Because it makes large losses competing head-on with Amazon, Wayfair (W, Financial) is an even more controversial company than Eurofins. Also like Eurofins, it’s a business we researched for years before recently exploiting a period of heightened investor anxiety in order to buy a stake at what we think was an attractive price. Only a year ago, an adoring Mr. Market seemed to have anointed Wayfair the undisputed king of online home furnishings retail, with near-unlimited potential in a massive category featuring as much as a half-trillion dollars of annual sales that have historically come at healthy margins. Today, with ballooning losses tied to ambitious simultaneous investments in logistics, selection and geographic expansion, the crown appears broken and the predominant narrative questions whether the company will ever be able to build a profitable franchise competing with Amazon in a commoditizing category.
While we think management should have paced its recent investments more modestly, we also think they were strategically wise, and importantly, we expect their cost to reduce significantly in coming quarters. Though reality is a bit more complicated, the idea here is that by and large, you can only build a national logistics footprint once, you can only expand your assortment to cover all categories of home furnishings once and you can also only build the overhead required to support European expansion once. The company’s decision to take on all three of these mostly finite tasks at the same time has had the effect of obscuring unit economics that we see as fundamentally sound. If we’re correct, then as sales continue to grow and the company “laps” this recent period of unusually elevated investment, cash flow dynamics should improve rapidly, potentially inducing another, more optimistic swing in Mr. Market’s mood.
While 2020 will be an important year in which a team we respect needs to deliver on its commitments and get back to living within its means, we don’t see why Amazon and Wayfair can’t both be long-term winners in a segment that is one of the largest and most profitable in all of mass retail. Crucially, it is also a segment in which the average consumer cares as much or more about browsing an endless selection and getting inspired about how to decorate a space as she does about buying a specific product at the lowest possible price and getting it delivered as quickly and conveniently as possible. Or to put it more simply, most people don’t want to decorate their homes in the same way—or at the same places—that they buy their laundry detergent. This is why many offline “category killers,” both regional and national, have thrived for decades in home furnishings, and why we think Amazon is about as likely to “own” home furnishings online as Walmart and Target are offline.
We like that Wayfair has already achieved a degree of scale and scope in the online world that vastly exceeds what any existing category specialists have achieved in the offline world. We also like that the network effects inherent in the company’s marketplace business model should enable it to offer a breadth of selection and quality of user experience that competitors will struggle to match. Though Wayfair is already orders of magnitude larger than its offline counterparts, if it can eventually earn a fraction of the profit margin that they have earned for years, we will have paid less than twenty times potential after-tax earning power for a dominant category leader that could grow enormously over the next decade.
From Ruane Cunniff (Trades, Portfolio) & Goldfarb's Sequoia Fund fourth-quarter 2019 letter to shareholders.
