✨ volume 2 -- mattress on fire: an analysis of casper's IPO
don't put your cash under your mattress... or on its ipo either
In this volume, I write about:
what Casper is
how its business model (direct to consumer works)
what direct to consumer (dtc) is
and the impact of product commoditization
All opinions are entirely my own. I do not own any Casper stock or Tempur Sealy stock. Nor do I represent any party related to Casper’s IPO. tl;dr - Bystander with some thoughts.
part 0 - ipo day
Casper IPO’d yesterday, Feb 6th 2020, with its fair share of press coverage. Key words surrounding the coverage included:
big private, VC backed “tech” company
cash strapped
no direct path to profitability
forced to IPO, and so on
A few days before the IPO, Wall Street Journal released an article foreshadowing public investors sentiments —
The mood in Silicon Valley has changed dramatically in the past year, as Wall Street investors have proven far less enamored with many high-profile, high-loss startups than venture capitalists expected. Uber Technologies Inc.’s stock is down 16% since its listing last year, and Lyft Inc.’s is down 32%, while the Nasdaq composite index is up over 18%. Their experience, along with the failed effort to go public by WeWork parent We Co., have left startup financiers fearing the same fate for their own investments, and sparked a scramble across Silicon Valley to stanch the flow of red ink.
Unsurprisingly, when markets opened the morning of Feb 6th Casper, sold shares at the bottom of its already lowered price target of $12 each compared to $17-$19 earlier that week. This brought down Casper’s valuation from its private company “unicorn status” $1.1bn to $575mm.
How can the discrepancy between private and public market valuations be as much as 50%? What metrics are private investors attaching themselves to? And why doesn’t the public market buy it?
But before I dig in, let’s talk about the company.
part 1 - what is casper and why buy it?
In 2018, I graduated from college and shortly thereafter, moved into my first “adult” apartment. The furnishings were sparse but the first line item on my furniture list was a bed. I wasn’t picky, and I didn’t know too much about the bedding market, but all around me friends were investing in “beds in boxes” (Allswell, Casper, Tuft and Needle, Purple, etc.).
The selling point of these boxed beds were especially attractive to somebody like myself:
It delivers in a box, without the need of much assistance, into your apartment (2) decent price point,
It’s affordable, and great value when benchmarked against other beds of equal caliber (a Tempurpedic can cost twice as much) and
Offers a generous return policy with a 100 day trial period and free returns (just schedule pick-up)
Given all of the above, it didn’t make sense to not buy a Casper… or one of its competitors… so I placed my order for my first boxed bed (yes, the caveat is to come - that it really does make sense to buy one of its competitors so how brand loyal can you be to a bed? - more on this later)
*** Disclaimer: Like most of the peers in my cohort, I too fall culprit to well-designed advertisement and social media influence. It was all over Instagram. My friends bought it. Even my favorite Kardashian sponsored this bed. I needed to know what it felt like to “Sleep like Kylie Jenner”
Source: @kyliejenner Instagram
part 2 - what is direct to consumer?
All of these benefits rode on the coattails of the newly minted direct-to-consumer or “DTC” business model. Though Casper now sells through 60 Casper retail stores and 18 retail partners, its innovation lay in its disruption of the mattress supply chain.
DTC changed the paradigm in three ways:
Price. While brands historically have had to share a cut of their profits so suppliers, distributors, and every middleman in between got paid their share, DTC cuts out all the middlemen and a sa result customers get the best price possible
Data. Previously, brand had no data on who the end customers were, how to best target them, and at best, they could only market into the void and hope for the best shelf space. In contract, DTC allows the brand to control the right messaging for the right audience.
Upfront cost. Instead of expanding geographically in one location first before selling to distributors in other geographic regions, direct-to-consumer brands could market directly to the demographic that bought it / are the most likely to buy it. Turnaround time to product innovation is also increased as the brand now has direct access to customers. It’s a win-win.
Casper entered the DTC market as such. They made it
Easy to buy a mattress online, cutting out cost of retail space and partners (no markup for customers)
Effective data and efficient advertising to acquire customers
Using the above to make the best products for customers
Repeat and do the best job possible to continue to win market share
This is an awesome roadmap. But like most problems with the DTC market, the disruption in the mattress space (buying a mattress) doesn’t necessarily mean the disruption of running the actual mattress business. Customer experience is heightened, better economics drives more competitors, and in the end, you’re competing dollar for dollar to acquire more customers. This means branching out to retail spaces, partnering with distributors to promote the brand, and eventually moving away from the core fundamental that make DTC profitable in the first place. This is exactly what happened to Casper.
part 3 - product roadmap from pure d2c to mattress firm part 2
Mattress Firm, was once the go to mattress retailer. They provided pervasive retail space dedicated to buying mattresses. When DTC mattresses rolled out in 2014, along with rising rents, decreased demand from slowing home sales the previous half decade before, Mattress Firm went under, filing a Chapter 11 in October 2018.
Casper took the win in that battle, but what it didn’t know that it was signing up for another. Once Casper took off, a dozen other boxed mattresses also took off shortly after, demanding ad space and customer attention.
Source: CBI Insights
This effectively commoditized the once coveted, innovative, and experiential bed in box customer journey. Casper does not report any numbers on Customer Acquisition Cost (CAC), but I imagine that what they did next was fueled by the burning mandate to expand, beat out competitors, and grow at all costs.
They started opening retail stores. First in Manhattan, then 59 more through the rest of America primarily targeting millennial-dense communities such as New York and California. In their S-1 they plan to open as many as 200 store in North America.
See below a beautifully designed timeline of Casper’s roadmap. See partnerships and first permanent store in mid 2017/2018.
Source: Casper S-1
This roadmap to success is matches the results on their financials. According to their S-1:
Our direct-to-consumer revenue was $310.2 million in 2018, up 41.9% over 2017, and was $258.6 million for the nine months ended September 30, 2019, up 13.0% over the nine months ended September 30, 2018. Our revenue from retail partnerships was $47.7 million in 2018, up 47.7% from 2017, and was $53.7 million for the nine months ended September 30, 2019, up 74.6% over the nine months ended September 30, 2018 (link)
This means the brand is moving away from their main business as DTC slows down (presumably from the lack of customer differentiation due to increased competition / commoditiziation of boxed mattresses), and more towards third party distributors and in store retail. This would carve a space in the mattress market similar to that of Tempur Sealy (NYSE:TPX), which owns a portfolio of several high quality mattress brands with reportedly good unit economics ~50% gross margins. It does not, however, position Casper as a truly disruptive unicorn-level “Sleep” company, as the brand so advertises.
There’s nothing wrong with carving out a niche in the Tempur Sealy space. They’ve dominated the high end mattress brands for the last decade. However, the problem is in the unit economics. Casper runs like a technology company, where recurring revenue is the norm, customers have high repeat rates, and the biggest hurdle is acquiring the customer — growth at all costs. However, Casper is not a software company with 90% gross margins. It’s margins top out at just under 50%. And to attract customers, it has spent $422mm in marketing from 2016 - 2019 (link).
High CAC and long sales cycles work for technology companies because of high gross margins and low churn with eventually payback the CAC (see LTV to CAC ratios). However with Casper, only 16% of customers that have purchased once through the DTC channel have returned to purchase another product (link). The counts on the marginal upsell of other sleep products to prove the value of brand loyalty and Casper as a “sleep platform”, but what is misses is this — the consumers who are buying Casper beds do so because of its convenience and price point. We might buy sheets and pillows there while we’re at it but we won’t try to replace every bed (their highest value product) in the house (if we even have more rooms in the house) just because the brand is Casper. We might be upsold by the lamps, but more often than not, individual tastes and preferences vary. This isn’t a platform technology play (like Peloton or Apple). And to assume brand loyalty can continue to drive topline substantially is putting a lot of eggs in a basket consumers might not pick up.
To add fire to the flame, only time will tell how successful this mattress company will be, and whether the concept of a lasting brand will stick in this generation of quickly influenced millennials. According to Consumer Reports (link) mattresses need to be replaced every ten years. The earliest Casper customers are only in Year 5 of their mattress lifetime cycle. Will these customers return to buy another Capser? Too much of it would be speculation so let’s work with what we have — some unit economics.
part 4 - casper’s unit economics
If only Casper’s S-1 laid this out formally, but we have bits and pieces we can deduce. And perhaps, it’s intentional they’re not drawing attention to their increasing CAC, slowing DTC sales and no direct path to profitability besides big hopes on a capturing a large TAM (through upsell/cross-sell) and brand equity.
The first metric to break down is the Average Order Value (AOV). According to Casper, the AOV - net revenue divided by total orders placed - increased from $583 in 2017 to $686 in 2018 and $710 for the nine months ended 9/30/19 in their e-commerce channel.
The main takeaway — Casper is successful in increasing their average order volume. But this growth in its e-commerce channel is slowing. Customer spent 18% more money in 2018 vs 2017, but only 3.5% more in 2019 Q3 vs 2018. Some of it could be seasonality not captured in the last quarters’ total revenue but in the mattress business, most sales take place around Spring / Fall around Memorial and Labor Day, and less so Christmas (you don’t get a box mattress + pillows for Christmas). This goes to say that it looks like each customer is spending more money at Casper but at a rapidly decreasing rate.
Growth, albeit slow, in AOV is good. But the question is at what cost. The cost here is $105mm on direct advertising. Breaking it down to the unit economics — Direct-to-consumer revenues in the corresponding period (last nine months to 9/30/2019) was $259mm. This leads to approximately 364,000 mattresses sold through this channel, and a sales acquisition cost of approximately $300 a mattress.
This next point is obfuscated in the limited data in their S-1, but it looks like CAC is also increasing. Advertising spend increased 23% in the corresponding time period, while direct to consumer sales only increased 20%. On top of that, 20% of customers are already assumed to be repeat customers, to emphasize that it cost more to get each new customer through the door.
Meanwhile, gross profit per sale is $355, ~50% gross margin. If the product has an AOV of $710, post production, Casper is left with $355. Taking out the (slowly increasing CAC), Casper is left with $55/mattress to cover the rest of the business (SG&A, retail space, sales and marketing (not direct advertising spend)).
In that time period, $106mm is spent on SG&A, and another $9mm on non-direct sales and marketing. Roughly speaking, this tacks on another $315 of costs per mattress. There’s an argument that SG&A becomes more efficient, but you’d have to cut SG&A by 80%, assuming sales and marketing remain at current levels, for each mattress to break even. tl;dr, currently not a sustainable business model.
At this point, I hope the drivers are clear. Some sort of the following must happen for the company to reach profitability (1) Gross margins improve - mattresses become cheaper to manufacture (2) Marketing decreases without largely decreasing sales (unlikely) (3) The company cuts almost all the staff it needs to operate (unlikely) or (4) Increase their AOV by a 30-40%.
part 5 - but we have a large tam!!
At this point, investors are pretty pessimistic. But Casper comes in, and it’s obvious throughout the entire S-1 that they have a huge TAM, and an awesome brand (the word brand is repeated 201 times in the S-1). Economically, this is to assure you they can increase AOV over time through cross sell and into new markets.
Source: Casper S-1
But investments into these spaces also require time and money. Say they invest in sleep services, they’ll be competing toe to toe against Calm, Spotify, Headspace, etc. all of which are also competing aggressively (with marketing dollars) for customers. In the end, the TAM doesn’t really matter. Casper can tout its dreams of being a “sleep” company with a lot of TAM left to cover, but until it makes headway in that already very competitive space, it’s hard to make so many promises on brand alone.
part 6 - i love my mattress but…
Driven by no real promises in the unit economics front, a very difficult to disrupt TAM that’s hyper-competitive, as well as increasing CAC driven by immense competition with no real product differentiation from comparable brands like Nectar, Tuft & Needle, Helix, Leesa, Tempur-Cloud (and dozens, if not hundreds more), Casper’s best bet in the near term is to wean off of the VC-funded, grow at all costs mentality and figure out its unit economics / how to properly scale. Will Casper ever truly be a “Sleep” Company? Are consumers that brand loyal? Or is Casper just selling public investors a dream? Only time will tell.
part 7 - the clock is ticking
Based on business model (difficult to scale, highly commoditized, and no real path to profitability) and current public market sentiments on VC backed, cash bleeding high growth startups, I predict that Casper won’t fare so well in the public markets. Current investors should be especially careful post the 180 day lock up period, during which existing VC shareholders totaling around 28% (NEA - 12%, IVP - 5%, Norwest - 5%, Red Cart - 7%) could decide to sell off their positions.
Investors also need to be careful of the short term cash flow bandaid that Casper gained from the public market capital infusion and the implied run rate Casper has to continue its current business model. Based on the shares sold (~8.3mm at $12 a share, the company raised a total of ~$100mm. Excluding bookrunning fees charged by GS/MS Casper is likely to take home $95mm in cash.
This $95mm, on top of their current cash balance of $55mm as of 9/30/2019 brings us to a total cash position of ~$150mm. In the last year, Casper burned through $72mm of cash on top of $13mm in CapEx, totaling a FCF decrease of $85mm. If Casper’s business model does not turn around, investors might be wary of providing additional liquidity to the company. What does this mean? Casper has a little short of two years to figure it out before it runs out of cash. Tick tock. The timer is counting down.