Q3 2021 Market Commentary

Warby Parker Investors May Need Their Vision Checked

At the end of September, eyewear maker Warby Parker went public via a direct listing on the New York Stock Exchange. If you are not familiar with the company, it was founded to solve the problem of eyewear being too expensive. Not only has the company been able to make inroads into the corrective vison market by going direct to consumer, it has also impacted those without any access to vision correction with its “Buy a Pair, Give a Pair” program, which has distributed more than eight million pairs of glasses to those in need. Additionally, the company is a certified “B-Corporation,” also known as a “benefit corporation.”

According to an article in Forbes, these companies are an organizational form of for-profit companies that are committed to solving social and environmental problems through the power of business. Other B-corps include well-known brands like Ben & Jerry’s, Dansko, The Honest Company, Cabot Creamery Co-operative, Patagonia, and New Belgium Brewing Company. Clearly, these companies have created a new context from which to operate and attempt to overcome big challenges. However, as we often do in these pages, our primary goal is to evaluate businesses from an investment perspective in order to answer the following question: Is the common stock (or bond, etc.) going to provide a commensurate return on the capital used to purchase it?

Cost and Ownership Structure Post Direct Listing

Warby Parker (WRBY) was launched as an online-only brand in 2010 and later began to expand into physical stores. As of June 30, 2021, there were 145 retail store locations. The cost structure of online only is much more streamlined than the dual channel (online and retail) model. Drilling further into costs, for the first half of 2021, approximately 50% of Warby Parker’s total sales came from online, down from 60% in 2020. It seems as though sales have shifted more towards the higher-cost retail channel. Moreover, marketing represents as large an expense as selling: general and administrative expenses tally 70% of revenue. Regarding ownership, the company’s founders will retain Class B shares that carry super-voting characteristics, leaving them with 48% of the voting power even after shares are trading publicly. Furthermore, the direct listing allowed executives, early private investors and employees to sell 92.5 million Class A shares and the company itself did not receive any of the proceeds from that sale to the public.

WRBY Valuation

Based on data from the Wall Street Journal, after its first day of trading as a public company, Warby Parker’s equity was worth $6.8 billion. This valuation was two times greater than the mark it received during a private funding round last year. The company is currently unprofitable on a bottom-line basis and is on track to reach $535 million in top line revenue this year. For the six months ended June 30, total sales revenue was $270.5 million and losses were $20.4 million. Looking back at 2020, WRBY generated $393.7 million in top line revenue with a net loss of $55.9 million vs. $370.5 million in sales and a loss of $57.5 million in 2019. Based on extrapolating 6/30/21 results forward for all of calendar year 2021, the stock of WRBY is trading at approximately 12.5 times estimated 2021 sales revenue, using the 9/29/21 closing price of the stock. The only upside to not being profitable is that no tax is due on negative earnings. Although no perfect comparison exists, let’s compare Warby Parker’s main fundamental metric – its price to sales – with a broader gauge of overall retail by looking at the exchange traded fund XLY (noting that the two largest holdings in XLY are Amazon and Tesla, which comprise almost 40% of the fund). XLY clocks in at 2.3 times next year’s sales.

Corporate Taxes and Earnings for the U.S.

Washington, D.C. is awash in talks about infrastructure bills, funding the government, raising the debt ceiling and, of course, how to pay for it all: taxes. At this writing, the proposal that seems most likely to pass is raising the corporate tax rate to 25%.

The current administration is working on plans to ask corporations to foot much of the infrastructure bill, as they would stand to benefit significantly from upgraded transportation and communication grids. The above table from NDR works through the math on the impact to S&P 500 earnings. On a net basis, if corporate taxes are raised to 25%, after-tax earnings could drop by as much as 9%. (Note: 2019 earnings were used for the above table, as 2020 earnings were skewed by the pandemic.) Adding to the complexity of a new tax picture is the percentage of earnings coming from foreign sources. Approximately 43% of the S&P 500 profits come from overseas and a change in the tax treatment of this earnings stream could present a bigger headwind to U.S. multinational corporations. No doubt there will be much horse trading as the fall season continues. Stay tuned!