Casper detour — VietEcon

A quick detour today to look at Casper, the mostly on-line mattress company, which filed its S-1 to go public a few weeks ago. I love looking at these internet companies and seeing if they really are as revolutionary as they say they are.

Let’s say right off the bat that Casper has been wildly successful. They have somehow convinced people to buy a piece of foam over the internet and use it as their mattress! To be fair - people really love the mattresses, and the company has the sales to show it - more than $400m in the past year.

The company was started in 2014, and it closed its Series D round in March of 2019 with a valuation of $1.1 billion. It was one of the first movers in the on-line mattress space. It turns out that being on-line only isn’t that exciting, so the company now has 60 stores, and management expects there to be room for 200 stores in North America. It also is offered in another 2,000 retail stores like Target.

Sales have been very strong (see chart up to the right), and gross margin is quite high at almost 50%. The issue is that the company is spending a lot of money to get those customers. This is a pattern we have seen with a lot of these on-line companies. For example, Blue Apron is a good example of a company that spent tons to attract customers. When they stopped spending, the customers stayed away, and the stock cratered.

But the list of competitors to Casper is long: Emma, Leesa, Tuft & Needle, Eve Sleep, Bear, Purple, Helix, something called Pangeabed. Those are only some of the on-line ones. There is also Sealy, Sleep Number, Simmons, along with a number of others. So it’s a highly competitive market, and what once differentiated Casper (foam, online, great customer service), no longer is so different.

Casper is small compared to its major competitors, but growing: One of the largest mattress companies out there, Sealy, has sales of $2.9bn in the trailing twelve months (end Sept 2019), while Sleep Number had $1.7bn. Purple, the only publicly-traded online company, had $383m in sales (end Sept 2019). Casper is much closer to Purple than to the big ones, in terms of both sales and growth. Although growth at Purple is actually quite a bit higher at 46%, compared to Casper at just 20%.

The company is looking to raise money, but it also wants to show a good return for its investors. In its Series D in March 2019, investors valued the company at $1.1bn. If they demand a 25% return, the company needs to be valued at $1.375bn. A 25% return is not great, but is somewhat appropriate for a late state investment and a year-long holding period. But reaching that $1.375 will be tough.

I did a quick DCF of the company (see table to the right). I find it difficult to get above $900m. Let me just go through a few of my assumptions:

Revenue goes from $410m in the trailing twelve months (end 3Q19) to almost $1bn in 2026, for a CAGR of 11.5%. This is pretty impressive, especially as the company gets bigger. Through the first nine months of 2019, the company’s revenue only grew 20%, which is quite low. I expect 4Q2019 will be big, but it will be hard for the company to get above 25% growth in 2019. Then I have it falling off to a terminal growth of 3%.
I keep gross margin high at 50%, and I have sales and marketing costs grow just 5.2% through the forecast period. I am even more generous with “General and admin expenses” (basically all the other overhead, including R&D), with just a 2.2% growth rate.
Ultimately, I get to an EBITDA margin of just under 9% and with losses through 2022.
I assume minimal working capital needs (0.5% of revenue), falling capex needs, plus no tax (given large tax loss carryforwards). Again, these are pretty optimistic.
I use a WACC of 9.5%, which is based on a beta of 1.5, risk-free rate of 2%, equity risk premium of 5%, debt rate of 5% and a 20% debt weighting. All of which are probably pretty conservative.

Source: Yahoo, company disclosure, calculations and chart by Vietecon.com

Another way to look at it is to see comparable valuations. Looking at peers, it will be hard to get to the $1.375 figure. Let’s say that the company reaches my 2019 revenue forecast of $448m. To get to our value, investors need to use a multiple of 3.1x. That’s pretty tough. Right now, none of its publicly-traded competitors are trading at that value. Purple is trading just below at 3.0x, but that company is growing much faster (revenue up 40% TTM). Plus the company actually made money in 9M2019.

Purple actually has lower gross margins, and spends less on sales and marketing. Moreover it spends significantly less on G&A. I think it would be hard for Casper to match these in the short term. For example, Purple spent just $28m on G&A in TTM versus Casper at $141m. That’s 5x as much!

Basically, if Casper could keep its margin and lower its operating expenses to Purple levels, it would have earnings of $43m in 2019, by my estimate.

If I were Casper, and I wanted to keep revenue flowing, I wouldn’t cut sales & marketing, but I would drastically cut other overhead. It is way too high at 34.5% of sales. This needs to come down by half, and more quickly than I have it coming down (in 2026 I have it at 18%, still double Purple’s spending). Even if this is a lot of R&D for new products, it seems way too high.

Conclusion: My view is that Casper is going to struggle to get the valuation that its most recent investors probably wanted. If it goes at the Purple valuation, then it should be able to get almost $1.3bn, but that depends on strong growth in 4Q2019 plus expectations of much faster growth in profits than I have built in my model.

In some ways, if Casper can get by with the cash it has ($55m as of Sept. 2019), it should probably get its house in order and then go for an IPO showing both growth and profit. This may be difficult because there are some debt instruments they need to pay off, and it is likely that growth will slow down again in 2020, which will make the company less attractive. Investors aren’t going to like a slow-growing company desperate for cash.

Overall, it will be really interesting to see how the market views the Casper’s IPO. I think something like $1.2bn is doable, but that gives just a 9% return. In a normal year that would be great, but it is low compared to how the S&P has done over the past year: +26%.