22-Oct-2022: Is the market overreacting? This post of mine is an attempt to answer the question posed by @juneauquan earlier today about whether the market has overreacted to Redbubble's latest update and Q1 (Q1 of FY23) results. Is it really that bad?

Firstly, the market usually does overreact, both to the upside and downside. However, RBL went up on potential in 2020, when the market was happy to base share prices off revenue multiples and all sorts of rediculous metrics. Who thinks they were worth over $6 when they were trading at over $6 at the beginning of 2021? I certainly don't.

The market is only interested in profits again now, and RBL have committed the worst sin of all, they've gone from being marginally profitable back to being unprofitable again.

Q1 of FY22, EBIT of $0.9m and EBITDA of $3.9m. Q1 of FY23, EBIT of ($17.0m) (a $17m loss) and EBITDA of ($14.6m) (a $14.6m loss).

Every metric on that chart has gone backwards over the 12 month period (Q1FY22 vs Q1FY23).

Here's the analysis from @Solvetheriddle (see straws) from 2 months ago (in August, after RBL's FY21 results were announced):

The last six halves with revenues (blue), PBT (orange) and CFO [cashflow] (grey/silver). The left side shows revenue, the right side shows the profit and cashflow.

"Its been a wild ride for RBL through C19. Revenues falling again this half but costs not --cash crunch. Only trading at about 0.6x sales, but the lack of control over the operating lines is disconcerting to me. Plenty of cash [coming in], but where is it going? One for the thrill seekers imo." (source: straw by @Solvetheriddle)

Here's the table that RBL gave us back in August with those FY22 full year results.

What they appear to be highlighting there is: Sure we had a terrible Annual result when you compare FY22 to FY21, but there is some positives if you just look at Q4 of FY22 vs Q4 of FY21, i.e. the most recent quarter at that time, as in, at least the revenue was slightly higher even if the profits and cashflow were lower. Other positive spin included:

FY22 Operational Highlights:

• 809K selling artists across the two marketplaces, up 19% vs FY21, the largest number of selling artists ever
• 14.4 million active Redbubble members, down 7% vs FY21, up 32% vs FY20
• 68% of Marketplace Revenue (“MPR”) is recurring from existing artists, up from 60% in FY21 - reinforces annuity value of artist content
• 60% of MPR from organic (unpaid) channels, in line with FY21
• Continued positive momentum in repeat purchases, to 46% of MPR, up from 42% in FY21
• 60% of sales from mobile platforms, with 15% of Redbubble MPR from apps 2
• Days to ship reduced 28% in 2H22 and delivery time estimates reduced 1-5 days for 91 products
• AOV of $59.7 (on GTV) up 5% vs FY21, and up 9% in Q4FY22 vs pcp
• Average base price rise of approximately 6% implemented in May 2022
• Successful free shipping UK trial in May 2022 

--- end of excerpt ---

Well, fast-forward to Q1 of FY23 and their trading update (just released), and EVERYTHING has gone down, even their revenue. And this current market is not going to take that well, sorry to say. The market wants to see profits again now, not losses, and they definitely don't want to see a company that was borderline profitable slipping back into being unprofitable along with every metric heading in the wrong direction.

So, in my opinion, this is pretty much how I would expect the market to treat both the FY22 full year result (when they released it in August) and this latest update (and Q1 result). You can call it an overreaction, but there are reasons behind it, and it's been similar to reactions across other companies that have had reports and updates like this.

RBL is basically heading the wrong way both in terms of their share price and in terms of their metrics - revenue is down, profit is down, cashflow is down, the only thing that isn't down is their overheads - their costs, which seem to keep growing. This is no longer a growth company and that's why people are getting out, even many of those who probably counted themselves as "true believers" prior to this latest update. You can only give a company so much rope. Hope is not a good investment strategy.

Here is the chart of a company I hold which have recently also gone from being profitable to being unprofitable for the most recent quarter:

It's a shocker of a chart, but since mid-August the share price has more than halved from over $1/share to under 50c/share now. Same deal. Even people who considered themselves true believers have been bailing out more recently. I still hold. Why? I believe I understand why the recent quarter tipped them into being loss-making, and I believe that all of the factors the caused it were temporary and not structural and that they should be profitable again either by the end of this current quarter (Q2) or the next one (Q3). I won't go into detail because this post is not about St Barbara (SBM), it's about Redbubble (RBL) but I've detailed my reasoning over in the "Gold" forum. One of the issues was a weather event in Nova Scotia (Canada) - Cyclone Fiona - see here: https://watchers.news/2022/09/25/fiona-makes-landfall-in-nova-scotia-as-the-deepest-low-pressure-system-to-hit-canada-on-record/ - which took out the power in the area for 10 days, including the last week of Q1. It also caused a pit wall collapse at SBM's Touquoy gold mine which was going to take about 3 weeks to fix. It has been described as the worst storm to hit Canada since they started keeping records. This is just one example. There are others. What I'm saying is that there were extenuating circumstances here, one-off events that should not reoccur, or at least they should not reoccur very often, so I think if you remove the effects of those events SBM would have been profitable and once those events are firmly in the rear-view mirror SBM will be profitable again. The company also owns well over $1 billion worth of assets - which includes 3 different gold processing plants in 3 different countries, 3 producing gold mines, and hundreds of millions of dollars worth of gold - most of it still in the ground, but it's there, and less than $100m worth of debt. So the short version is that I think their problems are temporary and with a market cap that is now down to under $400m, they are very cheap, and trading well below their net asset value (NAV) or their NTA (net tangible asset) value.

Can we say the same thing about RBL? RBL's market capitilisation (share price x number of shares on issue) is now down to $136m (@ 49c/share). According to their report in August, their net assets as at 30-June-2022 added up to $104m, however $70.7m of that $104m were "Intangible Assets":

Here's what they had to say in August about those Intangible Assets:

So their intangibles consist of (1) Capitalised Development Costs (CDC), (2) Goodwill (acquisition costs less accumulated impairment losses) and (3) "Brand Name".

Regarding the first one (1), CDC:

"Development expenditure is capitalised when future economic benefits are probable. The Group capitalises internal engineering time spent on development of the Redbubble and TeePublic marketplace websites. Expenditure during the research phase of a project is recognised as an expense when incurred. All costs for Software as a Service (SaaS) are expensed."

So - the cost of developing software and internal engineering time. Sure, that's an asset if it enables the generation of income, or if it could be sold to somebody else, and both are true I guess. They are generating income from their software, and their platform has value, so it could be sold to someone else. However, what someone else would be prepared to pay is probably not accurately relected in their own numbers, because their own numbers are based on what they have spent to date developing that platform and that software, and that is an entirely different thing to what someone else may be prepared to pay to buy it, should it ever be for sale. But sale value is what asset value is really about. That's why many people only look at NTA - net tangible assets - when looking at the fire-sale value of a company - or break-up value of a company - because the value of intangibles is usually more of an art than a science and can change quickly, and that is especially true of (2) Goodwill and (3) Brand Name.

So, it looks like the net TANGIBLE assets of RBL at 30-June-2022 was more like $33m ($103,957K less $70,746K of intangible assets = $33,211K or $33.211m), and at 49c/share it would cost you $136.1m to buy all of their shares, so they are trading at more than $100m higher than their NTA and around $32m higher than their book value including intangible assets.

That's fine if they get bought out by someone at a higher price, or if they can turn their metrics around and start growing again while containing or reducing their costs. So, if they can prove that they'll be worth more in the future than they are now, but right now they're not proving that. They're not scaling well. The best platform companies contain their costs a lot better so that extra revenue means more profit - or lower losses if they are not yet profitable. Even though they grew revenue (sales) in Q4 of FY22 (over Q4 of FY21), their costs were even higher, so the additional dollars in revenue did not fall to the bottom line. The costs wiped out the extra revenue and the bottom line was just a larger EBIT loss and NPAT loss, and their EBITDA went from a small $1.7m profit to an ($8.9m) loss. And things got even worse with Q1 of FY23.

If you want to hold on, I would suggest you need a rational investment thesis. And answer: What has happened over the past year that is one-off, not structural, that has caused this bad result, and why are RBL going to return to growth and profitability in the future?

I could be wrong about St Barbara (SBM) and other companies I hold that look like complete dogs on a chart, wrong about why they are going to turn around, but at least I can articulate my investment thesis. I've written it down, and I can measure the company against my expectations and if I decide at some point that the investment thesis is busted, i.e. if I realise at some point that I am wrong (either because I've made a mistake or poor assumption, or because new data/evidence has emerged), then I will cut my losses, no matter how big they are, because I can always make some money back by changing to a different horse mid-race, rather than lose even more by doing nothing (meaning leaving the investment in a company that is likely to go lower and not recover). If we get 6 out of 10 calls right, we should still do OK, but that all depends on how much you lose on your bad calls, and how much you win on your good ones. Knowing when to cut your losses is a big part of that.

Disclosure: I do not hold RBL. I have never held RBL. I do hold SBM (who I have used as an example above). I don't know RBL well. My very limited look at RBL is summed up above. Other than that, I know it's a company that a lot of people have lost a lot of money on (both real and paper losses), however I have no view on their future. They do not look cheap to me, but if they were a fast growing and profitable company where most of their additional revenue was falling through to the bottom line as profits, they would definitely look cheap, and if you have good reason to believe that they'll get to that point within a reasonable timeframe and without any dilutive capital raisings, then they may well be cheap.

P.S. Clarification: While Commsec lists RBL's m/cap at $136.1m, the ASX website says their m/cap is $147.19m, so about $11m higher than the number I've used above. My point however was that they do not look cheap to me (@ 49 cents/share), so adding $11m to their market capitalisation doesn't change that. It just makes them look slightly more expensive. But that's just based on their assets, not their potential.

Great post there Strawman thanks.

There are a number of markets where the economics of google search and facebook to a lesser extent make making money rather difficult.

It's a bit of a weird one too as paid advertising on google usually results in 2-4 companies being quite visible, which makes it very hard to attract the majority of sales. Many consumers would click on multiple and then go for the best price/value.

Natural google results also apparently have decent 2nd and 3rd slots.

Is there something of a network effect potential in not so much the consumer side, but the client side of things? If they become the place where the most artist products are sold, then artists will go with them, then creating a network effect as it become the place to look for customers? (I have no idea, just thinking out loud)

Nice process and analysis @Dominator 

https://strawman.com/reports/RBL/Dominator