#143 - Poshmark Throws In The Towel

ATT, FIFO, LIFO and M&A

Oct 16, 2022

Hi 👋 - The stock market selloff is creating M&A opportunities for companies with strong balance sheets and stronger intestinal fortitude. Today, a look at how recent changes to the digital advertising ecosystem likely spurred Naver’s acquisition of Poshmark. Thanks for reading.

If you’re finding this content valuable, consider sharing it with friends or coworkers. ❤️

For more like this once a week, consider subscribing. ❤️

Elvis

Sometimes odd combinations work. Sometimes they don't. Elvis Presley’s favorite sandwich was bacon, banana, and peanut butter. Odd, but good. While it’s too early for a definitive judgment, Naver’s recent acquisition of Poshmark seems just plain odd, like a tuna fish and peanut butter sandwich.

Poshmark is a Bay Area social marketplace for fashion resale founded in 2011 by entrepreneur Manish Chandra. The company went public in January 2021, pricing its IPO at $42 per share. On October 3rd, it was acquired by Naver, a South Korean internet conglomerate, for an enterprise value of $1.2 billion, equating to $17.90 per share.

Like a tuna fish and peanut butter sandwich, the deal is a head scratcher. Poshmark didn’t need to sell. It ended the second quarter with nearly $600 million of cash. It wasn’t a black hole of cash burn, so liquidity wasn’t an issue. Like many e-commerce companies, its growth slowed as Covid restrictions ended and consumers shifted spending from online to offline and from goods to service, but it was still growing. In the second quarter, active buyers increased a respectable 14% year-over-year. Adjusted EBITDA margins, though trending downward, were manageable, helped by gross margins over 80%.

Source: Poshmark financials. Note: Active Buyers in millions and Adjusted EBITDA in millions of dollars.

Can’t Help Falling in Love

Naver’s conference call discussing the acquisition was unfulfilling. The company rattled off an anodyne list of rationales. For example, Poshmark provides a foothold in C2C fashion resale. Its 80 million registered users, 8 million active buyers, and 25 minutes time spent per day offer a solid foundation with room to improve monetization through advertising. They’re also guinea pigs for testing with Naver’s AI technology. Gen Z and Millennials, two highly coveted demographics, represent eighty percent of Poshmark’s 18 million monthly active users. Despite recent headwinds, cohorts are healthy, with high retention. Naver can accelerate Poshmark’s international expansion into Europe, Japan, and South Korea, while Poshmark provides a beachhead for Naver in North America. In addition to gobbledygook about shared vision and shared values, there were buzzwords like circular economy and micro communities. There’s a lot there, but nothing about this combination feels particularly special.

Source: Naver, Naver to Acquire Poshmark, October 6, 2022.

WTF, ATT

Twice during the call, Naver mentioned that recent ad ecosystem changes impaired Poshmark’s growth, making its acquisition marketing less efficient. This referred to Apple’s app-tracking transparency (ATT) policy, which rolled-out with iOS 14.5 in April 20211. Billed as a privacy enhancing measure, ATT requires iOS users to opt-in to tacking across third-party apps and websites. Opting-in deprecates identifier for advertisers (IDFA), a unique device ID used by digital advertisers for targeting and personalization, prohibiting user-level ad attribution2. (Because investors love alphabet soup, you’ll sometimes hear ATT called IDFA; the two are used interchangeably below.)

Source: Apple, User Privacy and Data Use.

Apple’s motives might have been noble (protecting consumer privacy) or selfish (more control over app distribution, advantaging its own ads business, good PR and marketing, a strategy credit). Whatever the reason, Apple knee-capped mobile ads3:

The IDFA is the hydrocarbon of the mobile advertising ecosystem: it is the sine qua non of the device-centric targeting paradigm that drives advertising performance on mobile. Just as burning hydrocarbons is integrated centrally into the world’s energy infrastructure, the IDFA is the indispensable input to mobile advertising measurement and targeting.

ATT created headaches for advertisers, ad tech companies, and platforms as it reduces the effectiveness and profitability of targeted ads. Facebook said in February that ATT would have a negative $10 billion impact on 2022 revenue, sending Mark Zuckerberg scurrying to the metaverse. Industries like e-commerce and gaming reliant on retargeting for customer acquisition were also hit hard.

If a user opts-out of ATT, their data cannot be collected and paired for advertising. This impairs measurement and targeting, making both less granular and less precise. Measurement is the degree of visibility advertisers have into the engagement and revenue driven by their ads. Targeting is the precision at which ads can be served. As retargeting gets less precise, acquisition becomes less efficient. Eric Seufert, growth consultant, investor, and author of Mobile Dev Memo, sees ATT as a tectonic shift – it didn’t kill digital advertising, but it killed the status quo4.

The pain was not distributed evenly. Businesses that relied on Facebook and retargeting as acquisition channels were particularly exposed. In contrast, with third-party data restricted, ATT increased the value of first-party data.

“A Little Bit of Leeway” – Poshmark and ATT

Facebook wasn’t the only one with an ATT black eye. Poshmark’s user acquisition and marketing efficiency was negatively impacted too. IDFA was mentioned five times on the company's second quarter 2021 earnings call. Here’s one example, from Poshmark’s former CFO, Anan Kashyap5:

During the second quarter, similar to others who use digital marketing, we began to see the impact of IDFA, which effectively increased the cost of mobile advertising due to less efficacy when running targeted marketing programs. Since our marketing mix is highly diversified and adaptable, we adjusted by focusing on strong ROI user acquisition channels as well as investing in upper-funnel strategies such as TV and influence of partnerships to counter the effect of IDFA.

The impact was more significant in the third quarter – when IDFA was mentioned 13 times – as more iPhone users updated their OS. Chanda noted greater-than-expected headwinds from IDFA6:

The thing with IDFA is it has really increased the cost of digital advertising and decreased the efficacy when running targeted marketing programs.

As a result, Poshmark’s acquisition cost increased. However, given high gross margins, cohort stability, and balance sheet flexibility, it decided to relax its two-year LTV payback period to boost growth. Here’s Chanda answering a question on the impact of ATT on customer acquisition costs and LTV7:

Look, I think as it's no surprise, our costs have gone up. And when we think of how we invest in it, ultimately, we rely on our long-term behavior of cohorts and our high gross margin business, which allows us to recoup these costs. Certainly, we've represented and we've talked about how we have thought in terms of payback period, which has been in that 2-year time frame. In order to accelerate the spend in growth, we have to give a little bit of leeway to our marketing team to do that, and it will impact our payback periods temporarily. But when we think of the long term, we have successfully navigated several different digital advertising landscape changes over the last few years.

The trouble with grabbing one last french fry – just a little bit of leeway – is that it’s often not the last french fry. After IDFA launched, Poshmark’s sales and marketing spending as a percentage of revenue spiked from 39% in the second quarter of 2021 to 48% a year later. Over the same span, revenue growth slowed from 22% to 9%. Granted, this was a tumultuous time for e-commerce as a whole, with e-commerce penetration rates reverting to pre-Covid levels as consumers shopped IRL. Still, it’s clear that IDFA gummed up Poshmark’s growth algorithm.

Inventory Valuation – LIFO, FIFO, and ATT

Understanding inventory valuation, the accounting process that assigns value to a company’s inventory, is key to Naver’s acquisition of Poshmark. In the US, generally accepted accounting principles (GAAP) allows three options: first-in, first-out (FIFO), last-in, first out (LIFO), or average cost. For an illustrative microwave factory:

LIFO: Assumes that the microwaves produced most recently (last) are sold first. Cost of goods sold (COGS) is composed of newer units, while ending inventory consists of older units.

FIFO: Assumes that the oldest microwaves are sold first. COGS is composed of older units, while ending inventory consists of newer units.

Average Cost: The weighted average of all microwaves available during a period are used for to calculate COGS and ending inventory.

For a given period, inventory valuation methodology impacts a company’s balance sheet (inventory levels) and income statement (COGS, net income, taxes). Let’s say our microwave factory produces 100 units per month. Due to inflation for raw materials and components, the cost per unit increases each month:

Here’s what its income statement looks like at the end of the first quarter (as well as its inventory balance). Net income is maximized under FIFO, because the older units costing $50 to produce hit COGS while pricier new units sit in inventory on the balance sheet. Under LIFO, it’s the opposite.

During inflationary periods, the $50 microwaves produced in January become more valuable, which brings us back to ATT and Poshmark. An outcome of ATT was that some types of user acquisition like retargeting got more expensive. In the second quarter, Poshmark had 8 million active buyers, 6.7 million of whom were acquired before Apple released iOS 14.5 in April 2021. They’re like $50 microwaves in an inflationary environment. Unlike microwaves, which only generate revenue once when they’re sold, e-commerce customers can deliver a stream of revenue over time through repeat purchases.

Since 2011, Poshmark amassed a sizable registered user and active buyer base, helped by retargeting. The heavy lifting was done in a different paradigm for digital advertising, when user acquisition was cheaper. Replicating this user base from scratch in the post-ATT world would cost a lot more. Though not mentioned explicitly on Naver’s call, that’s likely the asset they were after.