COVID Sparks E-Commerce 3.0 and Birth of Digital Brands IPO

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  • Nearly 8000 investors participated in crowdfunding success story
  • Consumer sales accelerate online as conventional mall shopping declines
  • Reshaping retail and paving the way for a new era of brand building
  • Acquiring customers in the physical and retaining in the digital

Digital Brands IPO’d this past Friday and closed at $3.40. The online apparel company must have caught fire on social media as this morning it had already traded nearly 6 millions pre-market and is currently trading at $4.76 (+40%) 15 minutes into the open trading well over 13 million shares.

Evolution eventually hits all industries in time, but the pandemic accelerated the pace of evolution in the retail space.  When lockdowns closed the mall traffic, big box retailers from department stores, like Nordstrom (NYSE: JWN) holding companies such as VF Corporation (NYSE: VFC) to brands such as Ralph Lauren (NYSE: RL) had to rethink their strategy.  One major component of mall traffic is fashion apparel.  In order to survive, these fashion brands needed to find a way to get their goods to market using a medium other than a mall retailer.  The most obvious answer was to migrate sales online, but for authentic brands not skilled in the art of online e-tailing, that opened up a whole host of logistical challenges for the fashion brands.  It’s just too hard to scale a stand alone digital brand because the cost of acquiring a new customer is simply too high. Before the pandemic the Customer Acquisition Cost (CAC) of a Direct to Consumer (DTC) campaign was running about $80 per customer.  Once the pandemic hit, prices rose to $150 per customer.  A new paradigm is unfolding as brands like Digital Brands maintain a physical presence in retail to acquire their customers, and then use their digital prowess to retain and cross sell the customer. There had to be an ideal solution, and Digital Brands Inc. (NASDAQ: DBGI) seems to have found the sweet spot.

Customer Acquisition Costs

Since the pandemic the cost of advertising online has skyrocketed.  Almost all brick and Mortar retailers and established clothing brands flocked to online distribution to slow the hemorrhaging in their physical stores due to the lockdowns. Although apparel sales in the United States declined by 19% in 2020, according to a survey by The NPD Group, retail ecommerce sales grew to a whopping 44%

In apparel, sales of comfy cozy categories like sweatpants increased by 17%, those of sleepwear rose by 6%, and those sports bras grew by 10% during last year. Fashion footwear sales declined by 27% during the year.

Due to the ‘work from home’ trend, tailored clothing, dresses and dress shoes, which were already losing share to more comfort-oriented attire pre-pandemic, were hit particularly hard in 2020. According to Digital Commerce 360, retail clothing sales grew by 100% in 2019 as online apparel sales accounted for 38.6% of total U.S. apparel sales. Over the past 3 years, ecommerce’s share of apparel sales has grown nearly 10 percentage points, as online apparel sales accounted for 34.0% of total U.S. apparel sales in 2018 and 29.9% in 2017.

Source: 2020 Digital Commerce 360

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This mecca to online distribution means that only entrenched players with cash to invest are available to acquire new customers in this market space and continue to scale their business.  The cost of advertising a stand alone brand is prohibitive and has created a situation where the emerging fashion brands cannot effectively compete in the direct to customer market segment.  Existing fashion brands are only left with the traditional wholesale model which is prone to shocks related to the pandemic. In the traditional model fashion brands essentially trade their right to connect directly with the customer for a wholesale order from the retail department store.  They have no direct ability to reconnect with that consumer unless that consumer reaches out to them via social media.   

Department Stores 2.0 (reshaping retail)

Department stores no longer command the leverage they once had to be the exclusive distributor for fashion brands.  In the past loyal customers would go to Nordstrom and Macy’s because they had Ralph Lauren (NYSE: RL), Coach (NYSE: TPR) and Calvin Klein (NYSE: PVH) brands, but consumer preferences have changed and quite frankly so has the customer. Millennials out shop boomers 2 to 1 in the category of clothing.  This means that department stores need to cater to Millenials who are after authentic brands and really don’t care for the mega brand names like Michael Kors (NYSE: CPRI), Jos. A Banks (NASDAQ: TLRD), and Victoria Secret’s (NYSE: LB) . In addition, Millenials like to mix and match and never wear all of the same brand from head to toe.  They desire niche brands and love to accumulate loyalty points and get rewarded with new deals.       

The best way to understand how retail has changed is to look at how the consumer’s closet has evolved.  The first variable to consider is the number of brands that represent the shoes, jeans, blouses, jackets, and jewelry 10 years ago versus now.  There’s no definitive source for this data, but a quick look in the closet reveals that these numbers really haven’t changed much because people still like to mix and match.  What has changed in the closet in a significant way is the percentage of clothing and accessories that were purchased in a department store versus online and direct from the manufacturer.  Data compiled in The Direct-to-Consumer Guide shows the DTC movement accounts for 40% of the sales growth in the sector. Two out of every five Americans have made a purchase directly from a brand or manufacturer. By 2022, the number of DTC ecommerce customers will hit an all-time high of 103 million.

In the past almost all the clothes and accessories were purchased at the department store, but now it is split between the department stores and the online brands.  There is a big difference between the gross margins at a department store (aproximatley 50%) and the direct to consumer model (approximately 65 – 75%) excluding the marketing costs.  The department stores have all the costs of brick and mortar while the direct to consumer model cuts out all the middle men.  

In this evolving fashion economy department stores seem to have a new function of being the showroom for new brands.  There is actually a symbiosis growing between department stores and new brands.  This symbios can be traced back to a period of time where Best Buy (NYSE: BBY) was considered the showroom for Amazon (NASDAQ: AMZN).  Consumers would visit Best Buy, get all the customer service they needed related to the electronics and then purchase on Amazon who would not get any portion of the sale.  Allowing Best Buy to fail was not in AMZN’s best interests as it eventually acknowledged that BBY did a great job of educating the consumers.  So AMZN eventually partnered on projects and directed traffic online to offline BBY and started selling Fire TV products that were exclusive to BBY.  Fashion consumers want the same sort of experience and need to touch and feel the merchandise and get a feel for what size they are.  

Wholesaling versus Cross Selling

For up and coming brands the only way for them to acquire customers at a reasonable acquisition cost is to wholesale their product to department stores, which results in over producing product and subjecting yourself to the department stores mark-downs and return to vendor rules.  Brands that do this might eventually find themselves in a pinch if their products don’t sell through well, which leads to an eventual mark down by the department store and this margin compression is passed on to the brand at the end of the season when the department stores demand better pricing to keep the brand in the store.  If the brand tries to use the power of the internet to go Direct to Consumer (DTC) then they face high customer acquisition costs and have to deal with a large number of returns as consumers figure out the sizing of the clothes. In some cases returns are as high as 35% to 50%, which usually destroys the gross margin.  In either one of these scenarios the brand is left with low margins.       

Once a customer is acquired in the physical realm then a brand has the opportunity to cross-sell other products in the digital realm.  In the digital realm a customer profile is pieced together over time.  Their purchasing decisions are monitored and intelligent algorithms are able to help coordinate pieces with what they currently have in their wardrobe and make recommendations almost like a virtual stylist.  This approach has been proven to increase sales and results in a consumer stickiness to the brand.  

However, Digital Brands has taken cross selling to a new level because they have multiple brands to choose from.  Investors need to keep in mind that customers like to mix and match brands and are resistant to dressing from head to toe in the same brand so when the virtual assistant recommends a different brand that goes with their style the consumer is likely to pounce on the recommendation.  This is like a multiplier effect for Digital Brands which is essentially a holding company for multiple brands.  The more brands that join the company, in theory the greater the multiplier effect.  In the future this could be a very powerful influencer that encourages other brands to join the Digital Brands ecosystem to get a bump in sales from the cross-selling exposure. 

The New Paradigm – Acquire in Physical and Retain in Digital

Digital Brands calls this concept “Acquiring in Physical” and “Retaining in Digital.”  The key to this business model is keeping down the CAC in order to preserve gross margins.  The other issue plaguing the DTC market is the return ratio.  When the customer knows the feel and fit of the product they are less likely to return it.  This also improves margins in the DTC realm.  The digital realm is really a customer retention tool with tremendous cross selling opportunities.  Once the consumer is in the Digital brands ecosystem they can expect to receive personalized communications based on their preferences.  This adds to the stickiness of the customer and allows the expansion of the brand to the customer base over time.  They also recognized that the Millennials which now comprise a majority of shoppers want authentic brands which is their primary focus, and not mega brands. 

Digital Brands has a holding company concept that currently has 4 brands under its umbrella.  Their largest is Bailey 44, followed by DSTLD, Ace Studios, and Harper & Jones.  So with these brands they have tremendous cross selling opportunities with a wholesale to retail markup.  There is also a consolidation of the cost structure as well.  They are going to enjoy economies of scale with respect to purchasing power, shipping, packaging, and marketing.    

Acquisitions are a key part of their strategy.  The company is expected to acquire several brands in the next 2 years and grow from $10 million in sales to over $300 million. 

We believe there are three ideal acquisition targets: 1) strong legacy brands that have been mismanaged specifically their business model from sourcing to distribution has yet to evolve with the times, 2) strong brands that do not have capital to grow as the retail landscape is filled with niche brands that see the benefit of digital scalability for exposure yet can not capitalize due to funds nor compete with the majors, and 3) wholesale brands that are struggling to transition to e-commerce as they have historically dedicated very little to this channel of business. 

Competition

Digital Brands Group is set up and functions as a holding company model, a modern one that owns the portfolio brands capitalizes on shared back office services and has each brand communicate with their consumers individually. 

Then holistically the Group shows outfits and looks together across their own brands to the consumer like a department store would. These looks and outfits are shown in an editorially driven way combining the various dress styles appealing to the customer’s individual style preferences and trends.

Consumer shopping habits are then captured from both the customer’s individual brand purchases, as well as the combination of brands based on the look and style the customer purchased. This allows the company to create stylized groups utilizing data-driven cohorts that then shape personalized consumer cohorts that get further and further refined the more the consumer shops within the ecosystem and the more data that is created.  

The top three drivers of the Digital Brands business is based on the premise that no person exclusively wears one brand all the time, but rather multiple brands at any given time. The next driver is blending a DTC business with higher margins while leveraging wholesale’s broad, inexpensive and highly scalable distribution retail stores to acquire customers in a physical format. The final driver is the best in class loyalty program which keeps their consumers engaged and part of their fashion ecosystem.

One of the widely anticipated tools in the retention of Digital Brands customers is the personal stylist.  Only Stitch Fix has the quality of style recommendations comparable to Digital Brands.  Stitch Fix targets value oriented women and makes recommendations for a styling fee that is credited toward their order.  They positioned themselves as a wholesaler so don’t enjoy retail mark ups.   

Capris Holdings (NYSE: CPRI) – is a multinational fashion holding company, incorporated in the British Virgin Islands, with executive offices in London and operational offices in New York. It was founded in 1981 by American designer Michael Kors. The company sells clothes, shoes, watches, handbags, and other accessories. 

VF Corporation (NYSE: VFC) is an apparel and footwear company with over 30 brands in the categories of outdoor, activewear, and work. While this is a company with over $10 billion in annual sales the structure of Digital Brands is about the same, just smaller in scale and with one caveat.  What separates the company is their structure.  Each one of the brands is a stand alone business and they have failed to exploit any cross selling opportunities like Digital Brands. 

The Team

In most start up businesses it’s really important that the person running the company has experience in that field of expertise.  If the company is public then it’s important they have wall street experience. Digital Brands has a combination of wall street smarts and fashion experience.  The CEO Hil Davis has a successful track record in e-commerce and luxury apparel but before that he was a research analyst at Thomas Weisel Partners, SunTrust, and Citadel Investments.  This type of Wall Street experience is rarely seen in small public companies and bodes well for investors who see his vision.  His Chief Marketing Officer, Laura Dowling, was the key person at Coach who was responsible for the cross selling opportunities in the digital realm that brought in incremental revenue via social media and customer retention programs. They also have a CFO who worked with multi-national companies that included brands like Nike (NYSE: NKE)  and Qualcomm (NASDAQ: QCOM).         

Largest Crowdfunding Success

The company was listed on SeedInvest, StartEngine, and WeFunder for a reg A+ which raised $10 million dollars and was one of the largest fashion brands to date to raise that amount of funding.  There are 8000 investors that were issued registered stock as part of the IPO.  The minimum investment was $1500 at $.53 which resulted in almost a 10X return at the IPO price.  The company plans on maintaining a rich social experience for their investors.   

Investment Summary
Retail department stores are struggling to stay afloat during this pandemic and searching for a purpose.  Digital Brands is reshaping retail in the fashion business and is optimized to thrive in either a pre or post pandemic environment.  In essence, they are giving department stores purpose again.  They have been able to capitalize on an acceleration of customers into the digital realm. Their strategy is to acquire customers in the physical and then retain in the digital.  The company has proven that they cross merchandising multiple brands that they own to increase revenue and lower costs and the recent IPO represents an expansion of that model.  Retailers are often valued by their CAC and customer retention and it’s expected that Digital Brands will have one of the lowest CACs from cross merchandising and shared marketing costs, as well as one of the highest customer retention rate through personalization and a strong brand portfolio.  The company has a war chest of $8.0 million from the IPO and plans on several acquisitions over the next 2 years.  Their cross selling platform which uses AI is expected to have a multiplier effect for each and every brand that they bring in.  The management team is ideally suited to scale the business and has the ability to raise capital to sustain the business model.

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