Pando

How Stitch Fix built an IPO-worthy ecommerce company in an Amazon world

By Kevin Kelleher , written on November 15, 2017

From The Lessons from the Trenches Desk

'After several seasons of drought, the IPO market for consumer tech may be finally seeing signs of life.

For the most part, the IPOs with the strongest-performing stocks this year are in the enterprise space. AI startup Veritone is trading 93% above its offering price, for example, while enterprise-cloud company Okta has risen 72% from its offering price. Contrast these with brand-name tech unicorns like Snap and Blue Apron, which had high-profile debuts, only to see their stocks tumble well below their offering prices.

That dynamic seemed to change in late September with Roku. The streaming-TV device and platform company went public at $14 a share and shot up 67 percent on its first day of trading. Following strong earnings, Roku more than doubled to reach $48 a share earlier this week, before falling back to $37 a share yesterday.

Even amid such volatility, with Roku's revenue exceeding expectations and with the company on track to reach profitability early next year, Roku gave the IPO market something it badly needed: a consumer-tech name that investors could get hopeful about. Just think what would happen to investor confidence if a growing company like Roku went public with an actual track record of profits.

We may see such a company in the coming days, and it's one situated in a market widely regarded as trouble for startups: e-commerce. Stitch Fix is planning to raise as much as $195 million in an offering priced between $18 a share and $20 a share. Strong demand could push that offering price higher before the IPO date.

Why would Stitch Fix be in high demand? The company saw revenue in its fiscal year through July rise 34% to $977 million and posted an operating profit of $32 million. Stitch Fix recorded a net loss of $594,000 in that period, largely because of a $19 million remeasurement of stock warrants, which the company doesn't expected to recur in future years. In 2016, Stitch Fix had a net profit of $33 million, and a profit of $21 million the year before that.

Profits have become rare among tech IPOs. In 2009, more than 70% of tech companies were profitable when they went public. That ratio has fallen below 30% during each of the past four years. When companies like Snap and Blue Apron debut with no profit in sight, then increase spending only to see their revenue fail to keep pace, it leaves a sense of wariness around later IPOs that don't have a clear case for near-term profits.

Stitch Fix has not only delivered steady operating profits, it's done so in e-commerce in the Age of Amazon. The company, however, is careful not to call itself an e-commerce company. On its site, it's a “personal style service.” In its prospectus, it's a company “delivering one-to-one personalization to our clients through the combination of data science and human judgment.”

This wording is more than mere branding. It gets to one thing that Stitch Fix has in common with Roku: Both are commonly thought to be active in a troubled industry – manufacturing devices for Roku, e-c0mmerce for Stitch Fix – but in fact both have worked hard to evolve beyond those markets. Roku, for example, is becoming more of a software platform licensed to TV manufacturers.

In Stitch Fix's case, the company is trying to address a gap that CEO Katrina Lake saw emerging as shopping at brick-and-mortar stores was supplanted by e-commerce. As retail stores slashed costs, they became less personalized. Most e-commerce sites are even more depersonalized. “Personalization in retail can be difficult and nuanced,” Stitch Fix says in its prospectus, because it involves intangibles that vary by person and typically involve long-term customer relationships. The company's response is a mix of data science and human judgment.

The very human experience that we deliver is powered by data science... Our stylists leverage our data science through a custom-built, web-based styling application that provides recommendations from our broad selection of merchandise. Our stylists then apply their judgment to select what they believe to be the best items for each Fix. Our stylists provide a personal touch, offer styling advice and context to each item selected and help us develop long-term relationships with our clients.

Both Stitch Fix and Roku also have founder CEOs whose vision permeates the culture of their company and who are determined not to let outside forces distract them from that vision. Lake largely eschewed venture financing – Stitch Fix raised only $42.5 million in venture capital since its founding in 2011 – as well as the bro culture that often comes with it. In a July interview with Entrepreneur, Lake said the worst piece of advice she ever received was to raise as much capital as she could.

It was hard to raise money for this concept. We turned profitable in 2014, and we've been able to stand on our own two feet and invest in ourselves. All of that is a function of the fact that we were forced to think about the economics of our business early. And I think there are companies out there that may have failed, because they had too much money and never had to think about the economics of their business.

The success of that approach is underscored by financial metrics unlikely to be ignored by investors. The company has had positive cash flows since 2014. Fairly early on in its existence as a startup, the company became able to finance much of its expansion through its own operations. Last year, cash flows from operations were $39 million. As a result, cash on hand rose to $111 million in July from $91 million a year earlier.

Whatever the reception that Stitch Fix receives during its IPO, the company faces its share of challenges, most of them familiar to any up-and-coming tech company. To keep revenue growing, Stitch Fix will need to hire more staff, expand its fulfillment infrastructure, and spend more on marketing. To date, Stitch Fix has grown largely through word of mouth, but the company plans to increase advertising and other marketing initiatives.

In other words, spending will increase. Stitch Fix's operating costs rose faster than revenue in its most recent fiscal year, pushing its operating margin down to 3% from 9% in fiscal 2016. And it's not clear how much the frequency of Stitch Fix shipments taper off among older customers whose closets are filling up with regular deliveries of new clothes. Stitch Fix' prospectus warns that “helping [clients] find clothes they love reduces their need for more apparel in subsequent periods.” And that it's not likely to “force more spending” from them, but rather let them order when they want.

Despite those risks, Stitch Fix' offering stands out. Not just because it has years of operating profits. Or because it's financed its growth largely through its operations. Or because it's succeeding with only $42.5 million in capital invested. Or that it's done all this when so many online-fashion startups like Gilt and Fab have floundered.

Beyond these distinctions, Stitch Fix stands out because Lake basically tore up the playbook issued to startup founders, instead trusting her own instincts. As Bloomberg columnist Shira Ovide aptly put it, Stitch Fix is the anti-Uber. While the Valley was celebrating Travis Kalanick, and while many founders were emulating Uber's capital-hungry business model, Lake was quietly building a tech company that investors are likely to line up to invest in.