New Spin-Off CommerceHub Is Overvalued

On August 22, CommerceHub, Inc ($12.29, Market Capitalization: $522 million) reported 2Q16 results. Net sales increased 16% YOY to $23.1 million, primarily due to 17.5% YOY increase in the Usage revenue, which contributed 66% to the total revenue. Adjusted gross profit increased 15% YOY to $ $17 million, while margin contracted by 83 bps to 74.9%. Adjusted EBITDA reduced 24% YOY to $6.3 million, leading to margin contraction of 1,434 bps to 27.4%. Adjusted EBITDA declined due to YOY increase in payroll-related taxes triggered by the large amount of SAR’s exercised in 2Q16. Adjusted net income decreased 38% YOY $2.6 million or $0.06 per share.

CommerceHub Spin-Off Background

On November 12, 2015, Liberty Interactive Corporation announced plans to spin-off two of its newly formed companies - CommerceHub, Inc. and Liberty Expedia Holdings, Inc. to shareholders of Liberty Ventures. On July 22, 2016, Liberty completed the tax-free distribution of CommerceHub, Inc. In the distribution, LVNTA shareholders received 0.1 share of CHUBA and 0.2 share of CHUBK for every LVNTA share and LVNTB shareholders received 0.1 share of CHUBB and 0.2 share of CHUBK for every LVNTB share held as of the record date July 8, 2016. On July 25, 2016, CommerceHub Series A and Series C shares started regular-way trading on the NASDAQ under the tickers CHUBA and CHUBK, respectively, while Series B shares started trading on the OTC market under the symbol CHUBB. Our revised target price for CommerceHub at $9.25 per share (previously $8.50), implies ~25% downside from the current market price. We reiterate our Sell rating on the stock.

Key Highlights of the Conference Call

CommerceHub Expands Partnership with Walmart

August 22, 2016, CommerceHub signed an agreement with Walmart to expand its existing partnership, integrating directly with Walmart’s online third-party marketplace. CommerceHub will continue to support Walmart’s drop-ship fulfillment process through its virtual inventory solution.

Agreement with BJ’s Wholesale Club

August 2, 2016, BJ’s Wholesale Club, Inc. announced the selection of CommerceHub’s unified platform to drive omni-channel growth. The deal will help BJ’s to provide its members with great value and products by using CommerceHub’s network of numerous brands and distributors. BJ’s is a leading operator of membership warehouse clubs in 15 states. The platform will coordinate the process of buying, storing and shipping inventory from CommerceHub’s network of ~9,500 drop-ship suppliers that receive orders and ship products directly to consumers.

Free Cash Flow

In 2Q16, the company’s reported a negative free cash fl ow of $ 77 million as compared to a positive free cash flow of $6 million in 2Q15. Net operating cash outflow was $73 million as against cash inflow of $8 million and the company’s PPE increased to $1.8 million from $0.7 million, primarily related to the move into a new corporate headquarters.

Overall Results

Net sales increased 16% YOY to $23.1 million, primarily due to 17.5% YOY increase in the Usage revenue, which contributed 66% to the total revenue. The increase in the Usage revenue was attributable to 15% YOY growth in order volume. Total customer count at June 30, 2016 was 9,726 as compared to 9,191 at June 30, 2015. Adjusted gross profit increased 15% YOY to $ $17 million, while margin contracted by 83 bps to 74.9%. Adjusted EBITDA reduced 24% YOY to $6.3 million, leading to margin contraction of 1,434 bps to 27.4%. Adjusted EBITDA declined due to YOY increase in payroll-related taxes triggered by the large amount of SAR’s exercised in 2Q16. Net income for the period was $4.3 million as compared to a net loss of $1.1 million in 2Q15. Adjusted net income decreased 38% YOY $2.6 million or $0.06 per share. We note that in 2Q16, CommerceHub’s revenue has decelerated from 1Q16 levels, while earnings has also been impacted significantly on marketing initiatives.

Investment Thesis

Subsequent to the 2Q16 earnings report, management noted that the near term revenue growth is likely to moderate, following a review of the profitability of the customer base at its Mercent unit. Although we commend the management for its focus on profitability, we reckon that the decline in the top-line will significantly impact its ability to generate favorable operating leverage. We also note that higher operating expenses due to increased sales effort could continue to impact earnings, thereby eating into margins. Given the high-growth nature of the business, we could possibly ignore the current earnings weakness; however, the deceleration in revenue growth (2Q16: 16% YOY; 1Q16: 18% YOY) and management expectations of a further moderation in the near-term is a cause for concern.

Valuation

We have used a combination of relative valuation methods: EV/Revenue (50% weight) and Price-to- Earnings (50% weight) to value CommerceHub. We value the company at a multiple of 3.5x 2017E Revenue and P/E of 12.0x 2017E adjusted net profit. We continue to value CommerceHub at a significant discount relative to one of its competitors i.e. SPS Commerce, given the potential top-line moderation and also earnings weakness at CommerceHub.

Despite the company’s partnerships with key brands and investments in marketing initiatives, we believe CommerceHub is exposed to significant execution risk, especially with respect to the pace of adoption of its solutions by clients. However, we have modestly raised our conservative top-line estimates, which also leads us to a raised price target on the stock.

Company Description

CommerceHub, Inc. (CHUBA/B/K) provides cloud-based technologies and services that enable retailers to radically expand their product offering without inventory risk. It provides integration and fulfillment services to both online and brick and mortar retailers, distributors, and supplier companies such Sears, MSC Industrial Direct, Kohl’s, Macy’s,Costco, QVC , Staples, Best Buy, Meijer, drugstore.com, Walgreens, Dell, Toshiba, Sanyo, Minolta, Gateway and Little Tikes. CommerceHub acquired Mercent in 2015, which is a leading retail technology company offering product content management technology enabling profitable, high-growth retail marketing campaigns through channels such as Amazon, eBay, Google Shopping, Facebook and other major digital advertising programs.