A new study shows Wayfair is losing money on every new customer — and that's terrible news for the stock (W)

Wayfair, the e-commerce company that generates $3.4 billion in annual sales of home goods and furnishings, loses roughly $10 for every new customer it acquires, according to a new analysis by two business school professors. 

That unseemly statistic doesn't bode well for the company's future prospects, and it implies that Wayfair — which opened trading Wednesday at about $69 a share, giving it a market value of about $6 billion — could be overvalued by more than 80%. 

In a lengthy paper released late last week, Daniel McCarthy, an assistant professor of marketing at Emory University, and Peter Fader, a marketing professor at Wharton, present a new method of valuing publicly-traded retailers that focuses on customer retention. Wayfair is an unfortunate guinea pig example. 

The thrust of their analysis, which sprawls over 50 pages, is this: If you can suss out how much a company spends to attract each new customer and how much customers spend over their lifetime before ditching the company, you can deduce a company's future revenues and overall value. 

In Wayfair's case, McCarthy and Fader estimate that Wayfair is spending about $69 to acquire new customers, but it's only earning $59 back from the customer over the long haul.

"So they're losing money every time they acquire a new customer," McCarthy told Business Insider.

The paper calculates the company's value at $10.24 a share — about 85% below where the stock opened Wednesday.

A Wayfair spokesman declined to comment and referred Business Insider to research published by a Wall Street analyst who took issue with the assumptions in McCarthy's research. 

But the company has addressed the issue of customer acquisition costs and profits previously in presentations to investors. The company is currently unprofitable — having lost nearly $200 million in 2016 — but Wayfair and its investors, of course, believe it'll outgrow this problem over time and start turning a profit. 

McCarthy and Fader say the customer-retention data doesn't back that up.

Another Blue Apron?

The academic duo used similar analysis on retailers with subscription models, like Blue Apron. Prior to the meal-kit company's initial public offering, McCarthy calculated that the company's $10 a share opening price was significantly overvalued given its ugly customer-retention figures, calling for a best-case price of $8.40 a share. 

Blue Apron cratered after its IPO, and today stands at roughly $5.50 a share. 

Applying this analysis to retailers with non-subscription business models — companies like Wayfair, Amazon, or Walmart — is much thornier, as customer purchasing patterns are far less predictable and customer churn isn't observable.

But with the right customer data metrics, you can glean a far better picture of a company's health, according to McCarthy and Fader.

"Wayfair has disclosed data along all of these dimensions for many years now – quarterly customers acquired, total orders, active customers, and revenues – which allows us to use some statistical modeling to 'back out' what the implied customer retention and spend are for customers," McCarthy told Business Insider.

The paper compares Wayfair with Overstock.com, another online retailer, albeit a more mature company with more general product offerings. Overstock releases similarly useful customer-focused data, though its prospects look a lot brighter: Because the company spends a lot less to acquire customers — $38 compared to Wayfair's $69 — it actually turns a $9 profit on each new customer. 

If Wayfair reduced its customer acquisition costs to the same level as Overstock, its expected valuation would double, provided all else was equal, according to the paper. 

Of course, as with any valuation, assumptions are baked into the formulas and uncertainty exists. In the most optimistic scenario — in which Wayfair quarterly revenues eventually beat the baseline expectation in 2022 by a multiple of five — McCarthy and Fader estimate the company's value at $57 a share, or 19% below what Wayfair is trading at today. 

$1.2 billion in value erased

Since the paper was published late last week, Wayfair shares have already fallen from $83.77 to around $69 a share at Wednesday's market open — a more than 17% drop. Its market value has fallen by more than $1.2 billion. 

This is, it should be noted, a small dent given that the shares had more than doubled in the year through last week. Wayfair was already a popular target for short sellers this year — who profit from a falling stock price — though so far they've taken a bath on that bet. 

They were quick to jump on the research. Citron Research, the firm run by noted short-seller Andrew Left, has long been critical of Wayfair and was quick to tout the analysis. 

Smartest piece EVER written on $W. Not by a short or long. By a team of Ivy League scientists who specialize in predictive models. $10 tgt

— Citron Research (@CitronResearch) September 22, 2017

Cannot argue with this analysis- target $10 Smarter work than ANYONE on Wall Street has ever done on Wayfair. https://t.co/JpDPS8NA7A

— Citron Research (@CitronResearch) September 22, 2017

An equity analyst that covers Wayfair initially jumped to the company's defense. Aaron Kessler, of Raymond James, issued a note on Friday claiming McCarthy's analysis had "many questionable assumptions" and saying investors had overreacted.

Kessler followed up with an additional note Monday saying he had incorrectly interpreted portions of the paper but still disagreed with other aspects, notably customer retention and overall valuation.

Here's Kessler:

"The report argues that a cohort of customers is acquired and active for a period of time and then churns or becomes permanently inactive. We struggle with the assertion that consumers become permanently inactive on Wayfair -- caveat being a consumer had a really bad consumer experience. Wayfair publishes its repeat rate quarterly which continues to increase as its base of active customers matures (61% of orders in 2Q from repeat vs. 37% in 2012).

"We believe the analysis may be missing is that customers purchasing home goods likely purchase in waves - that is the consumer will purchase the most after they complete a move."

But McCarthy says Wayfair has a long enough track record of data to account for any potential issues regarding customers purchasing in waves. Annual data for Wayfair exists going back to 2003 and more granular quarterly data is available starting in the first quarter of 2013. 

And, he says, he and Fader have a business that models and analyzes customer-retention costs for dozens of large companies as well as asset managers performing due diligence — which gives him confidence in his analysis.

Analyzing a company with their cooperation and internal data isn't identical to analyzing a public company from afar for an academic paper, but the model and methodology remains the same, according to Fader, who has been at Wharton for 31 years and researching these specific models for the past 15.

"The basic models used here are quite standard and well-accepted in the quant marketing area — many of my colleagues and students (and countless practitioners) have been using them for years on internal transaction data," Fader told Business Insider. 

Joe Ciolli contributed to this report. 

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