Nordstrom Takes a Big Writedown on Trunk Club

By Markets Fool.com

Just over two years ago, Nordstrom (NYSE: JWN) spent $350 million to acquire fast-growing personalized clothing service Trunk Club. At the time, it seemed like a savvy move to combat the rising threat from Amazon.com's (NASDAQ: AMZN) fashion business. (Wall Street analysts expect Amazon to become the top apparel retailer in the U.S. next year.)

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Trunk Club is one piece of Nordstrom's broader plan to fend off Amazon.com. Image source: Nordstrom.

However, earlier this month, Nordstrom wrote down the value of Trunk Club by more than half, taking a $197 million goodwill impairment charge. What went wrong with this once-promising acquisition?

Great expectations

The key idea behind Trunk Club is to bring the personal stylist concept into the e-commerce age. Trunk Club primarily targets men who don't like to shop but need to look good. A personal stylist sends a "trunk" of clothing to the customer's home, where he can try on all of the items, keep the ones he likes, and send the rest back. Over time, Trunk Club stylists can get to know their customers' tastes, leading to better recommendations.

Amazon can't offer the same kind of personalized service as Nordstrom and Trunk Club. Image source: The Motley Fool.

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Buying Trunk Club seemed like a good way for Nordstrom to go on the offensive against Amazon.com. Nordstrom stores are known for their legendary service, and Trunk Club offers the same kind of personalized service in an e-commerce format. This is a big differentiator from Amazon, which doesn't provide personalized advice in a meaningful way.

Trunk Club also offered Nordstrom an opportunity to grow its full-price business, rather than relying solely on off-price channels for growth.

Lastly, Trunk Club was growing very quickly. When Nordstrom bought the company, Trunk Club was on pace to more than double its revenue to $100 million in 2014. In early 2015, Nordstrom projected that Trunk Club would double its revenue again in that year. Moreover, it was already nearing breakeven on an operating basis in 2014.

Profitability problems

Trunk Club is still growing quickly, helped by Nordstrom's decision to extend the concept to women's clothing last year. However, it may not be growing quite as fast as Nordstrom had previously expected. Most importantly, Trunk Club still isn't making money.

Nordstrom had warned investors that investments to grow the business would dampen Trunk Club's profitability in 2015, followed by improvement thereafter. But during the course of 2016, there have been some red flags indicating that Trunk Club's profitability still wasn't meeting expectations.

In late June, Nordstrom announced that it will close Trunk Club's dedicated fulfillment center in Chicago next year. Going forward, Trunk Club orders will be shipped from Nordstrom's existing e-commerce fulfillment centers in Pennsylvania, Iowa, and California. Nordstrom spun this as a move to support Trunk Club's growth, but it was also clearly a cost-cutting measure.

Last month, Trunk Club made an even more visible move to cut costs, implementing a $25 try-on fee. It also shortened the try-on period from 10 days to five days. The $25 fee can be applied to any items a customer decides to buy from a given trunk. The fee is presumably meant to reduce costs by weeding out customers who aren't serious and might just return all of the items in their trunk.

There's still some hope

Nordstrom didn't fully write down the value of its Trunk Club acquisition. This implies that it still expects this business to be profitable, which would be an improvement from its performance over the past two years. The recent changes to the try-on policy and the fulfillment center integration should have a big positive impact by this time next year.

Ultimately, it appears that Nordstrom overpaid for this acquisition. Nevertheless, it was a risk worth taking. Management's willingness to make big long-term bets like buying Trunk Club has helped Nordstrom weather the growth of Amazon.com and other e-commerce outlets much better than other department stores. Investors should applaud this type of long-term thinking, which is all too rare among public companies.

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Adam Levine-Weinberg owns shares of Nordstrom. The Motley Fool owns shares of and recommends Amazon.com. The Motley Fool recommends Nordstrom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.