Three years ago, apparel-focused subscription box service Stitch Fix (NASDAQ: SFIX) and Trunk Club looked like peas in a pod. Both were posting triple-digit growth -- and both were on the verge of turning profitable.
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In this episode of Industry Focus: Consumer Goods, the team explores the parallels between Stitch Fix and Trunk Club. In 2014, Nordstrom (NYSE: JWN) acquired Trunk Club for about $350 million, but the department store eventually found that Trunk Club's profit potential was much lower than it had initially hoped, and two years later, wrote down the value of the investment by more than half. Will Stitch Fix encounter similar problems?
A full transcript follows the video.
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This video was recorded on Dec. 12, 2017.
Vincent Shen: Adam, when we were planning this episode, you brought up a comparison to Trunk Club, which offers, I would say, a more bearish view of the long-term prospects for subscription-style companies. What's the story there?
Adam Levine-Weinberg: Trunk Club and Stitch Fix, if you looked at those two companies in 2014, they were basically mirror images of one another, with Stitch Fix serving women and Trunk Club serving men. In 2014, as I mentioned, during that fiscal year, Stitch Fix was a little under $100 million, around $73 million in revenue. And 2014, Trunk Club hit about $100 million of revenue.
In the middle of that year, Nordstrom came in and bought Trunk Club for about $350 million, made a really big bet on this subscription box business model. And at that point, when they made the acquisition, they stated that Trunk Club was already profitable -- so in that way, very similar to Stitch Fix -- that it was about to double its revenue in 2014, and that they expected to be able to double its revenue again in 2015. They had very grand ambitions for pushing into women's apparel, noting that the overall women's apparel market is much larger than men's apparel. So they saw a big opportunity both to continue growing that core men's business but also to push into women's business. It seemed like a really great acquisition at the time also, because Nordstrom has a network of over 100 full-line stores also selling very nice, upscale clothing. They could use those stores to provide services like tailoring that would be a lot harder for a pure e-commerce company to offer. Also, Nordstrom is a multi-billion dollar revenue company, so they have tons of inventory and relationships with basically every top brand, so you have much better inventory availability. So it seemed at the time like a potentially really successful acquisition. And it's just turned out to be a bit of a disaster for Nordstrom, albeit on a small scale.
Last year, the company, Nordstrom, had to write down the value of this acquisition by $197 million, so by more than 50%. At the time, they stated that the revenue growth rate was still pretty strong, but they significantly reduced their estimates of profitability. And if you look at what they did prior to 2016, unlike Stitch Fix, you could order a Trunk Club Trunk without paying that styling fee up front. And the problem with that in this kind of business model is, people end up sending back the whole Trunk, and you lose a lot of money if that happens.
Shen: In terms of the fulfillment costs, yeah.
Levine-Weinberg: Yeah. They ended up putting in a styling fee to order the Trunk, and like with Stitch Fix, you can apply that to any purchases that you make. But once they did that, it seems like the revenue growth has really stalled out. The movement to the women's business just hasn't been nearly as successful as Nordstrom had expected. So Trunk Club is a cautionary sign for people interested in Stitch Fix, because it's a company that seemed like it was on the same high-growth, high-profit trajectory, and everything fell off the rails in the last couple of years.
And to be honest, Nordstrom hasn't provided that much in the way of details about the nitty gritty of just what happened there, so it's hard to say how close the parallel really is to Stitch Fix, but it's definitely concerning that Stitch Fix might also run into a wall with growth, and also find that the cost of acquiring customers becomes so great over time once you get past the people who can really easily fit into this model and are really looking for this kind of solution. The marketing costs can get so high that it eats up all the profitability. So that's why it's somewhat concerning, from an investing point of view, that you saw the big drop off in profitability in the most recent fiscal year at Stitch Fix. And at the same time as they were ramping up their marketing spending at such an incredible rate, almost tripling it, you saw that really big deceleration in their revenue growth. And even just during the past year, there's been a further deceleration. At the beginning of fiscal 2017, you had revenue growth still over 50% year over year. By the second half of the fiscal year, which is roughly the first half of the calendar year, their growth rate was down to 26%. So it's going to be really interesting to look at the upcoming earnings report that Stitch Fix is going to put out soon to see where the revenue trend is going, and also how high is marketing spending going. Because it's definitely worrisome that they're spending more and more on marketing and getting a smaller and smaller incremental revenue benefit from that.