What is Going On in the AMZN TPS Ecosystem Right Now?
This post was co-authored by myself and Meghan Hillery
As headlines and stories emerge around the challenges some Amazon TPS (third-party seller) aggregators are facing, many founders, investors, and employees are wondering, what is going on in this space that was just recently exploding with growth? As an investor in AMZN TPS aggregators, I’ve spoken with aggregator founders, Limited Partners, and co-investors, and below are our general takeaways:
The TL;DR: 2022 will be the year separating the winners from the losers. The Amazon e-commerce space faced a variety of headwinds, and the companies that have done the best in the face of these have largely been made up of management teams with deep operating backgrounds, that stayed focused, and that didn’t allow general overhead costs to balloon in the face of a dramatically funded and fast-growing market.
While there has been some negative press around the space (and we expect other negative sentiments may come out as well), we are still seeing many aggregators win in a big way thus far, and we remain bullish on the thesis and ecosystem.
The businesses that have struggled the most have largely been made up of teams that tried to do too much too fast, let SG&A expenses get too high, and did not focus enough on the operations of their underlying assets.
First, some of the challenges:
Supply Chain Impact
Amazon Third Party Seller (“TPS”) businesses are struggling with pandemic-induced supply chain issues that have raised freight costs and kept popular items out of stock. Cracks in the supply chain began when there was a mismatch in supply and demand dynamics during the COVID-19 pandemic. Aid from stimulus bills and cost savings associated with staying from home drove consumers to shop online, bolstering demand for goods. Simultaneously, factory closures, port congestion, and labor shortages across the supply chain led to delays, further magnified as the variant spread.
The pandemic bolstered consumer demand for goods as aid from stimulus bills and cost savings associated with remaining at home drove consumers to shop online. . Worldwide, companies have been impacted by this combination of demand imbalance, equipment shortages, port closures, and insufficient staff to haul goods from U.S. ports which has made it substantially more expensive to ship products from Asia.
As shown below, container shipping rates from China to the U.S have exceeded $10,000 for nine months as of April ’22, currently ten times more than the pre-pandemic rates.
Supply chain issues have caused four problems for TPS businesses and therefore across aggregators:
(i) the delays leave sellers with the option to either overstock on inventory (resulting in the risk of additional storage fees or aging of inventory), understock on inventory (resulting in risks of going out-of-stock, which eliminates potential revenue and reduces organic rankings on the Amazon platform) or pay significantly higher transportation costs for expedited shipping to ensure goods stay in stock via speed boat or air shipping
(ii) the increases in the cost of goods sold (COGS) associated with heightened freight expenses have led to margin compression
(iii) inability to execute planned post-acquisition strategies (e.g. the aggregator might have wanted to add additional color variations or child-ASIN), as the delays or costs in the supply chain might cause the aggregator to focus on existing products
(iv) chaos and volatility in cost and duration of delays, causing problems forecasting the above three issues
That said, well-capitalized aggregators are much better positioned to handle the supply chain distribution by leveraging their third-party logistics infrastructure to mitigate against supply chain disruptions; smaller sellers have and will likely continue to suffer the most, potentially leading to more TPS business sales. Larger aggregators that are well funded can also over-stock on inventory.
Having equity capital allows larger aggregators to front costs in a way that smaller sellers or under-funded aggregators simply cannot. This is continuing to put selling pressure on smaller players, which we believe will continue to lead to lower purchase multiples over the near to medium-term.
Rising FBA Costs
The P&Ls of TPS businesses have also been impacted by Amazon-related fee increases. Fulfillment by Amazon (“FBA”) is a service that Amazon provides to its sellers that includes storage, shipping, and packing assistance. In 2022, Amazon increased prices for use of its service twice to date.
The first hike was implemented in January, where fee increases averaged 5.2%. Recently, Amazon announced adding a 5% fuel and inflation surcharge to existing fees, coming into effect at the end of April. The latest price increase is in line with broader market trends, evidenced in U.S. consumer prices rising 8.5% over the last 12 months, the largest 12-month increase since the 1980s. This, paired with the dramatic increase in fuel prices, has led several carriers to implement heightened rates. FedEx and UPS have both raised prices by an average of 5.9% this year, so those TPS businesses that do not use FBA will likely face similar expense increases. Sellers have a choice between cutting costs or increasing prices to afford the surcharge, with the most likely outcome being to pass the costs onto the consumer.
Slowing Consumer Demand
The past few years have been characterized by immense volatility in the e-commerce industry. In 2020, we saw an amazing pull-forward of demand for e-commerce goods. In 2021, the beginning part of the year operated much like 2020, and then as the year progressed we saw that demand taper off across the ecosystem.
The boost in consumer e-commerce demand during the pandemic really slowed as the world opened up, government stimulus fell off, and inflation increased the cost of goods and services. Additionally, consumers began spending more on services than goods as 2021 progressed, reversing prior changes in the goods-to-services mix in consumer spending. Interestingly, from what we’ve seen in our portfolio, the consumer slowdown was felt more heavily in the United States than in other countries.
Amazon was not immune to the e-commerce slowdown, evidenced in their Q1’22 earnings. Revenue attributable to TPS increased 9% in the first quarter, compared to a 60% increase in the first quarter of 2021. To provide additional context, this growth is inclusive of brands that were already operating on Amazon as well as all brands that onboarded over the course of the year. This means that many TPS businesses, and therefore aggregators, are dealing with negative year-over-year (“YoY”) performance metrics.
In 2022, we expect to see demand stabilize making performance metrics for large aggregators more predictable thereby creating better insight into which operators are excelling with the roll-up strategy, creating an easier path for institutional capital to enter the space.
Challenging Equity Market
Amazon TPS aggregators still rely on equity to fund cash burn created by their overhead and operational expenses given the newness of the business model. TPS businesses typically operate at ~20% margins, with a significant portion of that margin used to pay debt service (assuming the interest rates are in the low double digits for aggregators). The remaining cash flows that are available to fund corporate overhead, inventory swings, and an overstocking of inventory is often only in the 8-12% range of total revenues. This means that if companies over-invest in SG&A to spur future growth or manage inventory improperly, they will rely on equity capital to fund operations, and as margins compress proper capitalization is increasingly important. With the equity markets tightening, this may pose challenges for some aggregators. Aggregators that tried to do “too much too soon” (including pursuing omnichannel strategies too early, investing too heavily into R&D, expanding SG&A aggressively, etc.) increased their cash burn at a far greater rate than their asset-level EBITDA. Right-sizing the cost structure will likely be a focus while the equity market remains challenging.
Where are we now?
First off, some businesses are going through the painful process of right-sizing costs. That’s not a bad thing. A number of companies were built to exist in an environment where new competitors were being found weekly and where funding was available. It makes sense that they over-hired. But now, they are adjusting to a new reality. It’ll be difficult, but those companies are making hard decisions now that will allow them to control their own destiny and survive over the long term.
On the flip side, other companies were lucky enough to either not have raised as much or to have stayed focused and disciplined from the beginning. On the most optimistic end: we have seen companies manage to maintain positive YoY EBITDA growth, become cashflow positive and raise large equity and debt rounds on the back of such strong performance during a very difficult year.
In the more common scenario, we have seen companies maintain relatively flat revenues, see a reduction in YoY organic EBITDA (despite seeing rising inorganic EBITDA growth through acquisitions), but are starting to see a light at the end of the tunnel. Interestingly, many of these companies bought seller accounts where they structured in seller notes or earn-outs to combat a perceived 2020 COVID bump in EBITDA. So a 10-20% drop in EBITDA was priced into the initial purchase price. Some of these businesses reached cashflow breakeven, and some of them are nearly there (as companies grow, the % of their revenues that make up corporate overhead comes down, as fixed costs become less meaningful compared to the overall size of their businesses).
And in the more pessimistic scenario, we have seen companies who have over-raised, who have not been able to bring in expenses, and who will likely need to sell to other aggregators or who might fail.
Where are we going?
For the companies who came out of 2021 in a position of strength (strong growth, positive cash flows, and significant liquidity) they are entering a dream scenario. Their cost of debt is coming down as new lenders are entering the space, freeing up cash flows at the same time as their fixed costs are making up a smaller percentage of their revenues. Additionally, traditional asset-based lenders (ABL) and inventory-based lenders are expanding into e-commerce, allowing aggregators to better access flexible revolving facilities to maximize inventory positions during busy times of the year at a cheaper cost.
They are able to use their excess cash flows and equity to over-stock (and increasingly, ABL facilities) on inventory, which will allow them to battle a supply chain that is likely to remain difficult for at least the next twelve months or longer.
And as competitors start to pull back, re-trench, and focus inwards – the multiples of AMZN TPS accounts are coming down. This allows for aggregators to both buy more, and have a larger margin of safety in how they operate during an easier time to operate than in the past. If you buy a business for 2.5x you don’t need to achieve the same YoY organic growth numbers on that asset as compared to buying a business for 4.5-6x EBITDA.
Finally, these companies can grow at a more sustainable, and reasonable pace. Hiring fast is hard. Buying fast is hard. And operating in a world with a million well-funded competitors all moving at breakneck speeds means things will break. Growing at a more controlled pace may end up being a relief to operators who are trying to build maturity into their rapidly growing businesses.
At a core level, we believe that in 10-15 years, anywhere from 50-100 or more aggregators will each command a strong market share across the Amazon e-commerce platform. The ability to (i) create synergies across brand management, supply chain, and customer success (ii) access cheap and flexible capital to purchase inventory, and (iii) utilize continually complex technology and advertising strategies within the Amazon ecosystem, will continue to provide aggregators competitive advantage vs. the “mom and pop” or smaller operators. Put simply, these aggregators have “a reason to exist” as they professionalize the $300+ billion Amazon e-commerce market, and will be key in shaping the platform in the future.
We are giving our operators the guidance that the game has changed. It used to be “grow at all costs since growth will get you more funding.” Now the guidance is “grow sustainably.” That doesn’t mean we’re turning a 180.
That doesn’t mean we’re not continuing to deploy capital into the space - we have term sheets out to three companies in the space even with the news cycle. In fact, it means it's time to win. But it means it’s also time to win responsibly.
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