Simeon Siegel - Retail Therapy
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Bill: This episode features Simeon Siegel. Simeon is a Managing Director and Senior Analyst at BMO Capital Markets. That's Bank of Montreal, for those that don't know. I met Simeon at the Liberty dinner and we hit it off. We discussed doing a podcast, he agreed. This is the result. I had a great time recording this one, I think the energy and it's great and settle back and enjoy some retail therapy. As always, none of this is financial advice. All of the information contained in this program is for entertainment purposes only. Please consult your financial advisor before making investment decisions and do your own due diligence.
Thrilled to be joined by Simeon Siegel today, and we met at the Liberty dinner before Liberty Investor Day, sat next to each other, had a nice evening, and you explained a little bit of your Peloton thesis, and Shane was excited to have me meet you. So, that's how we met. How's life going, man? Interesting earning season.
Simeon: Great to be here. I can tell you that sitting next to a random person talking about Peloton, I did not plan for it to get aired. But always fun where conversations go. Listen, the beauty of earnings season is that they are never ending and they always keep you on your toes.
Bill: Yeah. You may be the first sell side analysts that I've had.
Simeon: Oh, well, that's a win. It's a funny job. We are a special breed of human, where we get to opine, and impact, and not get our hands wet or feet dirty, or whatever that phrase is supposed to be. I fully get that. But on the other hand, I would hopefully argue an opportunity to try and be intellectually honest the whole way through and the vicissitudes of the market, we can actually take a little bit maybe write the longest view, because we can't be squeezed out or called.
It just depends which way you want to look at it not having risk on the table, I think is generally viewed as a negative, but on the other hand, we're getting out very publicly and expressing our views, and I can tell you that there's definitely impact of being wrong. But what it allows you to do is take a really close view and say, "Do you believe?" Whether it was Adam Smith or not, because I think it's a falsely attributed quote. But this notion of staying solvent longer than the market sell side analyst in theory gets to. So, if taken the right way, you get to actually try and take the truest perspective of fundamental intrinsic value.
Bill: That's really interesting, because the perception that I run in, I think is that the sell side is usually late to upgrade and downgrade, and a little bit more focused on quarters. So, I haven't heard it put that way.
Simeon: I thought you were going to go with lazy when you went with luck. Late actually is a nicer way of going. So, let's go with late.
Bill: [laughs] No, I tell you what, man. The way that I learned is I studied Buffett and whatnot. I think that there's a misnomer in my interpretation of what he was saying and perhaps, what he was saying about the sell side or what people that study him say. I've come to appreciate what you all do very, very much. I don't know that on average I take the recommendation portion as seriously as I maybe would if I didn't know more, but I do think that as far as following what's going on in the industry, I think people that don't respect the sell side don't have a good idea of what you all do, if that makes sense.
Simeon: [crosstalk] I appreciate that. What I'm not going to try and do is argue. We all have different roles and I fully understand where the perception comes from. I also to your point listen, if I walk off of a call, whether it's with by-side or a corporate, and the response is you provoked thought or I hadn't thought about that before, that's an interesting question. Whether we agree or not on the dynamic move of the stock, that's a win, because that's in theory, what hopefully I'm doing, if I'm doing my job is taking the fact that I don't have to worry about my risk and take in the fact that I don't theoretically have to worry about the same level of duration. All I have to worry about is what are the metrics telling me, where's the puck going?
Being on that opposite side, hopefully, what I'm doing is making me think about something you didn't otherwise think about. You take that to do the same recommendation from a stock perspective, that's your product, because you're getting paid the P&L, I'm not. But it allows me effectively this freedom to really try and understand what do I believe the story of this company is telling me and then obviously, I figure out the sentiment in the direction, etc. But that's a separate conversation.
Bill: Yeah, that's interesting. If I'm hearing you correctly, it sounds you view your job as surfacing really important questions, and then having discussions around those, and then, if people disagree, that's fine, but at least if, let's say, I'm a client of BMO. If I can call you and have a conversation that I otherwise would not have had, because you raised an issue, that's one of your real roles in the whole process. Is that fair?
Simeon: 100%? Listen, I'll say two things, because I think you just hit on some very interesting points. I've had some of my worst days of the job, where I've had a buyer rated stock up 20% and my phone didn't ring. I've had some of the best days of the job when I've had a buyer rated stock down 20% and I didn't have chance to go to the bathroom. At the end of the day, if my opinion doesn't matter then there's no benefit. But the interesting thing is to your point, we just upgraded Under Armour recently. On that call and it's the first time we had to buy an Under Armour. Historically, I have had to sell on Under Armour. On that call throughout that day, every person I spoke to was effectively like, "Okay, these are some interesting points and I didn't get much pushback." I'll tell you, that's worse. I want pushback. I want to know that it's contrarian. Now, what made me feel better was that at the end of the day and I don't know when we're airing this, but this got to-- [crosstalk]
Bill: Probably, two weeks-ish.
Simeon: It just happened in the middle of January. As hopefully, as the listeners are not feeling, January was tough for a lot of people, especially mid-January. Everyone kept saying, the ideas make a lot of sense. I get it. But there's no way I'm putting something on right now. I don't have the leash, I don't have the P&L, it already feels it's October. It was this interesting dynamic where for my seat, the other benefit that we haven't addressed is, I get a sentiment perspective that if I'm willing to listen to it actually can help create this value add that, here's an idea that might be crowded sentimentally, but it's actually not crowded from an ownership perspective.
What that means is if it was magically Jan 1 instead of let's say Jan 15, or magically everyone just started, there's no watermark, there is no wall to climb. That stock would have been up in my opinion, because people want to own it. They just can't right now. So, that's a totally different reason to own a stock, but it is really important and it's an interesting perspective that if you listen to the conversations you're having as opposed to just speaking them.
Bill: Yeah, that's interesting. That's a unique place to sit and a unique funnel to have. I think what you're saying reminds me of something that I heard about somebody in another stock last year. The person was charged with researching disruptive industries was I think their charge. Found a stock, the PM pitched it, and this is all hearsay, but what I heard is like, "Look, if this goes down 30%, we can't lose and own this." We can lose and own something else that's more consensus, but this has got too much hair on it and it's interesting how that happens.
Simeon: That is part of my ethos. I just had this conversation with a recent-- I'm not going to say which one, but a recent IPO that we took public that we all know how the basket of IPOs are doing. And what conversation I had with them was effectively, you need to internalize. This company, this management team is the entire world. You need to internalize right now is there's no one sitting at a fund. Long only or hedge, that's going to lose their job by missing your stock go up 10x right now. Whereas, with everything going on, with all the potential flags, looking at the performance, etc., for someone to actually stick their neck out, that's a big conversation.
What's really interesting that I I overlay into my Mosaic is the person sitting at that whether it's an analyst or PM, or a PM to an investor, when they make this pitch, are they going out on a--? Are they going to get fired if they're wrong or is it easier just to ignore? It's a warped way of thinking about investment, but in my conversations, that's the subtle undertone that I hear all the time. This is not in my benchmark, it's not going to matter, I don't need to be a hero. Obviously, the hero calls when you get them right are the really compelling ones. Those are the ones you retire on. But the reality is not everyone's a hero.
Bill: Yeah, that's interesting. When I was at BMO Harris and there was a-- [crosstalk] Yeah, I was in the food group there for a while and then I went to a mid-corporate or not mid corporate. It was commercial middle market. But there was such a wall between you guys and us like we could not talk at all, but I always respected-- It was Joel. He covered commodities like potash and phosphate. [crosstalk] Yeah. Man, that guy was always on the road. He was busting his ass all the time. You guys don't sleep. It doesn't feel like at least.
Simeon: I call it discretionary. I started off covering Abercrombie & Fitch, and pivoted to just focusing on consumer discretionary, and what makes something no longer a commodity. I don't track unit philosophy. I don't know anything about Walmart. But if you tell me, I've got a pair of pants and it becomes a pair of Lululemon leggings, or I've got an oven and it becomes a Traeger wood pellet grill, or I've got a bike and it becomes a Peloton, that's what gets me going. This idea of understanding pricing power, this idea of understanding price elasticity of demand, internalizing that there's psychology behind what a consumer buys and pays, but there's also a ton of psychology driven by the management team, because no company is managed by an algorithm, the management people.
Bill: Yeah.
Simeon: When I think about it from that perspective, that's powerful, that's a lot of fun. What I will say though, is a lot healthier for me to have embraced this fitness area, where I spend half my time on the Peloton, or the tonal, or the hydro, or wearing my Whoop, I just took off the order. then just being on the food side or the other things that we have to get very comfortable with. So, I might not sleep, but the Whoop tells me about it every day-- [crosstalk]
[laughter]
Bill: I got my Oura on, man. I like this stuff.
Simeon: Yeah. Mine's charging.
Bill: Do you have an Eight Sleep?
Simeon: No.
Bill: Oh, I'm going to send you this and then, Eight Sleep needs to sponsor this podcast, damn it. It changed my life, man. It's incredible. All right, so, the best way I know how to describe it is, it's a thin water layer that goes over your bed. Some people know of the ChiliPad. I think the difference between the Eight Sleep and the ChiliPad is that, you can have different sides of the bed be different temperatures. I did a podcast a while back with this woman, Louisa Nicola, and she was telling me that I needed to prioritize sleep. I knew it was true, but I didn't know how to do it.
She recommended to get an Oura, get an Eight Sleep, and change some of my habits. I did it all at the same time. I can't say this is causal, but what I used to do is, I used to turn the temperature in my room way down, but then I get my blankets on, and then I'd sweat in the middle of the night. This cools me from the bottom and it changes temperature through the night. I like to wake up, I like to go to bed a little bit cold, I like to sleep cold, and then I like to wake up warm, and it'll change when I want it to and then it vibrates to wake me up. So, it doesn't wake my wife up when the alarm goes off, because it's just vibrating, and I can get out of bed, and then it's sick.
Simeon: This sounds awesome. My increasing unifying theory of everything tech is, retail was easy, you shopped in a store, life was good. Tech came along, it demolished the business. It destroyed barriers to entry, which means it massively enacted barriers to succeed and life became even harder. What's happened in the last five years, where people have realized that you can use tech to help you. I think this increasing pivot, any company that really has the unlock is a company that takes tech to demystify, de-elitify, basically, it takes something that people can't do or don't know how to do and they're embarrassed to try, and lets you learn in the comfort of your own house, and you make mistakes in your attic.
Peloton was a great example of that where people look and see spin classes. If you've never done it, you're not going to go into one, because they're intimidating. I think Traeger is a really good example. Also, I mentioned them same idea where I've wanted to know how to grill forever, I've flip burgers forever, and they generally don't taste all that great. But all of a sudden now, here comes a company that tells me, "Press this button and do this. You're going to be a hero." I actually have-- I think I'm on hour 20 right now of a brisket smoke happening, my kids think. So, this idea of if you can take this tech and you can say, "Listen, people want to know how to sleep, but they don't even know what they're doing wrong, [crosstalk] the tech can educate you, but it can do it without having to ask someone," that's powerful.
Bill: Yeah. I'll tell you what's wild is I put the Oura on and my buddy, Dan McMurtrie was like, "You're going to see what one drink does to you at night. "When you sleep, even one drink--" I don't know if I'm outing his theory. Sorry, Dan, if I am, but he's like, "You're better to just go get hammered one night and then be totally sober six nights." Then, this is not medical advice, folks, but it is wild. Even one drink, my heart rate through the night spikes 10, 12 beats.
Simeon: The problem you are talking about being causal, it's right is just prescriptive or analytical, but the problem is when you wake up and you feel great, that was a great night's sleep and then you open it up, and hit Oura, and hit Whoop, and look your Apple watch, and they tell you that you're nothing and you're all of a sudden exhausted and you're like, "What just happened?"
Bill: [laughs] That does happen to me.
Simeon: [crosstalk] you and it impacts, that's the problem. [laughs]
Bill: Yeah, because Oura would be like, "Your sleep score is garbage." I'm like, "That was a great night of sleep. What are you talking about?"
Simeon: [laughs] So, you had no REM sleep. I had a lot of dreams.
Bill: That's right.
Simeon: It's so amazing.
Bill: Yeah, that's exactly right. I do think that they need to get a little bit better. It seems when you flip over, they associate that with waking up. But whatever, it's not perfect.
Simeon: It's a good start.
Bill: Yeah.
Simeon: You know what? People that are willing to give that data, there's no end. Whether it's these guys, whether it's the new massage company, there's just a lot of really interesting things. I think that what connected fitness has done is it's opened up-- as we keep hearing about people willing to give less and less in terms of data for privacy purposes, connected fitness is telling you, "This is a self-selecting group that saying take all the data you want if you give it back to me, and if you tell me something about myself." So, it's this really interesting dynamic, where we're only at the beginning of letting someone give you a diagnostic of yourself.
Bill: Yeah. You know what, I think is so interesting about this privacy debate and what's going on right now, and I'm sure it's trickling into your coverage universe with advertising returns. Maybe not if you're dealing with bigger, but I just got off a call with somebody that manages small brands spend and this Apple change has just completely thrown off what they're able to do.
Simeon: You're hitting on something so important. That's also so contrarian and I don't know if you even appreciate this, because-- [crosstalk]
Bill: Am I? People on Twitter don't like what I'm saying right now.
Simeon: But the distinction you just made is, it's a new crusade of mine that people haven't been talking about yet. Small versus big is really important. I was just in a conversation with someone that was telling me-- lunch with the bunch of CMOs. A group of marketers, and they're all complaining about iOS, and they're all complaining that they can't reach their customer anymore. My response to him was just out of curiosity, how big are the brands? Small to mid, no billion dollar, stuff like that, right? You know who's not complaining about not getting access?
Bill: Huge.
Simeon: Ralph, Gap.
Bill: Yep.
Simeon: Anyone big. This idea, and we actually wrote-- you and I haven't spoken about this yet, but you're going to love it. Some people love it, some people absolutely hate it. We wrote a report, a two week report, like, you go back to this idea of like, "Why I love this job is because I actually get to take time and pull strings." We wrote a two-week report that turned into six-month report. The title is DTC Isn't All It's Cracked Up To Be.
Bill: Oh, dude, send this to me, please.
Simeon: Coming your way.
Bill: Yeah.
Simeon: [crosstalk] like the conclusion, the cliff note was as big brands pivoted direct. They didn't see an increase in revs, they didn't see any increase in gross margin, they did not see any increase in EBIT rate, and they did not see any increase in EBIT dollars. All four of those were massively contrarian and stark contrast to the world. But the main thing and we can go into it. But the main thing vis-à-vis your point here is, there's this perception net, there's a middleman, whether it's department store or someone else. It doesn't matter. There's a middleman. Cut out the middleman, you make more money. Factually incorrect, mathematically incorrect. That's number one.
But number two, every brand that's so convinced, they want to go direct for all this great data. If the data doesn't translate into higher revenues or higher profits, why is it worthwhile? If the data that you're saying you get, that you're just beautifully close to your customer, you have all this direct data and that's the problem now with Apple. Why don't the wholesalers have a problem with that? They're selling so much more. It's this amazing thing going on and I love that you brought a big and small, because people don't make that distinction, but it's critical.
Bill: What were some of the findings of the report that you wrote?
Simeon: Those four things were the main things. I'll tell you is that, there is now in my world, this collective push whether you're the largest company in the world or the digitally native tiny company, go direct, don't build a company the way people used to, whether it's stores or whether it's wholesale. When I say DTC, I mean DTC versus wholesale, not e-commerce or stores, just to be clear.
Bill: Yeah.
Simeon: These big brands somewhat by definition, the ones that are talking about pivoting away from director, because they are pivoting away from wholesaler, because they already became huge, profitable brands via wholesale. What we found is that we have to pick the right partner, but don't issue wholesale simply because it's perceived to be an added cost. This is amazing thing when they can think about digital natives. Everyone wants to be vertically integrated. That's the perception. Every brand, every small digitally native emerging really successful brand outsources their marketing agency.
Why are people that are maniacally against, they are maniacally opposed letting someone distribute their product and yet, they're so comfortable letting someone actually create the storytelling behind their product? The point is, you vet a partner. Vet both sides. That was one and it was really interesting in my-- as I talk to boards on either side of the spectrum large, big, and small, it's that idea. It's recognized wholesale is actually a very inexpensive salesforce. If you do it at wholesale in stores, you actually get a sales floor.
Bill: Yeah.
Simeon: You guys do this this in real life. On the small side, there're certain companies that totally get it. The company like Fiore, which is this incredibly exciting or it's been hailed as one of the hot new brands, and they embrace selectively wholesale as do a lot of. So that's this idea, I think I would say like, this perception, this pitch or just go direct, I think is misplaced. We saw that in numbers and that's what's interesting. As you and I become closer, you'll see, I can be incredibly opinionated, which means I can be incredibly wrong. The beauty of this report is almost entirely empirical, is almost entirely data driven.
Bill: That's really interesting. One of the things that I think people that have an aversion to the sell side may not understand is the power of being able to say, "I'm putting together this research report, and our bank has a relationship with you all, and these are the people that I've talked to. Can we come sit down and have a conversation, and how give and take the conversation is?" I don't know that a lot of retail understands that the sell side does that.
Simeon: I'll say, my best reports, my best research reports are, first of all, exactly that their research. They're not pre-written, I don't know the conclusion, I have hypothesis, we pull strings, and they take a lot longer, because we're learning things. This was literally a two-week report that became six-month project. That's number one. But number two, the best research reports generally trigger from if I'm talking to people and I keep hearing the same either question or assumption, the best, if everyone keeps telling me, obviously, if I hear the word, obviously, my antennas go up. Wholesale is obviously worse. Why? Because if I'm creating sneakers or sweaters and it's the same cog, the same cost of produce, and I sell it to Kohl's, and I have to take a cut, because they're going to get a piece of it and I'm going to get a piece of it, or if I sell it on my own dotcom, obviously, I'm going to make more money.
Rewinding 10 years, if I sell something via e-commerce, because this was really interesting. We wrote the same report effectively 10 years ago about e-commerce and 15 years ago, where everyone thought e-commerce was going to be the salvation. Why? Because obviously, there's no rent and obviously, there's no store labor. So, it must be better. Yet, circle through and you realize that maybe obviously, there's no rent labor, but there's obviously pick, pack, ship, fulfill, return, first logistic, it's all variable intensive unit in economics.
Bill: [laughs] Yeah.
Simeon: We got at e-commerce this deluded business. I think it's the same thing happening right now. If I hear the word 'obviously,' if I hear the same claim just said really quickly, that's a signal for me to dig in and actually take some time try and see if it's real or not.
Bill: I love that. I interviewed a guy named Adam Robinson and one of the things that Adam said to me, he was on Tim Ferriss' podcast four years ago or something. He said, "There's big money to be made and things that are blatantly obvious and things that make no sense." If you look at something and you're like, "Oh, that's clearly obvious." Dig in a little bit deeper. Tesla at a billion makes no sense to me. It's probably something I should dedicate time to. Either it makes sense and I don't get it or it doesn't make sense and maybe you can make money on the short side. I don't know which way, but spend time.
Simeon: I'm not smart enough to do biotech. I don't know any of that stuff works. But to me, the beauty of consumer is that, we're all consumers, which means we forget that we're supposed to be analysts. It's so easy to transpose your own anecdotal onto what's supposed to be a number conversation. Listen, if you and I are starting a company right now and we're about to give away the secret, the only thing we should do is focus on selling a product that Wall Street is going to buy. Because if we sell it to Wall Street, we're all ego maniacal enough to believe the TAM is through the roof.
Bill: [laughs]
Simeon: It's this beautiful thing of thinking, "Well, I use it, so, everyone will do."
Bill: Yeah, interesting. That's funny. I have two paths in my head that I want to go with this and I'll let you choose. One, do you want to get into Peloton or two do want to talk about why you're pivoting on Under Armour now? Because this is an intriguing idea to me.
Simeon: We should do both, because they're the same trade.
Bill: Let's start with Peloton if it's okay, because I thought that you were really early on the concept of-- COVID might actually be the worst thing that's happened to this company. Now, I'm starting to hear people say that and you've been saying that for a long time, so I'd be interested to hear how you piece that together and when the light bulb moment went off, where you were like, "Holy shit, this is actually not a great event. It's potentially a bad event."
Simeon: To start the conversation, I'm a Peloton user. Big fan of the product. I've had it for multi years. I also have a Tonal, I also use Hydrow, I've got a lot of these products increasingly and that's part of the problem. But what was so interesting to me was this notion of rhetoric versus reality. It was a quarter. We started watching this demand surge and the question was always going to be, was it an expansion of TAM or was it a pull forward of TAM? You couldn't know until one quarter. There was this really interesting quarter, where the company gives on their balance sheet a line item that's a proxy for backlog. It's called customer deposits and deferred revenues. Effectively, dollars given for service has been provided to the till recently. There's obviously more nuanced.
What had been happening through the pandemic was everyone kept looking at that number and dividing it by revenues. They kept saying, "If my backlog is [crosstalk] my revenues, it's already covered." The guidance is in the bag, because I already have it booked. I just haven't been able to deliver anything. I had that in my model. But what we also did was we divided by inventory, because from my perspective, the question is, if it's a pull forward or not, how is the company going to react if things slow down. Literally, the quarter where that number dipped below 100%. Literally, the quarter with a backlog proxy was less than the inventory already on hand was the first quarter the company started guiding down. What does that mean? The first quarter where you had to forecast the business, the first quarter where the inventory wasn't already accounted for was the first quarter where the business started downtick. That's when we got vocal.
Bill: All right. I just want to make sure that I'm understanding what you're saying. When deferred revenue is increasing, the market is looking at a business that is working capital positive. "Oh, we're bringing in working capital as we're growing. This is amazing. TAM is expanding." You still have the supply chain crunch, so, the bikes are not being delivered kind of make some extrapolation look artificially better than it may otherwise be. At the time that the business catches up to the forecasting, you see deferred revenue come in and now, inventory is outsized versus where true demand actually is and then you're like, "Aha."
Simeon: That's the quarter where they started guiding down, but only the beginning. What happened after that, what increasingly happened and that was getting this moment was the inventory ballooned to that point. But now, they had effectively bought or spent massive capital investment on three aspects of increasing manufacturing. They bought Tonic, which was the manufacturing plant or facility, they bought Precor, which was a commercial seller of product, and then they created or began breaking ground on a $400 million Peloton Output Park in Ohio. Now, you had this huge fixed cost spend, which is interesting. We'll get there. Actually, reminded me a lot of an Under Armour sell that we had years ago, where it's a similar idea of a company that's just triggering massive growth for a consumer that can understand it.
Again, this is not biotech. This is products that you and I use, where the company drinks effectively their own Kool-Aid sees the demand expects it's going to go forever, changes the entire capital structure of the business. By the way, Peloton raised a boatload of money through a convert about a year ago at a 0% coupon, 0%. Then a year later they had to raise capital at $46. Now, it's even lower. Looking at the deterioration of the financials, they were in this amazing spot, use that to completely rechange the fixed cost structure of their business, and then all of a sudden did see the demand fold.
Now, I think another point just to throw that is important is, because obviously, I try listen, I try to be intellectually honest, I try to look back and appreciate what are the learnings and where do we get things wrong. When I think about these, on the one hand, I watched management. I'm a huge proponent of watch how I spend, don't listen to what I say. We have a quarterly report assessing debt. Before the COVID, we had a framework to determine fixed cost versus variable costs, because if you're a growth company and you're pivoting to variable, chances are you don't buy your own growth and vice versa. When looking here, you have a corporate that's spending. Same to Under Armour. Back in the day, by all accounts, I should have been feeling like you know what they drink, they believe it. The problem was at the same time management was selling stock and the same thing happened [crosstalk] If you're both spending corporate dollars, [crosstalk]
Bill: And selling stock.
Simeon: Diversifying your own personal and not an insignificant amount of all diversifiable for liquidity, you just have to ask that question. That combination for us was where it started feeling like, if not for COVID, you and I right now would be talking about this amazing small to mid beautifully growing business called Peloton. That business would be in a drastically different fixed cost structure, they'd have a whole bunch of three PLs, they would outsource a lot of what they do, but they'd have this amazing growing demand and most importantly their financials would be in great shape, but more than that they spotlighted through this massive inflection, they spotlighted the fact that connected fitness was a great place to be, which helped their competitors raise a lot of money last year.
Bill: All right, let me dumb this down a little bit. If they don't buy Precor, and they don't buy these facilities, and they're not solving a temporary supply chain issue, there's a decent probability that their business is more variable in nature. Is that fair? Because it's more outsourced and that gives you more flexibility. What they did is they added a ton of fixed cost at exactly the wrong time.
Simeon: Correct. I've had a vocal sell on this. I've never called this GoPro, I've never called this Blackberry. To me, this is a great product or it's a great community. It tells a story. The engagement is among the best in many categories, and they retained that, and had they flexed R&D up and down, had they flexed sales and marketing spends up and down, and this was maintained as a business that was tracking its growth. They left dollars on the table to be a lot more dollars in the future. The problem was they completely pivoted. They had to go as vertical as possible. All of a sudden, there were liquidity concerns. That's why they raised billion dollars two weeks after saying they weren't going to.
Bill: I like how you said that. "If they had left dollars on the table, there would be more dollars in the future." [crosstalk] That's very poetic.
Simeon: A little bit poetic.
Bill: Yeah, no, that is poetic. It's an interesting issue and I may even be connecting some of the parallels to Under Armour. I've said for a long time, the thing that makes me nervous about Peloton is that it's Under Armour and why I said that was back in the day when Under Armour had the true Under Armour stuff, and they first started to sponsor Auburn football, they were dope, it was functional athletic equipment that was outflanking Nike. Then they tried to be everything to everyone and they became a crappy brand. At least perceptually and maybe you're not allowed to say that. I'm saying, that's just my opinion.
Simeon: We call it ubiquitous. You can choose whatever descriptor you want. [laughs]
Bill: Okay. Yeah, well, that's the thing. They tried to be everywhere. You go into Ross and you'd see Under Armour on sales racks, and it decreased what the brand was, I think in the consumers' mind. I have toyed with owning Peloton in the past. On the whole way down, I've toyed with it. The thing that has kept me out is that thought and also, I was talking to my wife and we were talking about the Bike+ and the bike and how they're marketing it. There's a commercial that is the bike and then there's a slash through the price, and then another in a lower price. That just hummed discounting to me. I was like, "I just don't think this should be a discount brand." Even if they think that they can roll out a Bike+, the presentation really upset me.
Simeon: If DTC is not all it's cracked up to be was my teams 2021 report, did COVID save retail was the 2020 report. Early in the pandemic, my team to their credit, I'm very appreciative did phenomenal price elasticity of demand work. Similar idea, two-week report that turned into data I don't even know how long. We upgraded Elle Brands, which at the time owned Victoria's Secret Bath & Body Works and we upgraded Under Armour from a sell first time I did not have a sell on it in years. That was early on pandemic, I don't know, March, April, I don't know when it was.
The premise was people believe retail is over stored. What we found any retailer in history closing a mass store-- triggering a mass store closure program really did not see the increase in EBIT rate, obviously, not EBIT dollars, but didn't even see the rate. It just didn't happen. By shrinking stores, you became a smaller business. What we found was that instead of closing stores, companies should commit to raising price. We ran this very elaborate elasticity demand model that effectively showed that there were certain companies Victoria's Secret and Under Armour were two of them that were literally under earning, because they were overselling and could give up if they committed to a 25% price, which sounds like a lot in percentages, but think about what that means on a $20 shirt that they committed to a 25% price hike.
Bill: 25%. You said dollars.
Simeon: Sorry, sorry, sorry. Yeah, 25%.
Bill: You [crosstalk] roughly $25. I just wanted to clarify.
Simeon: Yeah, exactly. If they raise prices 25%, they could give up 40% of their units or 0% and still EBIT dollar [unintelligible [00:33:28].
Bill: Yeah.
Simeon: [crosstalk] around not EBIT rate. They would make more money if almost half of the units they sold. What they said to me was the problem with North America is not that it's overstored, it's that it's overdiscounted and this is where you get into the problem here back to sell side is like you and I are both guilty of forcing companies to grow for growth's sake. What COVID allowed companies to do was for the very unique time, actually, take this force sales reset and figure out which customers were deluded, which sales were not worth having. Walk away from those and you can sell us, charge more, make more money. Victoria's Secret did that beautifully.
Bill: Really?
Simeon: For the next year, so, our math, we did we did a big deep dive on Victoria's Secret margins. My math was gross margins were in the mid-20s. You can't make money if your gross margins are in the mid-20s, but everyone was yelling that Victoria's Secret was worthless.
Bill: Yeah.
Simeon: Why? They're saying, it was dead. It can't be a dead brand if you sell $5 billion. What happened? They agreed to sell Victoria's Secret. LB agreed to spin off Victoria's Secret, Sycamore agreed, walked away. When they walked away, we jumped in, we upgraded that night, because the premise was Victoria's Secret can do more with less and what you saw was a massive gross margin expansion as the sales imploded. EBIT dollars went up. I don't remember. You can fact check this for me, but LB was one of if not the best S&P stock that year. This idea exactly what you're saying of you can do a lot more with less if you focus on elevating your brand. It's a hard thing to do in a public market in a public setting, but COVID allowed you to do it. It's very relevant for your Under Armour conversation and it's also probably going to be relevant for Peloton conversation.
Bill: Victoria's Secret is interesting, because I did a little bit of on the ground research, and I looked around, and I was like, "There are so many bras here." What used to be a sexy brand just looked like a lot of cloth smattered throughout the stores. This is 2018, 2019, because I got intrigued by the multiple or whatever and I was like, "Nah, it's too tough." Then once I did that, I put it away. I wouldn't have been open to the idea, but it's a very interesting concept where COVID forced them to be able to say, "Okay, well, what are we really good at, what does our customer really want to pay for, and how can we lean into that?"
Simeon: By the way to your point, you wouldn't have been interested, I was wrong, I was negative for a while on that brand for those same reasons. It was this idea, again, I flipped Under Armour from a sell to a neutral, and we went on LB to abide, because this change. This idea, we actually did a quadrant of-- this was very, very oversimplified. We just plotted revenues against margin rate with the idea being, if you're a huge tech company and you're losing money, that's allowed. There're reasons for that. Exactly your words, if you're selling cloth and you are selling $5 billion of it, you're not a dead brand. You might be very sick, but you're not dead. That's why I try to remind people. It's funny because it goes back to your point about big versus little.
Revenues are the external measure of customer buying. Gross margin is a measure of brand perception, but revenues tell you how many people want your things. You cannot say that a brand selling $5 billion is something that people don't want. So, got this idea if you can tweak that and then reelevate your brand, then that's powerful. I think Under Armour will emerge and is emerging from the pandemic stronger than when they started, because they were able to take all those logos that were slapped on anywhere you possibly could find and get rid of them. Under Armour went and reevaluated, a half the reasons that I had to sell one that they reevaluated it. They cancelled really expensive college endorsement projects, they stopped a big rollout of the Fifth Avenue store, or they very surgically looked at pieces of this business that were very much targeted to growth for growth's sake. Instead said, "How do we be a better brand, not a bigger brand?"
Bill: That's interesting, The Fifth Ave store I think, I don't know this like you do. If I say something stupid, please tell me. But I would think the Fifth Ave store could actually work better if the brand were reined in. It could elevate the brand presence in a smaller brand, but I don't think it would work when the logos smattered everywhere if that makes sense.
Simeon: Yeah, I know what you're saying makes total sense. The question is does it matter. Will Under Armour ever be luxury? No. Can you justify whatever the $20 to $40 million dollar price tag is? That's a lot harder-
Bill: Yeah.
Simeon: -and if you think about it, here's the wild part about Under Armour. They're still selling crazy amount of units. To synthesize your descriptor earlier, Under Armour became the gap hoodie in Disney World as opposed to being the thing that makes you jump higher. As they come reevaluate where they want to be, that's this notion of-- We're all told to try and really think carefully about what we want to be when we grow up. Same thing for brands. If you stretch too far, we've done a lot of work. This is actually something that really underpins everything we do. We've done a lot of work historically over the years over where brands peak. There's no reason to think that brands should have a common ceiling, but they do.
What we found is that, DTC-only brands generally peak in North America at $3 billion. Wholesale, if you outsource your salesforce, you get 5 to 6, somewhere in that vicinity. But what happens, going back to the idea that we talked about, companies are run by people, not by algorithms. Humans are not wired to acknowledge we've peaked. The world would be a very different place if it was.
Bill: Yeah. Well, this is as good as it's getting folks. [laughs]
Simeon: [crosstalk] Well, people stretch and so what you watch is you watch these companies go above that ceiling, but almost without exception, collapse back. The question is do you internalize that you've gone beyond your TAM and then you can salvage margin? You can proactively give up the revenues or do you fight it, and then you lose the revenues and the margins. That's what we see over and over again. Under Armour was that story and now they've internalized it. For the first time in forever, not that my opinion counts for much, but for the first time in forever, I felt compelled to put a bio on this on the recent market drop.
As this, I didn't want to have a sell on it, because I felt COVID was able to flip that, and that they did was I hadn't jumped full force to actually wanting to own it. But now, I look at this and I think they are emerging healthier, and I think that we're on a different side of this spectrum. Again, using these babies in bathwater in the recent market sell off to find what are going to be the positive ones.
Bill: Yeah, that's really interesting. I think COVID was the catalyst. Do you think that could Under Armour have pivoted if COVID didn't exist like they were the only brand pulling back or did it take almost an industry wide reset to be able to let everybody see what's rational?
Simeon: It is such a good question. In this did COVID save retail prior? I believe, no. I believe COVID saved retail. I don't believe brands saved themselves. I think that what we did in that report, we actually compared the current shrink to grow. So, Victoria's Secret and Under Armour were our two loudest versions of that with the shrink to grow five years prior were Ralph, Coach, Kors, there was this group that tried to do it then and the market did not reward them for it. By the way, Victoria's Secret has tried it in the past. The problem is, it's one thing. It's very hard, I'm not going to belittle. It's very hard to get out in front of people like you and me and say, by the way, expect revenues to be down 25% for the next year. That's [crosstalk]
Bill: Yeah.
Simeon: What's even harder is doing it four times a year at least and actually seeing the units collapse, because the beauty is, as I was pitching Victoria's Secret to people, and as I was pitching and then talking through the Under Armour conversation, I had a 45-minute conversations with close friends. They say, "Okay, I get it. I really like it." But like, "Isn't Victoria Secret giving up share?" I was like, "Yes, that's exactly the point." You want them to give up share. It doesn't compute. It's this cognitive dissonance of being willing to own something that's shrinking even if the EBIT dollars are exploding up.
Bill: Yeah.
Simeon: This idea, you can't do that in a normal environment when other companies are growing.
Bill: Yes,
Simeon: But COVID resets you, what happens is, if an enormous company is where their revenues go to zero, and their expenses become optional, because that's what happened. People stopped paying rent, they stopped buying inventory, unfortunately, they furloughed employees. There were no rent, no revenues, no expenses. What is that? It's a startup, startup pivot. Instead of shrinking from 19, the conversation became growing from 20. It was this magical moment for those [crosstalk] I think that's why COVID saved retail.
Bill: Yeah, that makes a ton of sense, because it really, really sucks to go and tell the street like, "We're shrinking, other people are growing." Your stock is inevitably going to be hammered. But once everything's in the toilet anyway, nobody's stocks were, especially in retail, everything was depressed, you can really take a fresh set of eyes at the problem.
Simeon: Again, as absurd as it is, you're not actually shrinking. You're growing from the 2020 base.
Bill: Yeah.
Simeon: That's semantics, but it matters.
Bill: That is really interesting. You see this, sometimes, I think when companies have a high margin segment under the hood, that's cannibalizing some of their current business and people hate it, because the revenue growth isn't there. It's like, yeah, but your margins are growing like a weed and it takes a while to see it.
Simeon: Now, the interesting thing here, though, is we wrote, did COVID save retail. The reality is, you had COVID allowed for the opportunity to be saved. You still have to take it. I think what we're dealing with right now, what's so interesting to me right now, and this goes back to sell side versus buy side, in theory, if I'm doing my job, right, I have the luxury of putting this all up on a whiteboard instead of actually putting it on a P&L, on a Bloomberg. What that allows me to do is say, I know what the conversation is going to be in six months from now. Everyone's complaining right now about inflation, everyone's complaining right now about lapping stimulus, about lapping pent up demand, because vaccines were like--
The only thing we did not know six months to a year ago was Omicron. We literally knew we were going to lap stimulus, because it happened last year. We literally knew we were going to lap pent up demand, it happened last year. I've been shocked. This inflation and supply chain conversation is incredibly interesting and confusing, because supply chain and inflation, we've been vocal about this are literally the same thing as higher prices and tight inventory. Inflation is higher prices, which you and I have been talking about is a good thing, and supply chain constraint is tight inventory. That's why people wanted to own retail at the end of 2020 through mid-2021. When the government started saying it, when we started turning it into a macro factor as opposed to a micro beneficiary, it became scary.
This interesting dynamic is, we knew last year that in 1H 2021 was going to be hard. What do we know? We also know that 2H 2022 is going to be easier than 1H 2022. We know the same way that we should have known that everyone was going to be scared. Right now, I can tell you, people are going to be excited five months from now. Again, barring whatever-- [crosstalk]
Bill: Why do you think?
Simeon: Simply because we are going to be on the other side of the hockey stick.
Bill: Yeah.
Simeon: My point is, barring externalities, I cannot tell you if something God forbid, negative happens.
Bill: Yeah.
Simeon: But barring that, you knew that people were going to be scared right now. By the same token, once we get through that, this is going to be a very hockey stick look year. Three, four months from now, once we've lacked stimulus, pent up demand, etc., then we flip back to starting to lap the other side, and people start getting more excited. That's when you get to chase these winners and losers, and that's what the divergence happens.
Bill: Interesting, I have begun to appreciate, and perhaps, it's a naive thing to admit, but I've begun to appreciate how much rate of change drives short-term movements. Would I be right if I connect an earlier part of the conversation to this part of the conversation in saying that like you might argue that your role is more dispassionate than somebody that's driving a P&L right now and you're able to take a longer view? Would be your general framework of where you're able to see things a little bit clearer than somebody that's terrified of paying the bills next month?
Simeon: Well, even though, you asked it's really fascinating, so, I would argue that both of our jobs are supposed to be dispassionate, but the nature of what I do if I'm approaching in the right way allows me to be more dispassionate like the best investors don’t [crosstalk] get emotional about their positions, but at the end of the day, we all are human. Listen, I've been asked to like, the Peloton call was not easy as the stock was ripping in my face. I didn't top take this. I didn't even downgrade it at the top-- [crosstalk]
Bill: Yeah. So, what was that like?
Simeon: Well, so, I've been asked and then I've been asked on the flip side, how great do you feel right now? What I want to be clear is and I mean this I'm not rooting for anyone to fail. These are real people, these are real jobs. What I view my job is, I'm supposed to look for deviations. Humans are natural storytellers. We don't tell facts, we sell stories. Numbers, assuming they're not fraudulent tell facts. I generally do my job as to synthesize the story that's coming, try to strip it down, and align it with the numbers and then recreate the story. Does it align or does it not? When people give guidance, there is always going to be an explanation for guidance. One question deep, but can answer two. If the logic falls apart after the second question, the guidance is conservative or not. You can hear that.
What I try to think about my job is, at the highest level, do the numbers align with the story, does the rhetoric align with the reality? If not, then what's going to be the timing? A big learning for me on Peloton and again I learn this every time, so, I'm drinking my own Kool-Aid here too, is you're never going to get paid or not never. On a probability weighted basis, you're not going to get paid to be the hero calling an inflection on a growth stock. Whereas what you will always get paid to do in my opinion, and again, always is a stupid comment to make. Let's say, what we will more likely get paid to do is wait for that crack and then make sure you don't buy the dip. When everyone's tries to buy that dip, if the KPIs are arguing against the story, that's where it gets interesting and we've seen that.
Victoria's Secret went to hundred bucks before it went this way. Fossil was an $8 billion company before it was an $800 million company. When growth stocks and this is in my world, I'm not extrapolating this to tech. Maybe it is, maybe it isn't. But when consumer focused brand growth stocks etc., when they break, it takes a long time for people to internalize their break. What I will say to this is, Peloton went to whatever it was above 160. I had a lot of people on the way down at 110, when it was so clear that there were cracks, when we're talking about that customer deposits line was already in the rearview mirror telling me, "Isn't this ratio by the dip?" I kept saying, "No, listen, you look for the cracks. Okay, so, one of the cracks going to be here." They're here. The stock is down a lot. This is exactly that point. I can be early because I recognize that I don't get squeezed out. But on a probability weighted basis to get paid, you don't have to be the hero. You can make a lot of money if you have a strong thesis and actually just stick through the KPIs.
Bill: Yeah. I like how you said that "it takes people a while internalize that it's cracked." I wonder what the reason is. I would assume the answer is, brands that have stocks that go up in the way that grow stocks tend to go up and have financials to support it tend to have some buzz, and then everybody gets rich owning them and while everyone that owns them gets rich. So, it's hard to tell you that my baby is no longer beautiful or something like that, right?
Simeon: I just learned this new term called JOMO, which is the joy of missing out which I absolutely love like love. [crosstalk]
Bill: [laughs] That did not exist until, what, September 2021. No one had JOMO. [laughs]
Simeon: Isn't that great? Isn't that perfect? We naturally have FOMO. If you weren't part of a run and it comes down, you've created like we know all the heuristics. We know the psychology, we know behavioral-- If we were all robots, people wouldn't buy the dip and that's true. But it feels it's a good framework. You see it, you anchor yourself to a position. Listen, here is really fascinating thing. It doesn't matter, because it's all nuanced and it doesn't actually mean anything, but as soon as Peloton dipped below the IPO price, everyone's like, "Oh, my God, Peloton dipped below the IPO price." You know what no one did, looked at the share count.
Bill: Yeah.
Simeon: Companies just raised a billion dollars of incremental shares. They've been paying out share-based comp brilliantly. It actually wasn't below the market cap, but we stick to-- The anchoring, and this is a conversation I'm having now recurringly, where it's this idea of, "Okay, well, shouldn't Apple or Insert, whoever big tech name or athletic name buy them, and they go buy a stock price." I was like, "This is a very good conversation to have and we should have it but you need to internalize it based on market cap or enterprise value." Don't look at it on the stock price because whatever reason the aggregators aren't using the diluted share count. If a company is going to buy them, we need to know what they're going to have to buy them for. There has been this piece here where people create these psychological anchors and we know this, this isn't me telling anything interesting, but we hold to them and I think that there's this belief that if it's a great consumer product until the emperor has no clothes, the emperor looks like he must be wearing Gucci.
It's that idea where it's this flip. Then once that happens and again, Under Armour was a great example of it. Under Armour, again, we had to sell, and it was early, but the idea was I'm looking at the receivables and I'm looking at the quality of sales drastically deteriorate. Revenues are continuing to grow. This is beautiful. This is back whenever we perceive we must protect the house and you want it to be wearing Under Armour. But all of a sudden, you start seeing receivables grow, which is when you have a wholesale brand, it is the easiest way to do it. You're thinking, well, that doesn't seem the same way you were driving revenue for the last 20 years. These first signs, balance sheets can be really helpful. I think that's the lesson.
Bill: Yeah, I like that. I think that's interesting. I think your Peloton explanation is a really good illustration of the interaction of three financial statements working together. Because if you're just looking at the cash flow statement, pretty easy get really amped up. But if you're looking at the balance sheet, it's like, "Wait a second, why? What is actually going on here?
Simeon: By the way, that's exactly the point about people tell stories, numbers tell facts. I go back to this and we'll find out how old your listeners are right now. I go back to that scene in The Matrix, where Neo is talking to Cypher, and you'll see these numbers going across, and he's like, "I don't even see the numbers anymore. I just see, whatever, is the woman in the red dress." The numbers don't lie. At least, we hope they don't. You take a cash flow, and it doesn't align with what the income statement is telling you, well, then you have to make some kind of adjustment or you really have to go and look at what the adjustment that they made is. Because ultimately, it's our job to hear what's the underlying, what's the recurring. There's a certain cash is real-- Totally, I love it. I love the way you framed it. The interplay, but there's a reason we have three financial statements.
Bill: Yeah, it turns out it works pretty nicely. [laughs] How do you think about the art of growth versus maintenance spend? It's something that especially in some of these high growth companies really perplexes me and ends up in the too hard pile too often.
Simeon: The fascinating thing happening with Peloton right now, with Under Armour a few years ago, with Victoria's Secret last year is and I'm going to say something that might be just completely wrong but in my mind you're either a growth company, or you're a value, or you're a turnaround. I don't think you can be both. If you try to be both, I think, generally it gets dangerous. Maintenance versus growth, there's no opinion that I can make that's right. It depends on where you are. This goes back to this framework we had created a few years ago or more than a few years ago, pre-pandemic of the best way to or an interesting way to judge a company is by determining are they growing or are they shrinking on a revenue basis? Then overlaying that onto this framework we created, are you having fixed costs or are you having variable costs?
Because at the end of the day, if a growth company believes in their growth, they should lay down fixed costs, scale the business, and get incremental margin. If a growth company internally in the boardroom says, everyone is seeing all these revenues grow, but by the way, we don't have this opportunity. It's rugs about to be pulled out. We need to variabilize because we need to protect on the way down. They are not going to say that in guidance, but the board is going to make that decision and tell you. For me, businesses obviously need to maintain their business. But if they're on growth mode, they obviously need to grow as well. If this internal conversation of just like to thine own self be true, and then hopefully, be true to us as well. But I don't think you can tell a company. Certain companies should be-- certain big tech companies.
When I did this, now, I used to cover Amazon, and my prior Shop and I compare it to Amazon and Nike a lot. The idea was, you have an Amazon laying down all the fixed costs in the world for AWS that all all the dying retailers are paying out on a variable expense structure to justify. If you watch who believes in their growth versus who believes that they're not, I just think is really interesting dynamic of again like to thine own self be true.
Bill: Why do you think Nike has been so successful at maintaining a brand over such a long period of time? I think there's some obvious like, "Oh, Jordan, or whatever." But I certainly don't and I think some people probably don't appreciate the nuances of what they've done to remain so relevant.
Simeon: There're a lot of questions and there're a lot of people that are a lot smarter than I am, and there're a lot of questions that I have no idea on. You're asking probably the number one that I've been trying to dig and have not been able to come up with an answer with. What I'll say is, the reason I'll go there, like, it's funny that you're asking this, you could have asked this for me earlier on the call, because I said something and I forgot to caveat it. I always try and caveat because it's important. At the back of all my big notes, I write where I think we can be wrong. I want to internalize it. I told you DTC brands peak at $3 billion in North America, wholesale brands peak at $5 billion to $6 billion. What I should have said was, on this bar chart that I have, which I laminate and give out to anyone who wants, and it reminds me to stay focused. I do not have Nike on the chart. Why? Because if I did, you wouldn't see-- [crosstalk]
Bill: It's such an outlier. [laughs]
Simeon: It would skew the entire sale. I've asked them, and I've spent a lot of time with them, and that's the exact question that you're saying, "Why is it that everyone whether you are luxury or mass has a certain level of consumer saturation?" Either if you're expensive, you sell fewer units at a higher price and vice versa, why is that Nike can do it? The beauty is, a bunch of years ago, we published a report called-- What do we call it? We call it a deconstructing athletic P&L. What we showed the conclusion was that athletic P&Ls are variable. Before COVID, before e-commerce, we just found out that if your Nike, Audi, Puma, Under Armour, not Lulu, we'll talk about that, but if you're an athletic business, you have a 10% to 12% of sales on marketing spend. I don't remember the numbers, but it was an equivalent sales and marketing like they aligned and it was mind blowing.
Nike and Under Armour, which at the time I remember being 8x apart in terms of revenues, why would they have the same opex structure as a percent of sales? That flies in the face of everything you and I learn of as you build a business, you scale, you get margins. Initially, that made me very negative on Nike. Again, this was years and years ago. My gut reaction was, "That's really bad, because you're never going to get margin." By the way, up until now, they haven't. But then what I realized was, "No, actually, that's really negative for Under Armour." This was what prompted the Under Armour sell before I started getting in, because if you live in a variable expense world, the best thing you can be is the largest. So, I like to believe, I try to be intellectually honest. Any single client that calls me and asked me about Nike, I say, "Listen, I have to suspend intellectual honesty for a second and just tell you that their size and scale is their competitive advantage." No one can compete on R&D, no one can compete and advertise. Because of that, I'm never going to be able to justify their PEG ratio ever again. But you can either fight that or you can internalize that it's expensive for a reason. So, this-- [crosstalk]
Bill: Beachfront real estate costs money.
Simeon: Totally. Right.
Bill: Some people like, "Why do certain stocks trade like they do?" It's like, "Look, man, it's irreplaceable assets traded higher multiples than you may think they should."
Simeon: I'm curious of your view on this. I'm not throwing around, because this interesting thing that I've been toying with, but haven't had time to actually stress test this is generally speaking, we're seeing this big growth, stock sell off that's not nothing new. The idea very simply is inflation, higher interest rates, discount rates, all these things. It's more expensive to own the asset. It's totally oversimplified. When I think about expensive stocks, I think historically, they were growth stocks. A growth stock means I have a very, very long DCF, I've got a 30-year DCF, so, I need to discount. The interest rate matters. As the interest rate goes up, the cost of those future cash flows become more expensive. I think over the last five, 10 years at least in my world and retail, expensive stocks went from simply being growth to then also being a bucket of consistency. You started paying up for consistency rather than growth-
Bill: Yeah.
Simeon: -off price. Best model in the retail business doesn't have massive growth, but as dependability.
Bill: Yes.
Simeon: You pay up for that. The interesting thing that I'm trying to toy with and this was similar with Under Armour. The huge thing that I was trying to toy with over the last few weeks is as higher interest rates take down higher multiples, because historically, we associate higher multiples with higher growth, should they actually take down higher consistency stories? If you're not actually paying for higher future cash flow, you're just paying for the notion you can sleep easy at night, should inflation matter? I don't know, I'm curious of your view.
Bill: I think my answer to this is, when you look at credit spreads, and what they have done, and I'm going to talk over a 10-year problem or a 10-year viewpoint, okay?
Simeon: Yeah.
Bill: I just think that when spreads tighten and business has been in a predictable March throughout a bull market, it is easy to convince yourself as an equity investor that quality businesses should trade at tight spreads to junk bonds or maybe even within it. I could buy an argument from somebody looking at Dollar General that says, "The equity risk premium of Dollar General should trade inside the high yields." Not spread is maybe not that, but high yield of oil. I just don't want commodity risk, I don't care if I'm higher in the cap stack, I don't care. Give me Dollar General's equity.
I am curious how much of that is a byproduct of not having a real prolonged recession for a while. Because I think that one of the things that has been interesting about margins throughout growth or a period of economic expansion, even though it was slower than maybe some would like is that, we haven't had a lot of slack being forced through the system. People's models, I don't think have been really stressed. I don't know how much of it is a secular uptrend that's just going to continue in economics and how much is people may be taking too much risk, because they're starved for yield elsewhere. I don't have a good answer for that.
Simeon: It's interesting. In your perspective this is well above my paygrade, but it's just the interesting thing that I've been trying to think through of forgetting about-- It's funny. As you say that all I'm thinking of in recession TJX does well, but that's not even the point. It's this idea that if it's the flight to safety premium as opposed to the discounting future value premium, inflation recession, all those things actually should theoretically work in their favor. But again, it's a philosophical study or it's an academic study that I would love to do and I don't have time to do it, but it's just something I was just musing on, because when I think about my group, this notion that I've mentioned about Nike, PEG ratios are out my window. I tried to put a PEG ratio on a Lulu or on a new hyper growth company, but the companies that beachfront property more likely than not in my world is because you can sleep really well in front of that beach.
Bill: Yes.
Simeon: Not because you're going to be compounding on top of that.
Bill: I think people think that you can both sleep well and you're going to compound.
Simeon: Sorry. We [crosstalk]
Bill: I don't know if that perception is correct, but I think that's the perception.
Simeon: No, you're right. You're going to compound, I mean, not high growth. I would think off price this is literally a compounder as opposed to you're going to exponentially jump ahead.
Bill: Yeah. [crosstalk] I think there stay wealthy stocks-
Simeon: Correct.
Bill: -until they break. Then it's like, "Oh, crap, what do I own?"
[laughter]
Bill: Actually, I was thinking about this for my own portfolio, because I have too much duration in my portfolio. I'm way long equities relative to where I probably should be. I've been trying to think about what is the right way to mitigate some of that risk? My answer is, I'm going to raise cash and run it like a barbell, because I do have-- I talk about Qurate, my beloved Qurate that I had to exit recently. But generally, it's high-quality equities and I think if I have something that punches the quality, long duration assets, I need something else that can play offense in that scenario. I don't have that right now and that's a good way to get whacked.
Simeon: Yeah. Which by the way, I think is a lot that, that goes back to my comments or the responses from the Under Armor upgrade. I think there's a bunch of companies that probably will emerge as a winner, but the macro factors, the externalities are as in rising tide lifts all boats, and they also pull them back out to sea. It's like figuring out when you can swim within them and when you can actually pick. What's going to win, lose as opposed to just what is the environment telling you, I think that's obviously the hard part. Hopefully, that's where part of the value I can add is because I'm standing on the pier by the beach. I'm not in the boat.
Bill: Yeah. It's been an interesting time to learn and get trained, because I have competing thoughts where one is, if you're Nike right now and you want to go to compete, I don't think there's any limit to the amount of capital that Nike could go out and raise. There's some natural limit, but if they came up with an idea and said, "We want to go kill the competition," the amount of patient capital that's out there right now, that would give them to them at no cost. I don't know where the multiple should be but a higher multiple is justified when that's your competitive position. I think that exists a lot of places. The place I can speak to reasonably well is media. I watch Viacom and Discovery where they trade and I see the pitch on why to buy them, and I'm like, "I get why people own them and I hope those people do well." As someone who can pick any asset on the planet, I'm not going to cheap media. It's just not going to happen.
Simeon: It's an interesting thought. I'm not smart enough to opine on media. But when I think about retail, the world is creation. If you're creating IP, whether it's a song, a TV show, a sweater, or a poem, or a recipe, it doesn't matter. There's a creator, there's a distributor, charge with curating and allocating something to its consumer, and then there's the end user, the consumer. If I think about retail, retail and brands, you can be really-- You either have to spend on distribution, you have to be really good at distribution or you have to be really good at content. It's very hard to do both. Figuring out, do you want to be someone that has to perpetually create new content or do you want to be someone who's going to figure out the best way to optimize distribution and just it seems media, media within retail, whatever it is, it doesn't end. You always need new media.
Bill: Yeah.
Simeon: That's then going back to your growth versus maintenance CapEx, content spend is perpetual growth or I guess maintenance [unintelligible [01:04:33] works better, the analogy works better, but it's this idea that content spent never ends. You stop producing content, you die. Whereas if instead your dollars are maniacally focused on being the best distribution channel as long as you like that, that's a different story. That's why this this interesting idea like, I'm not some huge department store lover, but I'm very anti the idea that they're dead.
Bill: Yeah.
Simeon: I think the idea is, if as long as if you've created the channel to the consumer, let other people fight on creating perpetually newness. It's just this interesting dynamic, like, when I think about like, everyone wants to be a media company, I'm like, "Why?"
Bill: Yeah. I think the other interesting dynamic on media is, the more you create, the quicker the half-life of your past creation accelerates. You almost create your own amortization by creating more, and then people demand more, the more that's out there. It's like a treadmill that only speeds up.
Simeon: I remember one of the questions I asked Peloton early on was, there was this period where they had to shut at the beginning of COVID. They had to shut down the instructors who can bring stuff in. At one point, there was a pause and then they gave them each product in their homes--
Bill: Yeah, my man, Alex Tucson was in his apartment. He had this Jordan jersey on. He was doing all that stuff, yelling at me in private.
Simeon: I asked them back then I said like, you just watched inability and had this phenomenon. That Alex class was the best watch class, like, the ESPN class or whatever it was.
Bill: Yeah.
Simeon: You had Robin from home was the first time they had some, I remember like 25, that whatever the number was. If you're seeing you're able to do this with a drastically lower cost, drastically lower frequency, and you're getting better engagement, does the model not say that you don't need to perpetually churn out even more? The response was like, "You're way off." Listen, I may have been way off, they obviously made a different decision. It's your point pumping out new, new, new, but it was just as interesting dynamic, where you watch them have to scale back massively, and yet you watch customers respond with a huge uptick. Obviously, an anomaly. Obviously, there's a sense of we get it let's kind of help support you. But at the end of the day, if you and were operating as algorithms, we would say, fewer is better, fewer is [unintelligible [01:06:37] sell less charge and make more money. It's just this constant idea.
Bill: Yeah. I wonder two things about Peloton. One, I wonder if they had come out with a rower instead of a tread if that would have been a better second product, because there are so many fewer rowers, I think in a house. And also, I could really see rowing classes being a thing. You see the Orangetheory. They've got some rowers. Then the other thing is if they had leaned hard in the middle of COVID, I think a lot of people like myself were looking for a good workout. If they had leaned into kettlebell classes or something like that and pivoted a little bit quicker into the non-bike attached subscription and not focus so much on hardware extensions, I wonder if this story could be different.
Simeon: We wrote a lot of deep dives over the last year and a half on Peloton. When you've asked what are the main learnings? I gave you one piece, but we've done a lot in here and I could not agree with you more, and we published a nice chunk on the fact that we were not excited about the tread launch, the initial tread launch. The reason was and I don't remember the number, I'm going to butcher the numbers. There's a generally accepted view that there's a reverse triangle of 10:6:1 or 10:6:2 some of tread to bike to the rower. The market and the conversation was always the tread market is so much bigger than the bike [crosstalk] and I totally agree with you. It was in reverse. I was like, "No, the tread market is already in existence."
Bill: Yeah.
Simeon: What Peloton, I think did so well, going back to that point of greater product that you can teach someone how to learn their mistakes and then privacy, so they can then go-- I would venture to guess anyone who does Peloton for two years, then goes to a FlyWheel class whatever SoulCycle class whatever still around, it's liberating. Also, you feel empowered. You're like, "I know what I'm doing."
Bill: Yeah.
Simeon: It's this idea of, you took people that didn't cycle before. You took this was a brand-new product that looked nice, fit, it was small, fit, and gave you a very time efficient workout. It was a very nice mathematical algorithm. What happened was, people that were not cyclists found this to be a life changing moment. Anyone that already had a treadmill, it didn't need upgrade. If I think through where I go from there, I totally agree with you. If you were able to do the reverse for rowing or have a rowing company got their first and said, "By the way, here, we're going to give you a full body workout instead of just the bottom half," and it's going to be cardio and time efficient. I think that had a lot of opportunity.
Bill: Yeah.
Simeon: I think an interesting dynamic, which is, who knows this doesn't make a whole lot of sense, but I'm just going to throw something out. But I wonder if rowing has been dealing-- they need a brand image change. I think you have certain like Hydrow is working on that like they're doing a nice job. But if you and I think about rowers, it's tall, white, lanky guys from Harvard. It's always the villain in the movie, whether it's the-- [crosstalk]
Bill: I was actually thinking--
Simeon: Kevin Spacey?
Bill: Yeah, that's what I was thinking of Kevin Spacey, yeah.
Simeon: Because I had this moment. I was thinking about this. I started House of Cards late and I was watching this, I'm thinking that's a beautiful machine like, "Why didn't rowing catch on?" I've realized, because he's the bad guy.
Bill: Yeah, it's possible.
Simeon: Who knows? I think they're moving to changes. If you look at Hydrow's focus, their story tells a very nice body positive diverse story that is helping to align the fact that you don't have to wear a sweater over your shoulder to be able to rub.
Bill: [laughs] What's going on with Lululemon and Mirror?
Simeon: Nike introduced the FuelBand, which I'm not revisionist history and just assume I think it was before FitBit. Maybe it was, maybe it wasn't. But Nike came in, they introduced a very early tracker. People loved it. Until they didn't, Nike shut it down, Under Armour bought something called connected fitness, introduced their own version of tech, had an app, that was part of our bare thesis initially, last year as part of COVID, they shut it down. When Lulu bought Mirror, the question was, "Are we watching this, is this that $3 billion?" What you could follow up with my $3 billion comment is what happens? How do companies stretch? What they do is they look beyond their TAM. They do something really, really well and then they figure they can extrapolate. All things considered with valuation. Objectively, if Mirror is a success, they got a great price. Every competitor is worth more than they are right now, but we just haven't seen. History has not shown athletic brands being good stewards of technological advancements. They're amazing stewards of athletic apparel advancements and marketing advancements, but we're just not seen this lift of Mirror. I think that what we just saw with the guidance speaks of Mirror. We're watching Lulu do a nice job in and of itself, and then very much reset that base. I don't think that's the end, unfortunately.
Bill: Yeah, that makes sense. You had mentioned we could come back to Lulu. I believe it was in the context of--
Simeon: P&L.
Bill: Yeah. What would you expand upon those thoughts?
Simeon: The fascinating thing was, as we looked at this and we saw that everything was variable, Lulu was not. Lulu had margins that were better than double the group. Inevitably, as we stripped it down, we have this in our initiation. This is some of the fun work we doing. But if you delete the word, Lulu, i.e., delete the sentimental value, and I love the product, too. Delete the sentimental aspect of the brand and just look at the numbers, it looks a lot like Michael Kors retail at its peak, and Tiffany at its peak. What does it look like? It looks like a highly productive box. I don't mean that in a good or a bad way. It's just what it is. The margins, retail margins are constrained to their fixed costs. That's been an underlying theme you and I have been talking about. The store's a great fixed cost. If you're selling over $2,000 a foot and you're paying rent, your margins are going to be great.
Bill: Yeah.
Simeon: Now, what that means, though, is your revenue is going to be capped. I think if you and I were to look at and say, "So, Lulu, in the US is right around that $3 billion threshold" it's going to be a very interesting one to watch. Now, you say to me, "Do they have permission to be an exception?" I would tell you, "Sure. They do have permission to be an exception." I could see Lulu going above, but they're also at the peak margin.
Bill: Yeah.
Simeon: If I think about Nike, Audi, Puma, UA, they all have wholesale, they have ASP, they have price points that are likely drastically less, well, they are drastically less. They have a much higher marketing spend, they sell footwear, all of these things that allow the company to sell a lot more has thus far been in direct opposition to the ethos of Lulu. If you want to be a very highly profitable margin story, you need to sell a lot of sales per square foot in a box. But that also means your revenues are going to be capped. It's this interesting dynamic, where it feels they're at this very interesting crossroads, where both revenues and margins appear to be at this potential peak, where they might both be at a peak, but I think to make one of them grow, you'd have to sacrifice the other.
Bill: Yeah, and that seems like a tough bar with a brand like that, because that brand has so much brand equity. To me, the price point actually has something to do with that. Now, their clothing backs up the price point. But to cut the price point, I don't know what that would do to the brand equity. That would be something that I would not-- I would be nervous about playing that game to try to drive revenue growth.
Simeon: Yeah, I would definitely agree with that. It goes back to it. It's this idea of high prices, good or bad is not an amp. That's what I'm trying to-- There're so many easy ways to be prescriptive, but the question is simply, "What are you?" High price points, Lulu's going to be a better business if it's heavily cashflow generative with incredibly high price points, but it does mean there's a cap on revs. I think that's this interesting dynamic. Now, you can come back to me again, going back to that $3 billion analysis and say, "Well, what does it mean?" Those are just numbers. Here I'm looking at specific leggings or specific polo shirts, what are your numbers matter? What it means in real life terms is that, at this saturation point the edgiest people, the people that discovered the brand initially go elsewhere, because they start seeing the product show up.
Bill: Yeah.
Simeon: It changes perception of what it stands for. What we're seeing now in a very interesting way is you're seeing huge valuations, you're seeing Fiore get a huge valuation in the secondary market, you're seeing headlines for success at Rome, you're seeing other brands get acquired by larger family. You're watching the emergence of the next group of competitors in a way that we haven't seen in a while, which helps speak to this idea of the edgiest people, the people that started your success are going elsewhere.
Bill: Yeah, that's a tough problem to face. I don't have a deep enough appreciation for the history of this company, but I do have an appreciation for the man behind it. Ralph Lauren, did they hit this $3 billion mark and whatever those dollars were back in the day and then tried to go into line extensions that then they tried to exceed that, and then through doing that diluted their brand, and created this consumer confusion? Is that the right story to tell myself in that density?
Simeon: 100% though with one tweak. They're the wholesale equivalent. If your DTC only, so Ralph sells 40% of their business to wholesale approximately, so you have this business. They're in that five to six range. If you're allowed, we created this bar chart, this laminated bar chart, what it shows is it segments whether you're a DTC or a wholesale brand, and then it shows where you peaked and where you've come back. It's a really fun color-coded sell side thing. Within that framework, you have a business that definitely did that meaningful expansion. Up until recently and by recently, let's call it five years, it's not yesterday. They were right there with Nike in that they were the only two brands and so Ralph and Nike were the only two brands historically that were able to sell a halo product and a diffusion product without diluting them. What I mean by that is, what Nike is currently the only company that's able to do on mass and this is your question of why is unanswerable is, they can sell $400 LeBron drops and in quantity that allows them with that halo to sell half a billion units of $50 shoes.
Bill: Yeah.
Simeon: For so long, you could buy the same shirt, the same Ralph Lauren polo shirt at Bloomingdale's and Costco for drastically different price points and it didn't dilute the brand at some point that caught up.
Bill: Yeah.
Simeon: That's your point about Under Armour. At some point, having the logo be too pervasive diminishes the value of the existing base. Nike is the only company that has been able to consistently avoid that, where despite the fact they are the largest company, the swoosh is everywhere, it's still perceived to be special. Ralph had it, they extended too far, and then they retraced. Ralph had one of the best operators, one of the best CFOs in this business actually drive that playbook of the shrink to grow. That's this idea of internalizing that you can either give up the diluted revenue, and try, and protect your margin or you can ignore it, fight through it, and inevitably, my belief is you lose both revenue and profits. So, they've taken a more proactive stance.
Bill: He had a CEO that came in and left and that guy was really heralded as quite the CEO. But then I forget, they clashed.
Simeon: Yeah, Stefan Larsson. It's a loaded question. [laughs] I am of the view that legacy retail was a merchant prince driven business. There's Ralph, Tommy, Mickey Drexler, there were heroes. Those heroes were the only ones with a license to opine on fashion. When Ralph created an image, it then became a real estate play. The way to win in retail in history, totally oversimplify, was you needed the person that was given the very few people had a megaphone and a platform to say, "This is what you should look like. This is fashion." A lot of times this was causation. That was then rolled out to their monopoly on real estate, whether it was the department stores or whether it was the Gap's thousand-store [unintelligible [01:18:19]. Retail is a real estate play. If you had the distribution and you had the magical perceived, well, not perceived. They had obviously scale, but you had that merchant, that was a winning success story.
The problem or the evolution and this probably started within detects and then morphed into Instagram was that, the license, it shifted from being a push model to a pull model. It shifted from being a, "I'm going to tell you what to wear and you're going to do it, because I say so," which is a mass model. Everyone wears the same thing to it being anyone, any 12-year old with an Instagram handle has the right to opine on fashion.
Bill: Yeah.
Simeon: Totally-- [crosstalk]
Bill: All of a sudden, we got to build something you want. More than that somebody else wants to wear that you think is cool.
Simeon: You have to listen. Now, all of a sudden, the people at the helm had to listen. I think when that happened, the individual leadership pivoted to a team focus. I think we've now watched individuals able to destroy companies with bad decisions, but a single individual doesn't make a company. I think this notion of hero CEOs for me has devolved a little bit. Again, this isn't my world. I think generally speaking and there're obviously exceptions. We watch Bezos do what Bezos did. But I think that generally speaking, what tech has allowed for is the value of a team to become a lot louder than the value of a person individually. That's this idea of when you have a person can hold the company back and I'm not going to opine whether Ralph or Stefan, like, how that played out. But the idea of internalizing and actually listening to the consumer, and listening to the reality, and internalizing when too large is too large, that I think is the new world. I think that was part of this conversation.
Bill: That's actually when I got interested in Ralph Lauren and did some research was when Stefan came in, because they laid out the plan to reduce the amount of brands, and I was like, "Okay I can get down with this," but I just didn't know. Them and Michael Kors hit a trough at similar points if I recall.
Simeon: You're [crosstalk] laminate. These are the ones. It was Ralph, Coach, Kors, Under Armour, the big brand hasn't done yet is Calvin Klein. Yeah, 100%. It was this period with a big department store heavy brands that made-- I used to cover Fossil. Michael Kors, my math. Fossil reported at its peak, I think $900 plus million dollars with Michael Kors watches at wholesale.
Bill: Oh, wow.
Simeon: That means that Michael Kors watches to consumers generated somewhere between $1 billion to $2 billion of revenue at retail. That's insane. That's bigger than most of the companies.
Bill: Yeah, that's hot watches.
Simeon: That's with watches. They sold through Macy's and so you had this period where there was this beautiful triangle, of course, Fossil-Macy's like fueling each other and driving the comp, and you hear about center core, and then all of a sudden, it morphed from being this beautiful triangle to being the Bermuda Triangle of Death, when you realize that all three of them were propping each other up, and they just had stretched way too far. So, that was years ago, but it was fascinating.
Bill: Huh. I assume that if we go back, we'll see that some of what began to erode a little bit of that competitive strategy was the advent of social media, and a little bit more sharing, and a little more of not. I'm going to tell you what to wear or this is how you're going to procure something, but you have the choice to procure things how you want.
Simeon: The irony was is probably it's both ways. Social media first, probably, got people to start wearing more watches purchase per person per year. That was this absurd metric that we tried to calculate, where it's just literally, normally you think about a watch as being-- You either, no one owns up a tech, but you take care of the next generation, which means you have one or you got your functional watch. The notion of having a different watch for every different outfit wasn't really a thing until Kors introduced these very flashy, $200 to $400 watches that people just started rotating now like they were tops. It was this interesting like social media actually allowed for that, but then you're right, there so flashy, they're so big that all of a sudden, they start showing up and becoming ubiquitous.
Bill: Yeah, and that's what I think and I don't know this to be true. But that's what I think really started to take down Coach and Kors too was when they followed, I don't know if it was Fendi or whatever, into the letter purses, and all of a sudden, they were everywhere, and it's like this-- What my grandma grew up liking Coach for the quality of the leather, she used to talk about-- [unintelligible [01:22:47] was on one level and then Coach was not at that level clearly, but it was in the conversation of high-quality leather goods.
Simeon: Totally, absolutely.
Bill: Then they became everywhere and then it just got saturated. I don't know if that's reality or not.
Simeon: I like to say and this is like, I hate when people say, I like to say, because they make it feel it's actually something smart they're going to say and there's no brilliant insight here. But every time I talked to a startup, I was just like, "Know the cost of today's dollar tomorrow." We talked about a little bit before, but accessories, and watches, and expanding your lines are such an easy way to drive incremental revenue, but the question is, "What does that cost you in the future?" If you're a handbag company starting to sell watches and by the way, doing it via license with another company, it is a no brainer. It is easiest thing in the world. There's no working capital, you're collecting 80% flow through on free dollars. If it works great, if it does not. Except, no. Then you are giving someone else complete stewardship of your brand.
Bill: Yeah.
Simeon: Does department stores selling your watches? By the way, you get paid by Fossil, not by Macy's. So, you're actually not incentivized by then. Macy's doesn't care about your brand, because they're a portfolio of brands. Again, I'm throwing Macy's under the bus. That's not true. Hopefully, Macy's does care. But a third-party retailer doesn't inherently care about your brand as much as they care about moving units. It triggers this weird dynamic, where you're allowing someone else to have full control over your brand. Because you believe, you're getting 80% of incremental, but it just doesn't work like that. I think you're right.
I think when you see companies really pivot into broader categories rather than necessarily deeper categories, you need to ask yourself, "Do they make sense?" Of course, certain line extensions are going to be amazing unlocks. It's not universally, "Oh, if someone goes with another category?" Short term, but make sure that this aligns. Fast forward five years, if all of a sudden, you sell a crazy amount of product in this new line, is that good or bad?
Bill: Yeah.
Simeon: If you think it's going to be bad, then it's going to be bad.
Bill: [laughs] Yeah. You've got to ask or think about it. Just don't do it. If it's alright with you, I have enjoyed this conversation, but I think that's the tidbit that I want to end on. That's the second time that you've alluded to maybe sacrificing some dollars today to extend the dollars tomorrow, and I think that's a very insightful place to end this. If you're alright with that, I'm going to do that.
Simeon: Beautiful. Love it.
Bill: I've really enjoyed it, man. Thank you so much for joining and I'll drop your contact information in the show notes. Do you want to tell anybody how to reach out to you, or contact you, or anything?
Simeon: LinkedIn generally is the easiest way, then we can bring it onto email. But this has been great. It's been a lot of fun.
Bill: Awesome. I'm glad you enjoyed and we'll keep in touch.
Simeon: Sounds great, bud. Good to see you.