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even nods in the direction of an industry, businesses tremble and investors flee. At


W 1.91%

the biggest online furniture merchant, investors did the opposite.

The company’s shares are up 115% in the last year, valuing it at $8 billion. Since its founding in 2002, Wayfair has mastered the art of selling and delivering furniture online, a logistical challenge, but it hasn’t figured out how to do it profitably. Now new competition, high marketing costs, low customer retention and its need to keep raising cash loom as risks to Wayfair’s future.

Much of its success in undercutting traditional players with faster and cheaper shipping options is due to its investment in its own in-house logistics network. “We were less enamored of its furniture business than its logistics strategy,” says

Brendon Osten

of Venator Capital Management, which has 5% of its portfolio in Wayfair. “It’s an interesting strategic advantage.”

That advantage may not survive new competition. Amazon has built warehouses to handle furniture, which it says is one of its fastest-growing categories. It also has partnered with local furniture stores and launched two furniture brands.


and Target also have made investments that could help them launch furniture efforts. Meanwhile, traditional furniture retailers are stepping up online sales. Around half of sales for retailers

Restoration Hardware



are now online.

More important, even though it sold $4.3 billion worth of furniture in the past four quarters, Wayfair needs to spend aggressively on advertising to bring in customers. Its total advertising spending for that period was $500 million. Only around 9% of Wayfair’s traffic comes from consumers searching for the brand, according to L2 Inc. By contrast, Restoration Hardware and Williams-Sonoma get 60% to 70% of their traffic from brand-modified searches, L2 says.

A recent study by marketing professors

Daniel McCarthy

of Emory University and Peter Fader of the University of Pennsylvania’s Wharton School found that Wayfair spends about $69 to acquire each new customer, but only earns $59 back from each acquisition. Using a method of valuing publicly traded retailers that focuses on customer retention, Professors McCarthy and Fader conclude that Wayfair is overvalued by 84%.

Wayfair’s weak brand loyalty may be tied to its lack of stores—there is still value in sitting on a sofa before buying. That would help it fight off Amazon but may leave it vulnerable as traditional furniture retailers gear up for e-commerce.

Wayfair’s biggest risk is its need to raise cash to offset its losses. It has sold stock twice in the last two years, followed by a convertible-bond offering in September. (The company reports full-year earnings later this month). For the first three quarters of 2017, free cash flow was negative $114.7 million—about the same as the first three quarters of 2016. At the end of the third quarter, Wayfair had $610 million in cash and short-term investments.

The stock market selloff makes Wayfair more vulnerable. “The problem is when the market goes down and there are businesses with good economics as alternatives,” says

Dan McMurtrie,

managing partner of investment firm Tyco Partners, who has shorted the stock in the past.

The company’s poor economics have made it one of the most shorted stocks in the internet retail sector, with 18% of available shares sold short. Those betting against Wayfair thought they had a winner last November, when shares fell 20% following a widening in net loss to $76.4 million from a year-earlier $61 million. Investors sent the shares down 20%, but they soared soon after, more than wiping away the losses.

Wayfair’s best bet, and the biggest risk to short sellers, is that it will be acquired. As the company’s valuation climbs higher, though, it will become more expensive to buy Wayfair than to clone it. The company’s investors should pray that someone makes that economic mistake.

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