dual class structures because the focus and self-interest provided by the person(s) in control generally turns out to be beneficial in the long run for other shareholders. But because the founders — who will have 57% voting control after the Wayfair IPO — don’t have any retail experience, including the CEO, I feel that too much power is being put in the hands of people who don’t have a firm grasp of retail.

Am I smarter than the folks from Battery Ventures, Great Hill Partners, and HarbourVest Partners? I doubt it. But just because Wayfair has smart people backing them financially doesn’t mean this trio of VCs hasn’t grossly miscalculated when it comes to this particular investment.

I guess time will tell.

Wayfair IPO: Losing Money

Wayfair spent $243 million on sales and marketing over the past four quarters ended June 30, 2014. In the first six months of fiscal 2014, it has spent $138 million spreading the word suggesting it will spend close to $300 million by the time the end of December rolls around.

It’s going to rack up a big loss by the time the year’s over.

Wayfair had an operating loss of $51 million in the first six months of 2014. Keeping all of the margins the same while inputing a $300 million marketing budget for the year, I expect it to generate an operating loss of $102 million or $1.23 per diluted share. If it continues to spend 23% of every dollar of revenue on sales and marketing, it’s going to lose money indefinitely.

And I don’t think we ‘re looking at the next Amazon — a company that watches revenue soar, even if it means losses. Wayfair is just going to lose money.

Wayfair IPO: Overvalued

As I write this Wayfair is currently valued around 2.3 times sales. That’s 50 basis points greater than Amazon, which has $8 billion in cash on its books and still generates more than $1 billion in free cash flow despite huge spending in recent quarters.

Amazon has earned a pass from investors because it makes a lot of money to offset its spending. The same can’t and shouldn’t be said about Wayfair stock.

Maybe Wayfair stock stabilizes and becomes more attractive down the line … but there’s a long way to go before then. In the meantime, there are much better places to invest your money than the Wayfair IPO.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.

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