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[EDITOR’S NOTE — When Blue Apron went public this summer, it shocked… well, almost no one when the IPO fell flat in the wake of the just-announced Amazon acquisition of Whole Foods. So when newer face HelloFresh took the same path Nov. 2, despite better results, eyebrows were raised — with good cause, according to guest author Daniel McCarthy, Assistant Professor of Marketing at Emory University–Goizueta Business School. So where do we go from here?]

Daniel McCarthy

The time has come — meal kit delivery business HelloFresh has gone public. The IPO was basically a reboot: HelloFresh initially planned and then abandoned plans about two years ago due to a weak IPO market and valuation concerns at the time.

Given that HelloFresh’s current IPO came just four months after the very disappointing IPO of its main competitor, Blue Apron, and the fact that HelloFresh was looking for a mouthwatering valuation — about 2x trailing twelve month sales, almost double Blue Apron’s current valuation — is history repeating itself?

HelloFresh’s CEO says the answer is a resounding no, because HelloFresh is different: He says that “his company is performing better than competitors, citing faster growth, better profitability and market-share gains.”

Shares in HelloFresh gained as much as 4% on the first day of public trading after launching at 10.25 euro. The company is rapidly gaining ground on Blue Apron in the U.S. and sold 31 million new shares in its IPO, giving it a valuation around 1.7 billion euros at current prices—more than double the $888 million (763 million euro) market capitalization of struggling Blue Apron.

Blue Apron’s stock value has fallen by nearly 70% since its initial offering at $10 in June, closing Nov. 8, at $3.19 and the company may need outside help to survive, some experts say.

If HelloFresh is dramatically better than Blue Apron, it would certainly deserve this premium valuation, so I took a closer customer-based look at the company, using virtually the same customer model that I had used to conclude that Blue Apron had a retention problem.

This model uses nothing but HelloFresh’s own publicly disclosed customer data to uncover the underlying unit economic drivers of the business — namely customer acquisition, customer retention, order rates, and spend.

Why Would HelloFresh Succeed Where Blue Apron Has Failed?

If I had to summarize the analysis in a sentence, it would be this: HelloFresh has been able to acquire more customers, and the business has been more disciplined in keeping its operating expenses under control, but customer acquisition has been entirely driven by high and rising marketing expenditures and the quality of its acquired customers is much worse than that at Blue Apron, which will create long-term headwinds for the business.

By the numbers:

  1. HelloFresh’s customers churn out more quickly — its six-month retention rate is 17%, well below the 28% that I had estimated for Blue Apron.
  2. HelloFresh’s customers spend less while they are alive — their orders per customer are 3.7, versus 4.3 at Blue Apron, while spend per order is comparable between the two firms.
  3. HelloFresh has historically spent more to acquire its customers — its historical CAC is $94, versus $84.60 at Blue Apron (HelloFresh defined CAC more aggressively than Blue Apron did, which these figures adjust for). HelloFresh spends 30% of its sales on marketing, well above the 25% that Blue Apron was spending prior to its IPO (although both figures are quite high!).
  4. On the positive side, HelloFresh does have a better operating margin than Blue Apron does, primarily because of its ability to keep operating expenses down (G&A is 4.9% of HelloFresh’s sales, versus 26% at Blue Apron).
  5. Another silver lining is that HelloFresh has kept its CAC under control — it has not grown over the past two years, while Blue Apron’s CAC increased considerably over the past twelve months.
A box from HelloFresh — which looks a lot like boxes from others…

These figures would suggest that HelloFresh is on the same “acquisitions treadmill” that Blue Apron is on, just set to a much faster speed. So while I agree with HelloFresh’s CEO that the company has faster growth and better market share gains, this is entirely due to the fact that HelloFresh is spending large and rising sums of money on customer acquisition expenses. This effectively makes marketing spend a part of the firm’s cost of goods sold, and also makes the path to profitability harder to see, particularly with such a high level of CAC. These data points do not suggest that HelloFresh’s fundamentals support twice the valuation of Blue Apron’s.

I spend some time on the model next before expanding on these conclusions.

The Model

The model breaks down into four main components — the acquisition of customers over time, how long those customers remain with the firm, how many orders they place each period that they are alive for, and how much they spend on each of those orders. Almost all of the data comes from a presentation HelloFresh released in August 2017 (see also the IPO prospectus they disclosed on October 23rd 2017), in which they almost perfectly replicated the customer data that Blue Apron had disclosed about two months earlier on June 1st in their Form S-1. Same data and same business, so I used almost exactly the same model that I used for Blue Apron (this also made it exceedingly easy to run the analysis in the first place!). As with Blue Apron, I provide a downloadable version of the spreadsheet here so that you can see the results yourselves.

As always, I want to make sure the relatively simple model I’ve posited is consistent with the customer data that HelloFresh has disclosed. I summarize the performance of the model below through a series of charts. The model’s performance here was virtually identical to the performance of the corresponding model for Blue Apron. Let’s take a look…

Total active customers:

Cumulative customers acquired, Q1 2014 to Q2 2017 (note: while Blue Apron defined CAC to be total marketing expense divided by total customers acquired, HelloFresh defined it to be total market expense minus customer care and overhead expenses divided by total customers acquired. This makes HelloFresh’s CAC figure smaller than Blue Apron’s. I assume that customer care and overhead represent 10% of marketing spend, but the conclusions are substantively the same if we assume this figure is 20% or even 30%.):

Order rate:

Total orders:

Average order value:

Total revenues:

As with Blue Apron, the fact that a relatively simple model is so consistent with all of HelloFresh’s customer data makes us feel more comfortable trusting the model’s results. I dive into those results next.

The Results

Retention: worse than Blue Apron. As with Blue Apron, we get the estimated retention curve “for free” from the model. Here it is:

Fully 83% of HelloFresh’s customers churn out after six months. This is a very low rate of retention indeed. These results are generally consistent with estimates from business intelligence firm Second Measure (chart here), which suggested a six-month churn rate of 84%. Second Measure’s data source is a large US credit card panel, which implies it is only relevant for HelloFresh’s US operations, which represent 62% of HelloFresh’s revenues. Our figures suggest that the international business is not much better.

A silver lining to this is that there is clear evidence of a “die hard loyal” set of customers who will stay around for a long period of time to come. Unfortunately, this segment is relatively small — for every 100 customers that HelloFresh acquires, only 8 of them are projected to remain customers for 2+ years.

Without running any model, these numbers make intuitive sense – HelloFresh acquired roughly 4.4M customers in 2014-Q1 2017 and had 1.17M actives in Q1 2017, while Blue Apron acquired only 2.9M customers and had 1.0M actives, which implies that HelloFresh’s retention profile is worse.

CAC: high, but flat. While HelloFresh disclosed its average CAC over the period from Q1 2014 to Q1 2017, our model gives us visibility into the evolution of CAC over time. As HelloFresh had noted, they have done a good job of keeping CAC under control — we see little evidence of CAC spiraling upwards as was the case at Blue Apron:

That being said, the overall level of CAC is concerning. At current exchange rates, HelloFresh has been spending approximately 11% more to acquire new customers than Blue Apron.

HelloFresh’s “CLV versus CAC” chart is potentially misleading. An important measure that both HelloFresh and Blue Apron alluded to is payback period — how much is spent to acquire a new customer versus how much economic value is accrued thereafter. Blue Apron had disclosed a chart in their S-1 showing CAC and the average cumulative revenue per acquired customer over time (see chart on left below). As if to mimic Blue Apron, HelloFresh disclosed a very similar-looking chart showing CAC and the average net present value of the contribution margin per acquired customer over time (see chart on right below), deflating revenues by the then-current contribution margin and accounting for the time value of money. HelloFresh used this chart to emphasize their favorable unit economics, but something is clearly off:

If there is one thing we know for sure, it is that after these companies acquire a cohort of customers, the total revenue derived from those customers will generally decline over time. This tends to be true for any company, and the analyses above and in prior notes of mine suggest that this is true for Blue Apron and HelloFresh as well. Why is it, then, that while Blue Apron’s cumulative revenue figures clearly show signs of leveling off over time, there is zero evidence of such a leveling off at HelloFresh, even when their graph should, if anything, slope off more quickly because of time discounting (I emphasize this by adding red dotted lines to both figures)? I suspect that HelloFresh may have been a bit aggressive in their visualization here. Instead of showing the average performance for a given cohort of acquired users, they are showing the performance for users who are assumed to all remain alive over the entire period. This is highly misleading, to say the least, given the fact that the chart looks otherwise identical to Blue Apron’s. As noted earlier, HelloFresh also defines CAC more aggressively, making the two CAC figures not comparable to one another.

This begs the question – what does HelloFresh’s actual historical payback period look like? I present my best guess below:

This chart suggests that their payback period is roughly 21 months. This is a much longer period of time than what I inferred for Blue Apron.

In summary, this customer-based analysis paints a picture of a business that is growing very quickly no doubt, but that this growth is fueled entirely by marketing spend, whose customer profile is otherwise worse than Blue Apron’s. HelloFresh will have to continue spending large sums of money just to maintain its current sales, let alone grow it. Returning to the question I posed to kick off this post, it does seem to me like we are seeing a repeat of challenging IPO market conditions, a difficult competitive outlook going forward, and an equally challenging customer profile for HelloFresh itself. I leave it up to the readers whether this cocktail justifies a relatively rich 2x sales multiple, absolutely and relative to its main competitor.

Daniel McCarthy completed his PhD in statistics at the University of Pennsylvania’s Wharton School in 2017. McCarthy is also the cofounder and chief statistician of Zodiac, a predictive customer analytics platform. His work has been published in leading journals and media outlets like the Wall Street Journal, Fortune, Barron’s, CBS, Slate, Business Insider, and The Motley Fool.

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