This text is excerpted from Tom Yeung’s Revenue & Safety e-newsletter. To ensure you don’t miss any of Tom’s picks, subscribe to his mailing checklist right here.
June’s No. 1 Revenue & Safety Decide… Revealed
On Thursday, I launched 5 high-potential picks chosen by the quant-based Revenue & Safety system. They ranged from speculative biotech agency 2seventy Bio (NASDAQ:TSVT) to blue-chip BJ’s Wholesale Membership (NYSE:BJ).
Now, if I have been a quant-based investor with a whole bunch of long-short positions, I’d purchase small positions in all 5!
However we’re right here to make huge, significant bets that may transfer the needle of a concentrated, well-researched portfolio.
So as we speak, I’m going to disclose which of the 5 firms has made it to the no. 1 spot on this month’s Revenue & Safety purchase checklist:
The Turnaround E-Commerce Play
At first look, the RealReal appears to be like like a bust in terms of e-commerce performs. Founder/CEO Julie Wainwright abruptly resigned earlier this week after overseeing a 90% share value drop since its 2019 IPO.
Firm morale is at an all-time low. Account managers are routinely overworked and clients are sometimes left pissed off by an absence of service.
I can maintain occurring about RealReal’s points. A scarcity of profitability… low employee pay… shareholder lawsuits… a sagging inventory value…
So what’s the excellent news?
RealReal has grow to be so low cost that it’s now a possible acquisition goal.
Because the quant-based Revenue & Safety identified, the agency’s fast development price and bettering profitability make its $3-per-share value as tempting as a few of its on-line choices (Anybody concerned about a $150 Salvatore Ferragamo purse?)
And with a market capitalization that hardly breaches $250 million, RealReal has grow to be so low cost that even struggling Groupon (NASDAQ:GRPN) may theoretically make an all-cash provide for its fairness.
Huge winners are by no means fairly on the time (simply consider Amazon’s (NASDAQ:AMZN) $6 shares in 2001). However at as we speak’s rock-bottom costs, RealReal is extra prone to bounce 2x to 5x than go straight to zero.
And right here’s why.
The Worth of Progress
The worth proposition for RealReal is easy:
The corporate depends on a optimistic suggestions loop to develop its market for used luxurious items.
The extra merchandise listed on the positioning, the extra enticing it turns into for patrons…
… Extra patrons, in flip, draw extra sellers on the lookout for a big viewers…
… And so forth.
It’s a virtuous cycle that retains on giving.
That impact has made RealReal a celebrity within the used luxurious items trade. The corporate grew 56% in 2021; analysts anticipate one other 32% yearly over the subsequent three years.
There’s additionally a component of scale. Excessive-profile fakes like a counterfeit $3,600 Christian Dior bag require specialised information to identify, and solely scaled-up companies can afford to coach such specialised authenticators. These companies are additionally higher geared up to weed out dangerous sellers attempting to cross off pretend items.
And the very best half? RealReal nonetheless has room to develop.
Analysts at Morningstar anticipate the net luxurious market will quadruple in dimension to $47.7 billion by 2031 (even the photo voltaic trade received’t develop that quick). And REAL has but to interrupt into the used sneaker commerce, high-end artwork market, wines and different high-value resale markets.
How Unhealthy Can Issues Get?
As we noticed final week, firms on the verge of chapter unintuitively obtain a excessive high quality rating within the Revenue & Safety system; inventory markets have a nasty behavior of overestimating the possibilities of a inventory going to zero.
We will hint the phenomenon by mapping out the efficiency of Russell 3000 shares over the previous decade. The quintile firms with the bottom Altman-Z scores — a quantitative measure of solvency — outperform the opposite quintiles by 0.6% yearly.
The impact is much more pronounced as soon as we take away delisted firms. If an investor may predict which firms would disappear, their outperformance from the bottom quintile Z-scores rise to eight.9%.
That naturally begs the query: Will RealReal go bankrupt?
The quick reply:
There’s a forty five% to 60% likelihood it is going to if nothing adjustments (however maintain studying for some excellent news).
The corporate’s $361 million money hoard is simply sufficient to cowl one other 20 months of bills. And analysts don’t anticipate optimistic EBITDA profitability till someday in 2024… a margin so small that I’m counting my fingers and toes to see whether or not RealReal could make it.
Debt markets agree… they usually’re not even taking off their footwear. The corporate’s 2028 convertible bonds promote for 48 cents on the greenback with a 16% yield to maturity. In different phrases, RealReal’s financials are in junk bond territory, and credit score markets understand it.
However on this planet of investing, issues do change. RealReal’s huge consignor community and fast development price make it a tempting goal for a buyout (CEO Julie Wainwright’s resignation additionally makes it simpler to soak up). And a change in inventory market valuations may make debt and fairness financing far cheaper.
I estimate that funding bankers will begin sniffing round at $2.50/share, and affords are available no decrease than $2.00.
And if inventory markets do get better this summer time, the corporate may elevate an extra $200 million to cowl one other 12 months or so of bills. Value-per-share may simply hit $15 inside three years.
What’s RealReal Price?
Collectively, meaning an funding in RealReal has three potential outcomes*:
- Chapter: $0.
- Acquisition: $2.50 (worst-case)
- Success: $15
(*This determine ignores low cost charges to keep away from double-counting chapter threat.)
Assigning a one-third likelihood to every final result costs RealReal at a conservative $5.80, a 95% upside.
Aggressive buyers may worth RealReal even greater. Reducing REAL’s likelihood of chapter to twenty% and elevating its acquisition value to $5.00 places its honest worth nearer to $8.00, a 160% upside.
Both manner, RealReal’s potential acquisition worth offers an affordable “Safety” ingredient to this in any other case high-risk wager. And although you received’t wish to put greater than a small portion of your portfolio into this funding, the Revenue & Safety funding system means that these fast-growing turnarounds usually outperform.
Find out how to Play Dangerous Bets
Hertz (NASDAQ:HTZ) at $2…
Kohl’s (NYSE:KSS) at $35…
Perhaps even GameStop (NYSE:GME) at $4…
Firms can generally grow to be so low cost that they grow to be buyout targets.
However not each firm will get a lifeline from white-knight buyers.
Think about Sears and JC Penney, two century-old firms that vanished from inventory markets.
In each instances, the worth of those retailers’ debt and lease obligations far outweighed any “residual worth” from their saleable property. No blue-light particular may save Sears shareholders from getting nothing.
So why did these storied retailers vanish whereas Kohl’s is getting a buyout deal?
All of it involves the worth of hidden property.
Kohl’s possession of prime-grade retail areas makes it way more enticing than its steadiness sheet implies. Sears, alternatively, famously inflated the worth of its actual property holdings.
Different instances, firms like RealReal are enticing for its community results. These are beneficial property that don’t present up on typical steadiness sheets.
Regardless, these potential takeover targets present some measure of safety from shares going to zero. And although not every of those firms survives, buyers are nonetheless statistically higher off betting on these moonshots than ready for the proper funding to reach.
P.S. Do you wish to hear extra about cryptocurrencies? Penny shares? Choices? Depart me a notice at firstname.lastname@example.org or join with me on LinkedIn and let me know what you’d wish to see.
On the date of publication, Tom Yeung didn’t have (both immediately or not directly) any positions within the securities talked about on this article.
Tom Yeung, CFA, is a registered funding advisor on a mission to deliver simplicity to the world of investing.