TLDR: I think Wayfair is going to run out of cash in the next 18 months. With no assets, it’ll have difficulty refinancing the 2025 debt leading to either insolvency or unfavorable terms. I’m selling call credit spreads.
After BBBY announced near term ongoing concerns despite debt not being due until 2024, I wanted to see who’s next. Wayfair’s income statement, balance sheet, and statement of cash flows are as bad as I’ve ever seen.
I’m posting my due diligence to a public forum to encourage discussion and see if I’m missing anything in my investment thesis that Wayfair’s common stock goes into the low teens in the next 18 months. Wayfair will run out of cash or have large equity dilution due to negative cash flow from operations and the requirement to refinance the 2025 debt.
Most of the numbers I’m quoting come from Wayfair’s 10Q and investor presentation linked below.
10Q
Cash flows: Wayfair burned through $1.1 billion in cash and short term investments in the 9 months ending September 30th. Wayfair has $1.28 billion in cash and short term investments remaining on hand. If the next 12 months are as bad as the last 9 months, Wayfair will need to raise cash. My opinion is that the housing market will see a slow down in transactions in 2022. The rise in mortgage rates has reduced home affordability, while home sellers stubbornly refuse to lower prices leading to less houses selling. Wayfair’s revenue should be correlated with housing transactions as furniture sales are largely correlated.
Current Ratio: Wayfair has cash now, but current liabilities completely offset resulting in a 1.0 current ratio. $1 billion in accounts payable is $670 million larger than accounts receivable. The low current ratio will lead to low liquidity if negative cash flow continues. An asset-light business model is ideal for profitable companies with manageable debt levels. With Wayfair, there will be very few assets to secure additional loans after it burns through the existing cash.
Liabilities: Wayfair’s bond holders give Wayfair an exceptionally low interest rate in exchange for a conversion option. Some have referred to it as free money. It might have minimal impact on cash flow today, but it’s transferring ownership of the company from the shareholders to the bond holders. The notes are essentially a call option that pays dividends. Page 11 of the 10Q has the details. $3.1 billion in notes with $200 million due in 2024 and $1.28 billion in 2025. The coupon rates are below inflation with 2024 at 1.12% and 2025 at 0.625%. If the bond holders weren’t getting the conversion option, I think interest expense would increase $300 million annually.
As 2025 approaches, I think the conversion price will have to be significantly reduced and the interest rate significantly increased, both a negative to an investor buying common stock at today’s prices. If the 2025 note holders play hardball, I think they can force extremely unfavorable terms to the point that they will own the company rendering the common stock worthless. I think as cash depletes and EPS remains negative, Wayfair will be in violation of covenants, but I got lost in the SEC files before I could prove this out.
Stock buybacks: The statement of cash flows lists $75 million spent on stock buybacks this year. Those shares were repurchased between $136 and $305 per share. Management is wasting cash. A company with negative shareholder equity should not be buying back shares.
Equity based compensation: Wayfair paid $355 million in stock to its employees in the first 9 months of this year. The market cap is only $4 billion. If that continues for another year it’s 10% dilution. Cash flow is being propped up by paying employees in stock. 10% of market cap is about as high as I’ve seen for equity based compensation. There’s only 6 million remaining shares authorized for compensation. Either employee compensation will have to decrease or Wayfair will have to pay a larger percentage of compensation as cash.
Analysts Estimates: Analyst estimates have 2023 EPS at -$4.56 on flat revenue. The original path to profitability required Wayfair to scale up to a level that was sending truckloads of merchandise to each major city.
Flat revenue isn’t going to allow Wayfair to grow to profitability. Cutting back to profitability is the only option. I’ve seen the argument that Wayfair’s loss is less than advertising suggesting that Wayfair could cut its paid advertising and rely on organic sales. Wayfair is already touting a high % of sales are coming from repeat customers. That’s management’s spin on the inability to acquire new customers despite spending $353 million on advertising in Q3. At that ad spend, active customer count is down 22% YOY. If Wayfair cuts ad spend, revenue will decrease leading to lower gross margin dollars.
My position: My argument isn’t unique. 33% of the float is short. The stock is down almost 90% from all time highs. However, it is up 35% off it’s lows. I have a 2/17 $45/$60 call credit spread that expires just before earnings. I intend to roll this out 45-60 days for the next 18 months.
Feel free to poke holes in the investment thesis. Or better yet, make suggestions on how to improve my credit spread. I usually sell puts, but wanted a position that benefits from a declining market.
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