M&A trends in e-commerce
Sam Fuller, managing director and UK head of the consumer sector at international investment bank Altium, comments on investment trends in the e-commerce sector, focusing on the elements that make an online retailer attractive to investors.
Valued at an estimated £78 billion last year and still growing rapidly, the UK e-commerce market is an extremely profitable sector that shows no sign of slowing down. Not surprising, then, that there continues to be significant interest from investors looking to move away from traditional bricks and mortar retail to take advantage of the continuing cultural shift for consumers to buy ever more products online.
Investors are keen to capitalise on the benefits of e-commerce without the cumbersome aspects of traditional retail. E-commerce eradicates the need for property leases, high street rent premiums and the staff, stock and logistical issues that come with running a portfolio of shops. Run well, e-commerce is efficient and lean, often only demanding a relatively small head office, central warehouse, distribution network and a website.
However, whilst the e-commerce market remains an active landscape for both private equity investment and M&A activity, there is evidence that investors are becoming more selective about the attributes and KPIs they look for.
At a basic level, profitability is becoming an increasingly important investment criterion. A number of e-commerce businesses continue to make losses despite several rounds of investment and as a result, investors are becoming less willing to stomach years of forecast losses in a business plan. This, in turn, leads to far greater scrutiny of the cost base; investors have become wary of big headcounts and are more easily won over by business models that only require lean operating teams. Similarly, there is a growing focus on marketing costs which are often the biggest cost centre for an e-commerce business. How cost effective is your marketing spend? Is the spend being directed at your most profitable customer category and are you getting a decent return?
Given the buoyant market conditions, the e-commerce sector is becoming increasingly competitive. As a result, online retailers need to work hard to differentiate themselves from their competition. Simply offering a good level of service and quick delivery is no longer enough to attract consumers. A key feature of recent transactions we have advised on has been the amount of time spent by investors on competitor mapping. Niche or defensive market positioning will always be a selling point for any business but this feature is becoming increasingly important in e-commerce, where barriers to entry are, rightly or wrongly, perceived to be low and there are often a lot of established competitors, both online and offline. In the vast majority of e-commerce subsectors, first-mover advantage is basically long gone and investors accept that creating the new Wiggle or ASOS will not be easy.
Another key element for investors is the strength of the brand itself. Investors want the reassurance that an online retailer is a trusted end-destination and that repeat customer statistics are strong. The brand strength works in two ways. First, in driving sales to the website, with the key aim of securing direct traffic away from Google rankings. Becoming a household name for a category or product is the nirvana. Secondly, developing an own-brand product is increasingly important. Invariably, own brands allow a business to deliver consistently better margins as well as ensuring a unique product offering on its platform; this boosts the chance of luring more direct customers.
Exposure to third party channels has also become a key focus for investors. Whilst successful online retailers such as Amazon and eBay represent very effective platforms to access large audiences, both in the UK and internationally, using them can come at a very real margin cost. A third party channel customer is also usually price-driven and therefore tends to be significantly less valuable than a loyal, repeat customer. Put simply, you do not “own” a customer or any of their data when sourced via a third party. As a result, investors are becoming increasingly wary about over-dependence on third party channels and will take this into account when valuing a business. Third party channel sales are often deemed to be materially less valuable than direct sales.
One of the main benefits of e-commerce is that with international postage from the UK being competitively priced, the incremental cost of setting up overseas markets can simply be down to a translated website and a well-honed fulfilment operation. With the UK online retail market relatively well advanced, there are some real opportunities for retailers to get in early and establish an international presence. Proving your business can successfully develop internationally is key and, at the very least, an investor would expect a business to have a clear road-map to international sales.
And finally, it is crucial to know your customer. Compared to traditional retail, e-commerce is incredibly data-rich, so investors in the space will want to make the most of this. They will be data-driven and will focus on statistics such as customer lifetime value, average order value, customer acquisition costs and all the associated historic and forecast trends. We find the e-commerce entrepreneurs we advise to be amongst the most numerate, KPI and data intense of any sector and the investors are the same. A growing number of private equity investors will look at KPI trends to assess a business’ potential before asking to see any financial information – their rationale being that if the underlying KPIs are good, the P&L will look after itself.
With Office of National Statistics figures showing an average 12% annual increase in online sales since 2011, we can expect to see appetite for investing in e-commerce businesses continue to grow. However an increasing number of investment opportunities will ensure that investors grow ever more discerning.
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