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Jun 29, 2017

S3 Research: Blue Apron Hoping to Deliver a Tastier IPO at $10-$11/share

Blue Apron Holdings, Inc.’s (APRN US) IPO is scheduled for June 29th, issuing 34.5 million shares (including the  greenshoe). Goldman Sachs, Morgan Stanley, Barclays and Citigroup will be the main IPO underwriters. The initial issuing price was $15-$17 per share, but has been lowered by a third to $10-$11 per share today. The IPO was placed to generate between $510 and $586.5 million for APRN, but will now only bring in $345 to $379.5 million, valuing the company at approximately $2.1 billion, or just over $13 for each of the 159 million meals they have served since their inception.

APRN’s price to sales multiple will be just over 2.6, which is drastically below SNAP Inc.’s (SNAP US) recent tech IPO multiple of 60 but appreciably higher than the 0.9 multiple Amazon (AMZN US) applied to its acquisition of Whole Foods Markets (WFM US). APRN is counting on continued sales growth in the $781.5 billion U.S. grocery market, where just 1.2% of sales takes place via online purchases.

APRN has strong historical sales growth with $78 million of revenues in 2014, $341 million in 2015, $795 million in 2016 and a run rate of $979 million so far in 2017. Unfortunately, as with most tech/internet based companies, increased revenues have not translated into positive net income. Instead, due to increased marketing and promotional costs, net yearly losses continue to grow with losses of $31 million in 2014, $47 million in 2015, $55 million in 2016 and a run rate of negative $209 million in 2017. Marketing expenses have increased to 25% of revenues this year, topping $60 million in 1st quarter 2017, more than a third of full year 2016 marketing expenses, as the company tripled offline based advertising including billboards, transit signage and television advertising. APRN has also spent over $128 million on property, plant and equipment and increased its full time employees from 1,051 in 2014 to 5,202 in 2017.

APRN’s customer base has more than tripled since 2015, with over 1 million customers ordering 8 million meals every month. Customer retention remains an uphill battle. Daniel McCarthy, a marketing professor at Emory University, told the Wall Street Journal that his research shows that 60% of new customers leave the service after just six months. Net revenues per customer have declined slightly in the past year, to $387 from $402 as marketing, capital expenses and employee expenses have taken a large bite out of the growing revenue stream.

Enterprise expenses have not been increasing across the board. APRN’s cost of buying and delivering its meals has declined by almost a quarter since 2014. In 2014, 93% of its revenues were spent in buying, preparing, packaging and delivering its meals and by 2017 that percentage has dropped to 63%. Besides economies of scale, APRN has built five fulfillment centers across the country to minimize delivery costs; bought their own wine label and beef farms to decrease bottom line costs; and reduced the number of SKU’s per meal to make order fulfillment more cost and time efficient.

In addition to operational, financial challenges, as well as customer acquisition and retention issues that APRN must overcome in order to become a successful IPO, the firm is also feeling Amazon Inc.’s (AMZN US) ever expanding retail footprint entering into their space with their recent acquisition of Whole Foods Markets (WFM US). In addition to their “normal” competitors such as Plated, Sun Basket, HelloFresh, Chefs Plate, Home Chef and Purple Carrot, APRN will have to battle an Amazon/Whole Foods partnership, which will have the advantage of dual brand name recognition; internet and brick and mortar sales; an international distribution network; and 310 million active customer accounts as of 2016. 

A larger factor than competition from Plated, APRN’s largest competitor, and increasing costs to compete in a crowded category, the impending cook-off against Amazon/Whole Foods is the primary reason behind APRN’s 33% decrease in its IPO offering price. IPO investors are becoming more wary of inflated IPO valuations, and coupled with the recent Amazon/Whole Foods acquisition, the lead underwriters may have felt that there is a higher probability of a post-IPO rally with a lower initial IPO price. One thing is for certain, short sellers that were interested in getting post-IPO short exposure to APRN before the drop in IPO price will be looking at APRN’s post-IPO price movement and will be poised to jump into the deep end of the trade at any sign of price weakness or low retail and institutional support.

Looking back at the SNAP IPO, we saw short interest climb steadily after the initial IPO date as more shares became available in the stock lending market. Borrow rates which rose to over 30% fee in the week after the IPO gradually declined to the 1% fee level once the borrow supply matched short selling demand. One month after the IPO, short interest stabilized around the $700-$800 million level (35-38 million shares). Short interest declined slightly as SNAP hit its post-IPO week high of $23.32 in mid-May, but both shares shorted and USD notional short exposure rose significantly as SNAP’s stock price slid into the high teens and lockup expirations loomed on the horizon. SNAP short interest is now over 72 million shares and $1.25 billion as short sellers are building their positions in anticipation of more share price weakness once the IPO lockups expire at the end of July and August. Stock borrow cost has risen along with short interest, with borrow cost on existing shorts hitting the 50% fee level and new shorts paying up to 90% fee on their recent trades.

APRN’s IPO will be much smaller than SNAP’s with only 34.5 million shares being offered versus 230 million for SNAP. Using SNAP’s historical short interest activity as a rough blueprint for APRN’s short activity we can expect a small amount of short selling in the first two weeks after the IPO with approximately 10%-20% of APRN’s float in stock lending pools and available to cover short sales. Short interest will initially be between 3.5 – 7.0 million shares, or approximately $40 to $80 million of short exposure until more shares settle into stock lending pools.

APRN’s stock borrow rates will start off very high, with fees over 20% which may spike to over 50% if borrow supply remains tight and short selling demand is high. SNAP’s stock borrow rates dropped quickly as prime brokers and agency lenders were surprised to find more inventory than they initially expected in their clients’ margin accounts and lending pools. Depending on the balance of retail versus institutional long shareholders, APRN’s stock borrow rates may ease quickly if borrow supply expands or remain expensive if borrow supply stays tight. Because of the relatively small float, we expect availability to remain comparatively tight over the near term and stock borrow rates to remain over the 10% fee level for some time.

Additionally, because short sellers will not have the ability to trade in size, this will be a long shareholder’s trading market. SNAP’s average trading volume over its first week of trading was 112 million shares. Of the 560 million shares traded in the first week only 17 million, or 3%, were short sales. We can expect the same trading profile for APRN: price moves in the short term after its IPO will be predicated by long shareholders either bidding up the stock price to increase long exposure, or pushing down the stock price in an effort to decrease their long exposure – short sellers will not be able to move the market as they will not be able to locate stock in size to execute their trades.

APRN’s IPO already looks less appetizing with its offering price dropping by a third, but shorts will have to wait to get a seat at the table until more stock becomes available to borrow. Stock borrow costs will more closely resemble Shake Shack’s (SHAK US) IPO where stock loan rates stayed above 10% fee for over a year rather than SNAP’s, which eased in less than a month. Any short sellers that are interested in building up APRN short exposure need to get into their trades early, if possible, because there might not be much leftover for seconds in this IPO. 

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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