Pandemic shutdowns across the globe drove one positive effect for e-commerce companies: a boom in consumer spending. People sheltered-at-home are choosing delivery for everything from daily necessities like groceries and personal items, to home improvement projects, house plants, and more.
Windfall e-commerce spending has peaked the interest of the bulge bracket, evidenced in recent funding and M&A activity:
Uber acquired on-demand delivery platform Postmates in a $2.65B all-stock deal. Postmates was valued at $2.4B in a September 2019 capital raise. Along with Uber Eats, the in-house competitor-turned-complement to Postmates, Uber now holds an impressive 37% of food delivery sales in the US. Postmates has around 10 million customers and Q1 2020 revenues of a~$107M, pricing the sale at around 5.6x revenue and around $240 per customer.
Walmart finished dining on Jet.com, officially winding down the company this May after purchasing it for $3.3B in 2016. Jet was a catch-all retail competitor to Amazon, and Walmart’s strategic buy allowed it to quickly ramp-up a gold-standard e-commerce division. Walmart has also shown interest in developing in-house brands through acquisitions of DTCs like Bonobos (apparel).
Days ago, Amazon received final approval from UK regulatory authorities to purchase a minority stake in food delivery startup Deliveroo. Amazon was previously in the food delivery market via Amazon Restaurants but exited in 2019. Deliveroo has raised a massive $1.53B to date, and while its valuation at the Series G round in which Amazon participated remains undisclosed, it’s estimated as high as $3-4B. Over 2018 revenues of £476M (and losses of £232M) that estimates the deal price at 4.8x - 6.4x revenue.
Using revenue as a valuation multiplier is common when discussing private transactions where valuation methods are undisclosed (such as those mentioned above), since it’s often the only data publicly available. It’s important to note, however, that venture capital market sentiments are shifting away from the “growth at all costs” mentality of the 2010s. Startups and venture investors need to consider not just “how much revenue” but “how sustainable is the revenue growth” and, ultimately, “does this company create long-term shareholder value.”
So how do we translate the COVID-19 e-commerce boom? There are three vital areas of company performance to consider when deciding if an e-commerce startup has achieved real growth that’s likely to increase its price per share: customer acquisition trends, customer retention and repeat purchasing, and shopping cart size and product mix.
Customer Acquisition: Will Ultra-Low CAC Trends Hold?
E-commerce companies, and companies offering digital consumer products and services in general, felt a surprising effect of the pandemic: CAC (cost per acquired customer) decreased at the start of shelter-in-place orders. In layman's terms, companies are getting more bang for their marketing bucks, evidenced by a windfall of new customers without a proportional increase in marketing spend.
What does this mean for company value? First we need to understand what role the company’s customer acquisition strategy played in acquiring these new customers.
If the company’s acquisition channel mix and in-house marketing efforts remained the same as pre-pandemic, increased user acquisition is likely due to macro changes to supply (competitor activity) or demand (consumers spending habits). Such changes may be traced back to combinations of:
consumers buying more;
consumers shifting distribution from brick-&-mortar to e-commerce;
competitors dying out or altering their strategies;
or bigger players retracting marketing spend thus leaving more consumers in the market to be captured.
Simply put: in this instance the company is getting more customers because there are more consumers available in the market, not as a result of more competitive acquisition strategies.
If the company has flexed its acquisition efforts, it may be finding more effective acquisition channels and gaining more high-value customers proportional to marketing spend, which bodes well for increasing valuation.
Customer Retention and Repeat Purchasing
Regardless of how the company acquired new customers, next begs the question: will they return?
For the uninitiated, a vital performance metric for startups is LTV (customer lifetime value) to CAC. It puts context around marketing spending, relative to how much value is derived from the customer before she stops returning permanently (AKA churns out and can be re-captured in the acquisition funnel). So if you spend $100 to acquire a customer, and she makes 10 purchases over the course of her customer lifetime for an LTV of $1,000, the company has a healthy LTV : CAC of 10x or 10:1.
So, a company that retains its customers for a long time and drives those customers to purchase more frequently, is generally creating company value. Regarding our discussion of e-commerce valuations in the COVID era, the questions are:
Will new customers return to purchase;
Will new customers purchase more or less often than the existing customer base; and
Are newly acquired customers making purchases in the same pattern as previous customers?
Companies that answer yes to the above are managing customer retention well. Companies that answer “no,” or even worse “we don’t know,” should be digging deeper into shopping cart abandonment, page engagement (via click-thrus and time spent), acquisition source, and other areas.
Shopping Cart Size and Product Mix
In some e-commerce models, even a long customer lifetime filled with frequent purchases can be sullied by customers not spending enough per order (a low dollar-amount cart size).
Key questions are:
Are new customers checking out with cart sizes greater or less than those of existing customers;
How does the mix of products that new customers are purchasing compare to what’s typical of the existing customer base?
Similar to the examination of repeat purchasing, we’re trying to understand if we can expect better, equal, or worse LTV for the new cohort of customers.
Performance-Driven Growth Drives Valuation
Whether you’re an investor evaluating a company or a startup assessing internal performance, considering the above will help you understand whether the company has significantly increased in value or whether recent trends are an anomaly related to macroeconomic and sector-based events.
Companies that are increasing shareholder value will:
Have strong customer base growth combined with sustainable CACs, resulting directly from a competitive marketing strategy;
Show strong customer retention and repeat purchasing patterns from their existing and newly-acquired customer bases;
Show customer shopping cart mixes that drive both revenue growth and per-order profit margin.
Lastly, this discussion has revolved largely around revenue generation, with little focus on operating model and expense management. It’s important to note, however, that revenue is rarely the single determining factor in company valuation, especially in the transactions that the typical startup or venture investor will participate in. A general rule of thumb for evaluating startup performance (and thus valuation) is to use EBITDA (profit); it’s the gold-standard valuation metric, which is why it’s used across transactions: from startup funding to private equity buyouts and M&As. Drive EBITDA whenever possible, so long as you don’t sacrifice growth that can be achieved through bonafide competitive advantage.