Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.
Today we’re working to figure something out, namely the tradeoffs that D2C unicorn (and soon to be public company) Casper faces as it seeks to balance growth and profitability. And then we’re going to stack it next to its most obvious public comp, Purple, to figure out what it might be worth.
This is going to be a little more wonky than usual, but I can’t help myself. Let’s go.
Profit v. Growth
Every growing company faces a tradeoff in growth and profitability. The faster a company grows, generally speaking, the lower its profitability. In reverse, companies that grow more slowly can focus on wringing profits from existing operations. Companies that grow quickly while generating profit are rare (the Zooms of the world).
The tension between growth and profit is so well-known and understood that startups are held to a rule regarding the pair, called the Rule of 40. (In the post-WeWork IPO era, get used to hearing about this sort of thing more often.)
The Rule of 40 says that a company’s profitability (in percent of revenue terms) plus its revenue growth (percent expansion, year-over-year) should add up to 40. So, if you grow at 20% per year, you should generate profit of around 20% of revenue. Of course, no startup grows that slowly or generates that much profit, so the numbers tend to look more like 100% growth and -60% profitability. (That still adds up to 40.)
Casper is an odd duck. It’s not a startup anymore, but given its focus on growth (visible in its large, growing sales and marketing spend), we can view it through a similar lens. No company spends nearly 74% of its gross profit on sales and marketing costs if it isn’t hell-bent on expanding its business!
Startups are the same. So, if Casper is mimicking startups — despite its unicorn valuation, IPO-scale revenue, and $340 million in raised private capital — how does it perform on a Rule of 40 basis? Poorly.
The company grew a little over 20% from the first three quarters of 2018 to the first three quarters of 2019. And, in the same nine months of last year, Casper lost just under 22% of its revenue on a net basis. So that’s a Rule of 40 score that’s negative. You could swap in a more generous profit number to make the math look better, but that’s too kind to a company as large and mature as Casper.
So, what to do? Casper could cut its sales and marketing spend,at the risk of lowering its growth rate. If its growth did slow, the potential attractiveness of its shares could diminish. The company is only growing at 20% with huge spend; how slowly would it grow without the outlays?
The company could belt-tighten to profitability by reducing its sales and marketing spend by its operating profit deficit. That would leave the former startup and current venture darling with just 43% of its sales and marketing budget. If that cut led to a commensurate decrease in its growth rate, Casper’s revenue expansion would slow to at just 8.6% per year while it effectively broke even. That’s a better Rule of 40 score, but not a great one.
This is why Casper took fire over the weekend. After $340 million or so in private capital, why isn’t it closer to making money?
Comps
Speaking of which, Purple — a publicly-traded, similar mattress company that raised little and makes money.
Here are some figures from its most recent quarterly report:
- Net revenue growth of 66% to $117.4 million in Q3 2019
- Gross margin improvement of 5.3% YoY to 45.0%
- Net income of $8.4 million in the quarter
- Adjusted EBITDA of $15.4 million during the three-month period
And all that is worth? $565.9 million, according to YCharts data. Its Q3 2020 revenue puts Purple on a run rate of around $470 million. That gives it a revenue multiple (loosely) of 1.2x.
At that same multiple, Casper is worth about $613 million. Casper, however, may not trade at the same multiple. Despite better gross margins, it loses money and is growing more slowly. However, even at Purple’s revenue multiple Casper is worth just a fraction of its prior, $1.1 billion valuation set during its final private round.
You can start taking bets, then, what the company may be worth at IPO. This is going to be a fascinating debut to watch.