Why Investors Are Driving Valuation Declines of Consumer Discretionary Startups

From Peloton to Carvana to DoorDash - and on to meal kits, instant delivery and streaming - valuations are declining as consumers find prices and fragmentation insupportable just as venture investors are realizing that such companies are unlikely to generate tech company margins and growth. 

The result is that much of the promise has faded of  companies using tech platforms to sell consumer discretionary services and products popular during the pandemic are now facing the harsh reality of an economic reversion to the mean in both consumer behavior and financial prospects.  JL

Christopher Mims reports in the Wall Street Journal:

Amid the longest boom in tech, investors subsidized the losses of startups delivering conveniences - and subsidized consumption of their products - on the logic they would grow into their oversize valuations. What enabled these startups is technology, which (is) why they were valued at earnings multiples of high-growth tech companies with high margins. What’s apparent to investors now is these companies - many of which have high fixed costs in low-margin industries - aren’t going to generate the growth and profits tech companies do. Food delivery, meal-kits, instant delivery and streaming are experiencing slowdowns. Companies have been hammered by investors' prioritization of profitability over growth.

Over the past decade, startups delivered Americans conveniences of every description, and more recently, pandemic lockdowns supercharged our spending on them.

Amid the longest boom in tech so far, investors were eager to subsidize the losses of these startups—and by extension, subsidize our consumption of their products—on the logic that they would grow into their oversize valuations.

Now, the party is ending.

Americans’ confidence in the economy is at nearly its lowest point since the 2007-09 recession, on account of inflation-battered spending power, a cooling job market, and a stock-market dip that is hurting the finances of retirees in particular. As a result, consumers are paring back their spending on most things.

That’s showing up in the revenue of companies in what might be called the “nice-to-have economy”—those companies offering the kinds of luxuries and conveniences that many of us got accustomed to in the past few years, from rapid delivery and used-car vending machines to personalized fashion or online fitness coaches. Part of what has enabled these startups is technology, which helps explain why they were valued by investors at earnings multiples typical of high-growth tech companies with the potential for high margins.

What’s apparent to investors now, however, is that these companies—many of which have high fixed costs, and operate in relatively low-margin industries—aren’t going to generate the kinds of growth and profits that tech companies do, says Thomas Eisenmann, a professor at Harvard Business School and author of the book “Why Startups Fail.”

And while many companies are suffering declines in revenue and valuations of late, the woes of these nice-to-have economy firms in particular illustrate that not all of the pandemic changes to lifestyles and consumption patterns are sticking.

The food-delivery bellwether

In 2020, Nestlé bought Freshly, a home-meal delivery service, for $950 million. At its peak during the pandemic, Freshly said it was delivering more than one million meals a week to Americans. Yet Nestlé is shutting down home delivery of Freshly meals this month, citing shifting consumer demand. Nestlé didn’t respond to requests for comment.

Meal-kit startup Blue Apron‘s revenue has declined and its valuation has collapsed, and the company is now in danger of being delisted from the New York Stock Exchange as its share price lingers below $1. Blue Apron didn’t respond to requests for comment.

The meal-kit market leader, Berlin-based HelloFresh, has fared better. The company saw a spike in demand during the pandemic, and anticipates continued growth in revenue of at least 25%, year over year, according to a spokeswoman. HelloFresh’s profits have shrunk due to higher food and marketing costs, however, as it tries to retain customers who are rethinking their household budgets, the company has said.

Ben Wynkoop, a strategist for grocery and convenience at supply-chain consulting firm Blue Yonder, says that many ailing meal-kit startups were tech companies that thought they could take on the grocery industry, without realizing that it demands much more than just better software. Other challenges like supply-chain disruptions and fluctuating ingredient costs hurt them more than experienced companies, which have lived through this kind of turbulence before.

200

%

Cooling growth

While still expanding, many

streaming services are adding

customers at a slower pace

than in the past.

150

Paid subscribers, change from

a year earlier, select services

100

Paramount*

50

ESPN+

Disney+

HBO Max/

Discovery+†

Hulu

0

Netflix

2021

2Q

3Q

4Q

2022

2Q

3Q

*Total for Paramount properties, including Paramount+ and Showtime. †Includes HBO and reflects figures reported by Warner Bros. Discovery under a subscriber definition first published in the second quarter of 2022.
Note: Not all streaming services publicly report subscriber numbers. Disney controls Hulu and ESPN+. Chart dates are calendar-year quarters for which figures were reported.

Source: the companies

In the so-called 15-minute delivery category, the ultimate pandemic-era indulgence, many startups have already thrown in the towel. In March, New York and Chicago instant delivery startup Buyk declared bankruptcy. In June, Jokr ended its operations in the U.S. And in December, embattled delivery startup Gorillas sold itself to larger and more successful rival Getir.

Instant-delivery startup Gopuff had to put off its IPO and in August sought $300 million in debt to insulate itself from what could be a prolonged economic downturn. The company has said it has enough cash reserves to operate for four more years. Gopuff is still losing money, say people familiar with its finances.

As for companies delivering hot food from restaurants, DoorDash has said its customers are changing their behavior by ordering fewer items or choosing cheaper options, such as fast food. This has contributed to slower revenue growth for DoorDash and competitors such as Uber Eats.

This shift in consumption patterns for delivered food illustrates a broader trend. Naturally, consumers still want some versions of the nice-to-have conveniences and luxuries they’ve become accustomed to. But they are now finding they must cut back how much they spend on some of them, to continue spending on the ones they value most. It’s a phenomenon my Wall Street Journal colleague Rachel Wolfe has called the “split-brain budget.”

 

One company that has mostly suffered from this shift is Peloton Interactive. Revenue has been falling and its stock price is down 92% from its all-time high in January 2021. Chief Executive Barry McCarthy said in October that if his plan to cut costs doesn’t succeed, Peloton isn’t viable as a company. 

On the other hand, if his cost-cutting efforts succeed, Peloton could benefit from the relative affordability of its monthly plans when compared with a membership at a higher-end gym, at least for those who have already bought its stationary bikes. Low churn among existing customers—Peloton said in its last earnings report that its customers leave at a rate of 1.1% a month—suggests that even though people can go back to gyms, the kind who opted to exercise at home are continuing to do so.

Even some companies that you might think would see a resurgence with the return to offices and normal life have been hammered by declining faith of investors and their collective reprioritization of profitability over growth. The valuation of Stitch Fix, an online personal-styling service that delivers clothes, is down more than 95% since its peak in early 2021. Its CEO has stepped down, and it recently announced it will cut 20% of its salaried workforce. In line with consumers reprioritizing their spending, the company has projected that the number of active clients will decline for the second fiscal year in a row.

Like food delivery, streaming is also experiencing a slowdown in growth. Companies are trimming budgets for content and marketing as they rapidly shift from trying to grab subscribers to getting costs under control. Consumers, meanwhile, are realizing they may have subscribed to a cable bundle’s-worth of services, and are canceling some services as soon as they’ve binged the shows they came to watch.

An existential threat for some 

Many companies in the nice-to-have economy are in areas that might grow in the long run, but not quickly enough to guarantee a particular firm’s survival. Meanwhile, companies whose valuations are in decline can get locked into a vicious cycle that causes them to take more risks, which in turn may hasten their demise, says Mr. Eisenmann of Harvard Business School.

“All kinds of bad things happen if the valuation of your startup goes down,” he adds. For example, a company might have to accept more investment on unfavorable terms, which can hurt the value of the stock options held by employees and cause them to leave.

Online used-car shopping startup Carvana seemed a perfect fit for the pandemic era, with its zero-touch, haggle-free sales and delivery straight to buyers’ doors. Now it is suffering. Sales, which grew throughout the pandemic, are now shrinking, and its stock has dropped 98% from its peak in 2021. The company has accumulated more than $7 billion in debt, laid off more than a fifth of its staff in 2022, and is continuing to quietly terminate positions. While Americans seem willing to continue to increase their consumption of goods online—even of used cars—it’s far from clear Carvana will be the one to capitalize on that trend.

 

And then there are the countless direct-to-consumer startups—small companies hawking everything from kitchen gadgets to niche fashion trends—that have shut down. What caused their demise? The cumulative financial insults of supply-chain bottlenecks, changes in the online ad market that hurt their ability to reach potential customers, and consumers trimming their spending.

While the decline of the nice-to-have economy will lead to varied results, much depends on the depth and length of a possible recession that most investors and business leaders anticipate.

“It is hard to know right now whether we’re headed for nuclear winter, or we’re in something that will work itself out in six months,” says Mr. Eisenmann. For consumers, that could determine whether those nice-to-have conveniences and luxuries remain accessible—with obvious consequences for the companies providing them.