E-Commerce Sector Update – December 2023 – ESF Equity, LP

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E-Commerce Sector Update – December 2023

Consumer resilience persists within the E-commerce sector, setting the stage for a potential rebound in the M&A market.

Holiday spending traditionally serves as a significant boost and eagerly awaited period for players in the E-commerce sector. Despite ongoing challenges faced by consumers, online holiday sales are projected to remain strong, with forecasts indicating growth of between 10.3% and 12.8% year-over-year, potentially reaching up to $284 billion, according to Deloitte. Monitoring year-end sales will be crucial for sector participants as they assess the health of the consumer and the broader market. In the first half of the year, leading big box retailers and online players have experienced varied sales outcomes. As we approach the end of the year and look ahead to 2024, private businesses demonstrating growing sales, low customer acquisition costs, and recurring revenue are expected to attract steady attention from buyers. This anticipation contributes to expectations for a robust merger and acquisition (M&A) market in the coming year.

Consumer spending within the E-commerce sector has faced challenges but has not come to a standstill. An environment of inflation and a gradual decrease in consumer savings has posed hurdles for both retail and online sales, which have failed to match the rapid growth rates seen in the post-pandemic period. Despite these challenges, the resilience of the U.S. consumer has been a notable feature of the economy in the first three quarters, helping to prevent a widely anticipated recession. Notably, retail sales saw a stronger-than-expected growth of 3.8% year-over-year in September, according to the U.S. Census Bureau. However, the decrease in personal savings in August to the lowest level since December 2022, as reported by the U.S. Bureau of Economic Analysis, has raised concerns about the sustainability of robust spending levels.

Despite these consumer headwinds, e-commerce spending remained strong in the first half of the year, with sales reaching $277.6 billion in Q2, marking a 7.7% year-over-year increase, according to Digital Commerce 360 and the U.S. Department of Commerce. This growth in online sales in Q2 closely mirrored the performance of the previous two quarters, indicating the resilience of e-commerce spending in a challenging retail environment. Moreover, web penetration remained healthy through Q2, with e-commerce accounting for 21.1% of total retail sales, consistent with levels seen in recent quarters. Despite expectations of a slowdown in online purchases due to tightening monetary policies and increased inflation, the sector has yet to experience a significant pause in online spending.

Public Companies Show Varying E-Commerce Results

The performance of e-commerce sales has been a mixed bag among big box retailers in the first half of 2023. While retail spending has shown a pullback in larger ticket items such as furniture and home furnishings, demand for consumer staples has remained steady. Walmart (NYSE:WMT) saw a notable 24% year-over-year growth in its e-commerce sales, while BJ's Wholesale Club (NYSE:BJ) improved its digitally-enabled sales by 15%, as reported in their recent earnings releases. Walmart attributed its strong e-commerce growth to store-fulfilled pickup and delivery services, emphasizing its efforts to optimize inventory management by leveraging stores as fulfillment centers, which are often closer to the customer.

On the other hand, Costco (Nasdaq:COST) recorded a slight decline of 0.8% in e-commerce sales, while Target (NYSE:TGT) experienced more significant declines, with digital comparable sales falling by 10.5% year-over-year, according to their respective earnings releases. Pure-play e-commerce operators have also shown varied revenue performances. Chewy (NYSE:CHWY) and Amazon (Nasdaq:AMZN) emerged as leaders in sales gains, with revenues rising by 14.3% and 11% year-over-year, respectively, according to their earnings releases. However, online furniture and home goods retailer Wayfair (NYSE:W) reported a 3.4% year-over-year sales decline, as stated in its earnings release. The trajectory of consumer strength through the end of the year and into 2024 is likely to dictate revenue growth for sector players in the near term.

Outlook for M&A Volume and E-Commerce M&A Multiples Favorable for First Half of 2024

Despite caution among both buyers and sellers, M&A activity has maintained stability through year-to-date (YTD). The total sector deal volume has seen a 4.8% increase year-over-year, with 87 announced or closed transactions. Buyers have become increasingly meticulous in evaluating customer acquisition costs of potential target companies, conducting thorough due diligence on marketing spend efficiency and engagement. Supply chain diversification has been a priority for many strategic and financial buyers, with a preference for sourcing locations that are not overly concentrated in China. Furthermore, post-pandemic inventory management has been a focal point, with sector players working through excess product into Q3. Many potential sellers have adopted a wait-and-see approach, anticipating a more favorable transaction environment, which is expected to result in pent-up demand and boost E-commerce M&A multiples in Q1 and Q2 of 2024.

Strategic buyers have remained the driving force in the M&A market through YTD 2023, accounting for 74.7% of total transactions. Private strategic acquirers, in particular, have been highly active, constituting 43.7% of deal volume. Attractive target companies in the current market possess attributes such as recurring revenue, low customer acquisition costs, and a loyal customer base. Financial buyers have exercised increased caution due to higher transaction financing costs and uncertainty surrounding the near-term strength of the consumer. Financial acquirers have represented 25.3% of total transactions through YTD, primarily through add-on acquisitions that typically involve lower debt usage than traditional buyouts.

Strategics Bolster Capabilities, Sponsors Enhance Portfolio Holdings in E-Commerce Sector

While M&A markets have faced challenges through Q3, certain buyers have remained active in the current market. The Business-to-Business (B2B) segment has shown resilience, with market participants aiming to enhance existing capabilities. Despite private equity's cautious stance due to higher transaction financing costs and a challenging exit environment, add-on acquisitions to portfolio holdings have remained appealing. Below are some recent transactions:

1. MSG Distributors Acquires Boxed (August 2023, Undisclosed): MSG Distributors purchased Boxed, a seller of bulk-sized pantry items at wholesale prices, in August. The terms were not disclosed. MSG specializes in regional distribution of consumables and household essentials and serves B2B accounts through its distribution and fulfillment centers across the U.S. Mark Gadayev, President of MSG, stated, "This acquisition strengthens our inorganic growth strategy and diversifies our distribution models nationwide. The loyalty and trust that customers and brands have in Boxed is priceless, and we are committed to continue this model of offering bulk-sized products to customers at wholesale prices," in a press release.

2. Cedar Brands Acquires Nuzzie (July 2023, Undisclosed): Cedar Brands, backed by Downing Capital Group, acquired Nuzzie, a leading weighted blanket brand, for an undisclosed sum in July. Nuzzie specializes in knit weighted blankets ranging from eight to 25 pounds, sold directly to consumers (DTC). Cedar Brands operates as a consumer brands platform focused on Home, Family, and Lifestyle categories and is actively seeking additional acquisitions, as per a press release. The acquisition of Nuzzie underscores private equity's appetite for category-leading brands with a strong customer following. As debt capital remains expensive, sponsors increasingly favor add-ons to portfolio companies.

For updates on your business or to explore ESF Equity, LP's advisory services and expertise in the E-Commerce sector, including insights on E-Commerce M&A multiples, please reach out to us.

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