Asos: grin and wear it
What if the winner does not take all?
An unpleasant question for internet investors: What if the winner does not take all? Paying up for leaders – in search engines, chat apps, or whatever – makes sense only if leadership confers lasting advantages. On Thursday, a leading web fashion retailer, Asos, gave a doozy of a profit warning. It pointed to “zonal” pricing problems. Asos is not, it seems, set up to charge different prices in different regions. This sounds fixable. The bigger problem is competition. Operating margins were expected to be above 6 per cent this year. They will come in a third lower than that. The shares fell 30 per cent.
Over five years, Asos sales have expanded at an average rate of more than 50 per cent, to £1bn annually. The shares, even after falling by a quarter since late February, traded at 78 times earnings before the warning, reflecting confidence that the company would not have to make hard choices between margins and growth. But management’s contention that a bit of discounting will not harm the business model does not ring true. Pricing tends to be slippery on the way down and sticky on the way up. Ask any UK food retailer.
The company’s valuation has not mattered to acolyte investors – Asonistas? – who believe it will be as dominant in its fashion niche as Amazon is elsewhere. But fashion is not electronics or toys. It has its own dynamics and how those will play out on the internet remains uncertain.
The share price drop appears to reflect a cut in operating earnings expectations from roughly £64m to £45m; the impact on the multiple could be negligible. But talk of “increased promotional activity” suggests more than a step down in margins. Growth is becoming harder to find. The multiple will compress. This happens to all growth stocks, and the internet cannot stop it.