​Redbubble (RBL.ASX) is an e-commerce marketplace that connects consumers with artists globally. The business model is one we like; it enables shoppers to choose from many different designs and product categories and get it printed on demand. This business model is favourable as it carries no inventory risk and the company receives the purchase payment upfront while paying artists and fulfillers after.

In mid-2020 we took a position in RBL at around the $3.00 mark. As we articulated last year on many occasions, businesses that facilitated and enabled consumers to shop online during lockdowns and restrictions were amongst our so called “Covid Winners”.

Unlike many of its peers, RBL was cashed up and profitable. It also operated on a global scale which meant it wasn’t limited by its addressable market like some of its land constrained peers, Kogan (KGN.ASX) and Temple & Webster (TPW.ASX).

During 1H2021, RBL reported strong sales growth and profitability was on track to hit $60m of EBITDA by 1H. Cashflows were strong with cash balances ballooning to over $100m. RBL was not only benefitting from consumer demand for online shopping, but also from reduced marketing costs and higher gross margins in (temporarily high demand) products like face masks.

We understood from day one that RBL would likely struggle to maintain elevated sales growth in 2H2021 and beyond. We did however believe that, due to the global nature of its business, RBL could maintain growth and profitability, albeit at a lower level. We also expected management to begin paying dividends to investors. Our valuation over 1H2021 increased to $7.00 based on consensus estimates. We also had a bullish best-case scenario valuation of $10.00 had RBL achieved our estimate of $100m EBITDA in FY21.

During January 2021 the stock exceeded our valuation of $7.00 and we sold down substantially to secure profits for our investors. We maintained a small position going into the Q2 update.

There are many sayings in investing, but one that never fails is that “good news travels fast”.

The market (and us), were expecting very strong sales and EBITDA figures for Q2 and there was an expectation that management would update the market by late January. As the news never came, we became concerned and reduced our holding even further at $7.00+ as the risk/reward trade off was no longer balanced.

RBL reported Q2 results during its half year result in late February and although sales were as expected, gross margins were significantly below expectations as competition increased. We exited our holding above $6.00 on the day. Overall, RBL was one of our top performing stocks in 2020.

Last week, RBL provided a Q3 update to investors and laid out a new strategy for investors under the reign of recently appointed CEO Michael J. Ilczynski. As we no longer owned the stock, we looked on with interest from the sidelines.

Unfortunately for investors, the update was disappointing as sales growth slowed down and profitability completely disappeared as margins were heavily impacted by discounting and increased marketing spend. To make matters worse, the new CEO laid out a strategy of reinvestment and lower profits for the next two years to drive top line growth.

The ultimate reward for investors is a $1.25bn sales target beyond 2024 and EBITDA margins of 10-15%. Essentially, or in other words, the company now needs to spend more on marketing to stay competitive and relevant. Investors were not impressed and sent the stock to $4.00.

At this stage we don’t believe so. There are serious headwinds for the company for the remainder of CY2021. These short term hurdles include cycling the elevated sales from the lockdowns from April to December last year and a persistently stronger AUD, which has appreciated 17% against the USD (RBL’s main sales currency).

To make matters worse, RBL was added to the ASX200 index just three days before the disappointing update. It is now likely that RBL will be removed from the index on the next rebalance, adding more artificial selling pressure to the share price.

Overall, we did well out of RBL and we may re-enter the stock at some point in the future. Experience has taught us that there is no immediate rush to do so, and we will want to see a material discount to our updated valuation of $4.50, based on consensus forecasts for the next two years.