This was the only new stock I bought in August

Farfetch Limited (FTCH -8.22%) may not be well known to US investors, as the company is based in London and led by a visionary founder-CEO from Portugal. However, there’s a lot to like about this e-commerce platform, which seems to consolidate the online market for global luxury goods.

Last month, Farfetch struck a transformative deal that may be undervalued by the market. Against the backdrop of a 70% drop in its share price this year, this battered tech stock could be a big opportunity. That’s why it was the only new stock to enter 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: mastering both software engineering and the unique particularities of the global luxury industry.

Luxury brands are mostly family businesses, historically skeptical of technology, with unique concerns that may go beyond maximizing this year’s finances. But Neves’ unique background as both a software engineer and designer of luxury clothing (one of his previous ventures even won a British Fashion Award in the Retailer category in 2006) won him the trusted luxury brands where others could not.

Farfetch’s startup on the eve of the 2008 financial crisis was also fortunate, as the recession pushed brands and retailers to embrace its marketplace to expand their reach. The pandemic that began in 2020 was another catalyst to grow the offering on Farfetch and further strengthen its network effects, with e-commerce sales growing from just 9% of the $350 billion luxury goods market in 2017 to around 22% today.

A combination of Amazon and Shopify

Farfetch is basically three different and very attractive companies.

The first is the Farfetch market. Like with Amazonthird-party seller’s business, Farfetch does not take ownership of the inventory; instead, it connects store inventory from suppliers around the world, in an attractive asset-light model, aided by a booming advertising business.

Second, Farfetch Platform Solutions (FPS) is the Shopify to the luxury industry; Farfetch’s API-based software powers direct-to-consumer websites for luxury brands and retailers.

Third, Farfetch bought its own brick-and-mortar retailers and luxury brands, starting with London department store Browns in 2015. In 2019, Farfetch acquired Stadium Goods, a high-end sneaker platform, for $250 million, and New Guards Group, a luxury brand incubation platform, for $675 million.

While this may seem counterintuitive to investors who would like a “pure play” e-commerce stock, these acquisitions have many advantages. With Browns, Farfetch bought a very cheap asset and grew its sales 20x since 2015 through the use of technology. Farfetch is also using Browns to experiment with its vision of “augmented retail,” which combines online and in-store connected technology.

Stadium Goods and New Guards are growing businesses themselves. They provide valuable data that helps inform Farfetch’s software, while providing the company with the opportunity to acquire the next big luxury brand. For example, Farfetch acquired Palm Angels, one of the New Guards brands, in 2021. It also acquired beauty retailer Violet Gray in 2022 and is just beginning to offer a curated selection of beauty products on its market.

Image source: Getty Images.

A perfect storm in 2022

The recent discount came because Farfetch is having a perfect storm in 2022. Russia was its third-largest market, but now it sucks. China, the second-largest market, has seen sales drop 30% to 40% this year due to both demand destruction and supply constraints caused by COVID lockdowns. (Farfetch gets other international revenue, but reports in US dollars, so the strong dollar limits revenue.) Meanwhile, AppleChanges to Privacy Identifier for Advertisers (IDFA) have led to increased marketing spend, squeezing margins.

With all of these headwinds, Farfetch expects gross merchandise volume (GMV) growth of just zero to 5% this year, following GMV growth of 33% in 2021 and 49% growth in 2020. Encouragingly, Farfetch continues to target adjusted earnings before interest, tax, depreciation and amortization (EBITDA) to break even, through a reorganization and restructuring currently underway.

However, given that the company will catch up with the Russian shutdown and the Chinese recession next year, these headwinds could turn into headwinds for growth comparisons in 2023. For his part, Neves expects the company to return to its 30% growth target next time. year and beyond.

A big fashion deal

Farfetch is expected to rebound not only due to macro factors, but also because it reached a transformational deal in August that could boost results next year.

The company is to acquire 47.5% of rival e-commerce platform Yoox Net-a-Porter (YNAP) from the luxury giant and parent company of Cartier Richemont (CFRUY -3.00%), with an option to purchase the remainder in five years if YNAP achieves certain measures of profitability. Richemont had previously invested in Farfetch’s Chinese joint venture with Ali Baba in 2020; Richemont CEO Johann Rupert has said publicly that Alibaba’s tech team told him they couldn’t even duplicate what Farfetch had built, calling its software “truly remarkable” technology.

As part of the YNAP deal, Richemont will take a 10% to 11% stake in Farfetch, rising to 15% to 16% if the acquisition goes through. The big part of the deal for Farfetch is that Richemont will bring its luxury “houses” (subsidiary businesses) to the Farfetch marketplace, while also implementing FPS for its houses’ direct selling websites. Richemont had over $3 billion in digital GMV in 2021, almost as much as Farfetch’s total in 2021, which could nearly double Farfetch’s business in a short time. If Farfetch manages to turn YNAP around, great. If YNAP’s turnaround is not successful, Farfetch may outsource it to a strategic buyer or hold an initial public offering.

The important takeaway is that Farfetch has acquired a major competitor and appears to have reached trailing speed by consolidating the luxury e-commerce market for itself.

Low valuation, room for growth

Farfetch is currently trading at just 2x sales and 1x GMV.

With its 2021 GMV of $4.2 billion representing less than 2% of the luxury market and around 5% of the luxury e-commerce market, Farfetch still has plenty of growth potential. And with a solid contribution margin (gross margin less demand generation marketing expenses) of 31.7%, the company should be very profitable once it scales above its infrastructure of company.

Besides these turnaround catalysts for 2023, its reduced valuation and multibagger potential is why Farfetch was the only new name to make it into my portfolio last month.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Billy Duberstein has positions in Amazon, Apple and Farfetch Limited and has the following options: January 2023 short calls at $210 on Apple, $20 short calls on October 2022 on Farfetch Limited, $7.50 short calls on Farfetch Limited in October 2022, $7 short calls on Farfetch Limited in September 2022, and $8 sell shorts in September 2022 on Farfetch Limited. Its clients may hold shares of the companies mentioned.

The Motley Fool holds positions and recommends Amazon, Apple, Farfetch Limited and Shopify. The Motley Fool recommends the following options: Shopify January 2023 $1140 Long Call, Apple March 2023 Long Call $120, Shopify January 2023 Short Call $1160, and $130 Short Call in March 2023 on Apple. The Motley Fool has a disclosure policy.

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