– Lot of initial buzz about Casper IPO but sales growth, though strong, decelerating

– After $423 million in marketing spend, net losses continue and no end in sight

– Need for continued high investment in marketing and SGA; long product cycle

The initial public offering market has had a rough time of it since the WeWork IPO debacle last year. The stink from that spectacularly failed IPO has stuck to the new issues market in general, but particularly where an IPO tries to market itself as a tech type company when perhaps it isn’t.

That brings me to the Casper Sleep (CSPR) IPO last week. Unlike WeWork’s IPO, Casper’s offering went off, but not without a hitch as it had to reduce its price to $12 per share from a previous range of $17-$19, after prospective investors pushed back.  They did for good fundamental reasons, as I hope to show below. These remain relevant even as the stock is down 20% to about $10.

Consequently, some investors might be tempted to buy now. However, if you bother to look through its 285-page IPO filing, you might not. Its market capitalization is less than $500 million, though at one time it was thought it could go for over $1 billion.

Casper Stock Might Not Let You Get a Whole Lot of Sleep

 Let’s start with the many buzzwords—a WeWork specialty—that Casper sprinkles throughout its IPO document: the “sleep economy,” which Casper values at $432 billion; the wellness equation; the business of sleep; and “cutting edge technology,” all to  describe an operation that sells mattresses (and to a smaller extent, pillows, sheets etc.) but doesn’t make them. Indeed, two contract manufacturers produce 70% of Casper’s mattresses, so there’s a supply concentration risk.

I don’t wish to paint a totally negative picture for the company that pioneered a “mattress in a box” sales technique.  Casper has shown fast revenue growth; created strong brand awareness in just a few years; is using a multichannel approach—online, 60 retail outlets—and uses retail partners like Target (TGT), among others; improving gross margins, and has relatively low debt. Casper cites a study forecasting the U.S. sleep economy to grow at a 3.6% compound annual growth rate (CAGR) by 2024. (See chart.)

In the first nine months of 2019, Casper’s average order value (net revenue divided by total orders placed) rose to $710 and $820 from $583 and $437 in 2017 through e-commerce and retail channels, respectively. In 2018, 2017, and 2016, net revenue was $357.9 million, $250.9 million, and $169.1 million, respectively, or a 45.5% CAGR.

Nevertheless, I believe these positives are more than offset by a host of concerns about its business and fundamentals, even at $10 per share. For investors looking to play the “sleep” theme, important words are missing in the Casper IPO document: They are “net profit,” or any prospect of such in the intermediate term. After about six years of existence and $423 million in marketing spend over the past three years, the company has only red ink to show for it.

Perhaps more importantly for the near-term stock price, Casper’s vaunted sales growth, though still strong, has rapidly decelerated. That doesn’t bode well. For 2019, the company expects 23% growth. Though strong, it’s a big drop from 45%.

There’s another, more important trend going the wrong way. The 2019 net loss is expected to be between $96.4 million and $91.4 million, compared to 2018’s loss of  $92.1 million. Taking a toll is continued investment in sales and marketing and in general and administrative expenses to support growth, particularly in retail stores and product development.

Given the competitive intensity of the mattress business, it’s reasonable to assume this kind of spending isn’t going to end any time soon. In its IPO filing Casper admits as much, writing that it needs to invest in marketing and its supply chain, since, as mentioned, it doesn’t make its mattresses and has a concentrated supply chain. 

As a recent report from New Constructs, an independent forensic research firm, points out, Casper’s brand awareness has not come cheap and the costs don’t look to be subsiding any time soon. Total operating expenses made up 71% of revenue through the nine months ended September 2019, up slightly from 70% over the prior nine-month period. For comparison, over the same period, rival Purple’s (PRPL) total operating expenses were 38% of revenue.

New Constructs believes that Casper cannot cut out these expenses and generate meaningful recurring revenue, given the industry’s multi-year replacement cycle. According to The Better Sleep Council (BSC), the average mattress should be replaced every seven years. This relatively long product replacement cycle means Casper spends heavily to win a customer, but doesn’t see repeat business for years, thereby diminishing the return on customer acquisition costs.

Since its beginning through September 30, 2019, 16% of customers through its direct-to-consumer channel have returned to purchase another product. Hmmm. Casper may want to sound like a tech firm, emphasizing its data and insights, but its products have nowhere near the recurring revenue of a true tech firm, New Constructs opines.

Casper Stock Might Not Let You Get a Whole Lot of Sleep
Source: FS Insight, Bloomberg

Lastly, I’ll point out that Casper says in its IPO filing that it has a “material weakness” in its internal control over financial reporting. Now this is likely to be remedied but it does not inspire confidence.

What is Casper?  If there’s one thing investors learned from the WeWork disaster it’s that just because a company tries to look like a tech company, it might not be. To me, Casper looks like a stock that isn’t going anywhere.

After all the buzzwords and marketing, this situation reminds me of the scene in the movie “Inside Llewyn Davis” where musician manager Bud Grossman says to the lead character, an aspiring musician:  “I don’t see any money here.”

Where I could be wrong: There is “stupid money” risk. With a small cap like Casper, it’s always possible that someone, a competitor or private equity, might make an offer.

Bottom Line: A history of losses, the prospect of more, plus intense competition don’t inspire confidence. Casper mattresses might be great but the stock could keep you up at night.

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