Blue Apron

This post highlights some of the key ideas from my short pitch on Blue Apron. Download the PowerPoint file here. As this is my first short pitch, I’d love to hear any comments or questions regarding my investment recommendation. Please don’t hesitate to contact me at ashenoy8@uwo.ca or on LinkedIn.

For Blue Apron (NYSE: APRN), the American meal kit service known for its underwhelming IPO in 2017, the COVID-19 pandemic acted as a lifeline by providing its sales a much-needed boost. In March, shares jumped 612% in 5 days as investors believed that lockdowns and work-from-home orders would increase demand for Blue Apron’s services. Investors were indeed right as Blue Apron added 50,000 subscribers over the course of just months. However, it looks like investors have yet to realize that the company’s performance has returned to pre-COVID levels. This presents a potential short selling opportunity, the reasons for which will be explored in this article.

Blue Apron (NYSE: APRN)

Blue Apron is a direct-to-consumer meal service that provides fresh ingredients, recipes and wine to consumers across the United States. Customers can purchase up to four recipes online each week, with meal kits serving up anywhere from two to four people. Meal kits consist of a recipe as well as fresh ingredients that are apportioned into plastic bags. They cost approximately $10 per serving and customers historically tend to spend $60 per order on average.

Now that we know how the business makes money, it’s time to explore the key reasons for why the business is doing poorly. First, it’s pretty evident that Blue Apron profitability issues stem from its revenue problems. The company that saw exponential growth in the mid 2010s has seen its revenue plummet. Let’s see why this has been the case.

Blue Apron Revenue and Growth. The light blue bar is an estimate for Q4 2020.

After exploring Blue Apron’s revenue model, it’s clear that the company’s problems start with customer retention issues. Last quarter, Blue Apron served 357 thousand subscribers. Compare that number to its 1.04 million subscribers in early 2017 and that should raise a red flag almost immediately. Furthermore, Blue Apron’s margins have remained relatively constant, with its gross profit margin hovering around a respectable 40%.

Customers since Blue Apron’s IPO year (2017). Note that number beyond 2020 Q3 are estimates.

Let’s dig deeper. It’s clear that the number of customers has been falling but a deep-dive into Blue Apron’s quarterly statements suggest that, surprisingly, Blue Apron’s customers are ordering more on average. For example, even one year ago, the average customer ordered 4.5 times per year compared to 5.4 times last quarter. So despite an increase in the frequency of orders, the number of customers is falling. The takeaway here is that while Blue Apron’s loyal customers may have continued to use its service frequently, Blue Apron is losing infrequent customers that only buy a couple of times each year. The number of infrequent customers is falling and that increases the average orders per customer as Blue Apron is left with customers that order more frequently.

What could be the reason for this? Well, following the IPO in 2017, management recommended that Blue Apron cut its marketing budget from roughly 25% of revenue pre-IPO to 15% post-IPO. Over the last few years, that percentage has fallen even lower, and Blue Apron’s current marketing expenditure sits at around 10% of revenue.

Blue Apron’s marketing expense since 2017.

It’s clear that customer retention is an ongoing issue. But Blue Apron still has well over 300,000 customers and compared to most other American meal kit companies, that number is incredibly high. So what’s the issue?

Well, the company has made some financing decisions that are frankly questionable, and it’s these decisions that could come back to haunt Blue Apron.

Let’s explore Blue Apron’s capital structure. When the company reported Q3 earnings, it had a revolving credit facility with approximately $34 million outstanding and $121 million of common stock (market value). Since then, the company decided to refinance its debt. On October 16th, Blue Apron received a senior secured term loan of $35 million due March, 2023 with an interest rate of 8% + LIBOR. The company, which had around $60 million of cash on hand, used $10 million of cash and some of the proceeds from the term loan to settle the revolver. Assuming that they have made no pre-payments since then, they have $35 million of the term loan outstanding. With a cash balance of around $60 million, that doesn’t seem too worrisome.

But wait! The term loan carries with it multiple restrictive covenants. While I won’t describe every covenant, I want to highlight 2 covenants that I think could jeopardize the company’s future. First, Blue Apron must have a subscriber count greater than 300,000 until December 31st, 2021 and 320,000 beyond that date. I predict that this covenant will be breached by Q3 2021. Furthermore, the company must have at least $30 million cash on hand at all times. This liquidity covenant could be breached in 2021 as well.

First, Blue Apron’s subscriber count is currently sitting at 357,000. This number, while marginally higher than its pre-COVID count of 351,000, is significantly less than its peak of 396,000 during Q2 2020.

Blue Apron’s subscriber count is subject to seasonal fluctuations. The company has, since its IPO, added customers during Q1, but lost them during the rest of the year. Management suggests that this is due to the fact that during the summer (Q3) and winter (Q4) holidays, customers have less predictable weekly schedules and therefore, are less engaged. This certainly makes sense and we can expect a small spike during Q1 2021 as lockdowns continue. However, as more people get vaccinated and as we head into the summer of 2021, I predict that Blue Apron will see significant dips in its customer count. By Q3 2021, I expect the subscriber count to fall below 300,000 and for a covenant to be triggered.

Blue Apron’s subscriber count. A covenant will be triggered beyond a minimum subscriber count of 300,000.

Next, the liquidity covenant. Please check out the PowerPoint included in this post to see my model and assumptions.

There is one question that all investors should have. Can’t Blue Apron simply turn to the capital markets again and issue equity to pay off its term loan? While that may be true, I believe that Blue Apron’s ability to do this is limited.

First, let’s see what would happen if Blue Apron tried to do this. We don’t need to guess here because in August, the company did its first equity issuance since its IPO. Blue Apron raised $37 million and shareholders were diluted 29%. Shares fell 21.5% in a single day. Since early August, Blue Apron’s share price has fallen by roughly 50%, so if the company did raise equity, they would have to dilute existing shareholders even further. I predict that shareholders will not take kindly to another round of equity financing considering that the last issuance took place just months ago and the share price slid significantly.

Finally, short sellers may worry that Blue Apron could simply be sold to another strategic buyer or financial sponsor in the near future. This is a legitimate concern, but for the reasons I will lay out below, I think this risk is limited.

  1. The meal kit industry isn’t an attractive industry.

Buyers would be much more likely to look at targets in the meal delivery industry. Recently, companies like DoorDash have done exceptionally well in their IPOs and the meal delivery industry has historically grown and will continue to grow much faster than the meal kit industry for the foreseeable future.

Personally, I don’t believe that the meal kit industry is attractive because the value that meal kits provide to customers is relatively limited. Blue Apron has all of its recipes on its website, so customers are not paying for access to recipes. Ultimately, they are paying roughly $60 per order for convenience (the ingredients are sent to them) and the portioning of ingredients (customers only receive the quantity of ingredients that they will need). With meal delivery on the other hand, the service is still convenient and they don’t require that the customer cook the meals. I think the meal kit is a fad and one that will not last very long.

2. The meal kit industry is slowly becoming dominated by a few large players.

I found it difficult to find comparable companies for Blue Apron, simply because there aren’t many. Blue Apron once had 40% market share in 2016. Today, it has 13%. This isn’t an inherently bad sign for a buyer looking to pursue a turnaround strategy. However, during this time, HelloFresh, the largest player in the meal kit industry has increased its market share from 16% in 2016 to 49% in 2020 and it’s still growing. Other smaller private companies like Relish Labs and Sun Basket have around 10% market share as well, up from around 4% in 2016. The percentage of market share for firms outside of the four listed in this article (HelloFresh, Sun Basket, Relish Labs and Blue Apron) has decreased from 36% in 2016 to 20% in 2020. The market is getting taken over by these large companies, making a turnaround all the more difficult. If the industry was very fragmented and Blue Apron still lost market share, it wouldn’t have been as big of a deal.

Meal kit industry market share.

3. Every C-suite executive will have been replaced by the end of 2020 with no improvement in the company’s financial position.

Typically, a buyer may look to replace senior management. However, Blue Apron has already taken care of that and has unfortunately been unsuccessful. Since its IPO in 2017, the company has had 3 CEOs. Its CTO left last year; its COO left in June and its CFO will leave this week. Management turnover hasn’t improved Blue Apron’s financial performance so a potential buyer’s options are limited in this regard.

Blue Apron’s short-term liquidity issue is the symptom of a much larger internal crisis. COVID-19 may have provided a lifeline to the company but Blue Apron’s operations are burning $10 million every quarter; with only $60 million of cash on hand, it’s options are limited. The company has turned to the debt and equity markets recently and it looks like creditors and shareholders aren’t too happy as evidenced by strict covenants and sharp declines in the share price. Even if the company triggers a covenant and is able to amend the terms of the loan or receive additional financing, the problems regarding customer retention aren’t going away any time soon.

A small window of opportunity still exists for short sellers so start the new year by betting against Blue Apron.