Research Notes: The WISH Activist

The AVTA story comes to a close, and the WISH story perhaps begins

Highlights:

• WISH stock has collapsed since its late 2020 IPO — and with good reason.

• So dire is the outlook that even shareholders want the business to shut down.

• As a result, the company is a deep net-net with an enterprise value of negative $430 million. That’s brought activist attention.

• The business is essentially hopeless. But there is a path forward for WISH — if the strategy can change.

  ---

Back in December, we briefly discussed the story of Avantax AVTA 0.00%↑. Avantax was originally known as Infospace, a darling of the dot-com bubble that by the early 2010s was essentially dead money. The company was profitable, but its content syndication revenue was challenged. Its balance sheet was pristine, with significant cash, but there was nowhere in the business for that cash to be invested.

However, Infospace had a substantial amount of net operating loss (NOL) carryforwards which could be used to shield future profits from corporate income taxes. And so Infospace hired an investment banker as its chief executive officer, and decided to spend its cash on profitable businesses that would utilize the NOLs. It’s first acquisition, of TaxACT, proved to be a home run. Later deals were more mixed. In 11-plus years, the stock rose 132%, or about 7.4% on an annualized basis.

Back in December, we noted the similarities between late 1990s conditions and the current era. A consequence of the proliferation of recent SPAC mergers, there exists a good number of companies that raised quite a bit of capital that have simply been unable to grow. One of them is ContextLogic WISH 0.00%↑which also has an activist pushing for outright liquidation.

WISH Falls Out Of The Sky

Since the second half of 2020, more than a few speculative growth stocks have crashed and burned. Even within that group, however, ContextLogic WISH 0.00%↑ stands out:

WISH log chart, source: Koyfin.

The stock is down 99.5% from a 2021 peak above $900 (that price is adjusted for a 1-for-30 reverse split in April). Despite the dreadful-looking chart, Wish actually was a functioning business. At the time of its initial public offering in December 2020, Wish reported more than 12 million monthly active buyers, and over 100 million monthly active users. The company argued it had a huge opportunity with what it called “value-conscious customers” and argued that its mobile-first design would allow it to compete with the giants of the industry.

The numbers, meanwhile, looked reasonably strong. In 2019, Wish generated $1.9 billion in revenue. About 80% of revenue came from its marketplace business (the remainder from logistics). Wish didn’t recognize the entire sale as revenue, but only its commission, and so product sales were far higher.

In 2020, revenue increased 34% year-over-year to over $2.5 billion. The company remained unprofitable, with an Adjusted EBITDA loss of $217 million, but aggressive marketing was the reason. Sales and marketing spend in 2020 was, almost incredibly, 67% of revenue. Wish was spending in the near term to acquire customers for the long term. After its initial public offering, ContextLogic had roughly $2 billion in cash on its balance sheet, more than enough to maintain aggressive promotions while keeping a margin of error in case the strategy needed to be changed.

There was enough for investors to be intrigued. WISH stock did struggle on its first day, closing down 16% from its IPO price of $24. But that first-day close still gave the company a market cap of about $14 billion, and at the $24 price ContextLogic raised $1.1 billion in the offering.

An Incredible 2021 (Not In A Good Way)

What followed is one of the more staggering reversals we can remember. Here’s how ContextLogic’s first five quarters as a public company looked in terms of top-line growth:

• Q4 2020: revenue +34%, core marketplace¹ +24%

• Q1 2021: revenue +75%, core marketplace +40%

• Q2 2021: revenue -6%, core marketplace -32%

• Q3 2021: revenue -39%, core marketplace -55%

• Q4 2021: revenue -64%, core marketplace -74%

Obviously, pandemic re-opening played a huge role, but revenue collapsed as Wish significantly throttled back sales and marketing spending (-10% year-over-year in Q2 and -62% in Q3).

In 2022, with investors demanding profitability over growth, ContextLogic wound up delivering neither. Sales and marketing spend fell 77% year-over-year, and revenue plunged 73%, with marketplace revenue down 80%. Adjusted EBITDA loss actually widened to $288 million, 50% of revenue.

Year-to-date performance has been just as bad. Revenue down 46%, Adjusted EBITDA loss growing to 74% of revenue. The midpoint of third quarter guidance projects the top line will decline more than 50%; Adjusted EBITDA margins are guided to negative 100%.

Wish Doesn’t Work

The conclusion the market is drawing is that this business simply isn’t viable. Wish spent years buying users — per, the S-1, its cumulative Adjusted EBITDA loss from 2015 to 2019 was $1.1 billion — but never showed any ability to profitably serve those users. 2021 was perhaps the best year for retail in decades, and Wish still lost $199 million on an Adjusted EBITDA basis and posted a GAAP net loss of $361 million. Since then, the almost 1-to-1 correlation between sales and marketing spend and revenue further indicates there’s simply no value-add here.

It’s possible to make some excuses for recent performance. Demand for goods has been swapped for demand for travel and experiences. The rise of Pinduoduo PDD 0.00%↑ unit Temu and Shein — both of which, to some extent, are copying Wish’s playbook — has provided a negative catalyst.

But even a quick qualitative look shows it’s hard to even take this business seriously. This is the first group of items for sale on Wish’s home page on Wednesday afternoon. Would you put a 79-cent piece of jewelry into your nose?:

source: Wish.com, September 27, 2023

Clearly, the equity market is no longer taking Wish seriously: ContextLogic now has perhaps the most negative enterprise value in the entire market. At the end of Q2, ContextLogic had $531 million in cash on its balance sheet, and zero debt. Net current asset value (NCAV, calculated as current assets less all liabilities) is $318 million.

The company’s market cap is $106.3 million. Its enterprise value is negative $425 million. ContextLogic’s cash per share, at least at July 31, was five times its share price. WISH stock is a deep net-net².

So dire is the outlook for the operating business that even shareholders want ContextLogic to shut down. Last week, J. Carlo Cannell of Cannell Capital, a long-time fund manager, sent a letter to the company calling for its liquidation.

Cannell bluntly told ContextLogic chief executive officer Jun “Joe” Yan that “you are not going to remediate this business”. Cannell closed with something close to a threat: that if ContextLogic didn’t begin a strategic review process by Wednesday (9/27), Cannell would form a group of shareholders and “disseminate select sections of the minutes from the Board meetings chronicling the historical destruction and accompanying self-enrichment by management and the Board.”

Is There Value To Be Found In WISH?

As of this writing on Wednesday night, there’s been no response from ContextLogic and no move by Cannell. The market has mostly shrugged at the activist effort: WISH has gained just 4% since Cannell’s letter.

There are two stumbling blocks here. The first is whether ContextLogic is actually going to do anything. As we’ve discussed a few times, value on paper needs a catalyst to be translated into value in practice.

The good news for Cannell is that there isn’t a structural impediment to a liquidation. At Feb. 22, the entirety of the board and management team owned little more than 8% of the company. That can be bad news if executives are incentivized to simply drain the company of cash for as long as possible, but cash salaries are exceptionally low: a little over $500,000 a year for C-suite executives. The one board member with skin in the game is founder Piotr Szulczweski, whose 26.7 million share stake is still worth over $100 million, and whose annual compensation in 2021 and 2022 totaled less than $1 million, nearly all of it in stock.

As a general rule, it’s exceptionally difficult to get a managerial team to stop managing. Managers almost always believe they can fix any problems; without that confidence, they wouldn’t have risen to the C-suite of a publicly-traded company in the first place. But there doesn’t seem to be any further stumbling blocks to ContextLogic making a more aggressive move. This might be a team that can be reasoned with at some point (though it’s worth noting Cannell, in his letter, complained that Yan had canceled a video call with him the week before).

The problem is that “at some point” might not be soon enough. The $22 per share (!) cash position sounds like plenty against a share price below $4.50. But the $531 million in cash starts to evaporate in a hurry.

In a liquidation, ContextLogic presumably would have to cover its $247 million in liabilities at cost. Even giving credit for $34 million in prepaid expenses and funds receivable, ContextLogic would spend $213 million, leaving cash of $318 million.

There’s also the problem of how much cash has been burned since June 30, and how much more will be burned by liquidation. Adjusted EBITDA guidance of a loss of $55-$65 million suggests burn of roughly $60 million in Q3 alone (ContextLogic will get some interest income, but also have some capex spend, which roughly speaking cancel each other out). Q4 loss might moderate if the company zeroes sales and marketing spend (60% of revenue in Q4 2022, and about three-quarters of the Adjusted EBITDA loss) and just gets some residual sales. But even taking Q4 2022 performance and zeroing S&M still gets to cash burn of ~$25 million. Assuming a collapse in revenue that figure likely doubles at least.

Call the Q4 loss $50 million and cash is now down to $208 million — admittedly, still more than double the current market cap. But there is probably severance of some kind required: Yan gets 12 months of salary, and other executives six months, plus accelerated vested of stock-based comp which means likely $1 million-plus each. That probably gets the corporate bank account down below $200 million. Against the basic share count of 23.8 million, liquidation value here starts looking closer to $7 per share — a far cry from the $22 per share cash balance.

What Is Cannell’s Angle?

But that ~$7 target assumes that ContextLogic starts the process immediately (and, notably, just before the holiday season in the West). That requires management to come around, which doesn’t seem likely to happen. The Q2 call in August included plans for generative artificial intelligence benefits, a round of cost-cutting that should save $40 million-plus a year, and a seemingly unreasonable amount of optimism toward the company’s future. Certainly, nothing on that call suggested any possible interest in liquidation, let alone any plans for such an outcome.

Even assuming Cannell winds up winning, the time to a board election next year likely means that first-half 2024 losses eat up what upside remains in a liquidation scenario.

Or at least the losses eat up the upside in the cash balance. It’s worth noting that Cannell has been in a somewhat similar activist situation before. Back in late 2014, he took a 9% position in investment website TheStreet and wrote a public letter to its co-founder, television personality Jim Cramer. Like ContextLogic, TheStreet had gone public in a bubble (May 1999); by the time of Cannell’s involvement, TheStreet wasn’t quite as cheap as WISH but certainly was a deep value play³.

TST wound up working out big. The company divested assets, paid two big special dividends, and then eventually sold the legacy business to what is now The Arena Group AREN 0.00%↑. All in, shareholders roughly tripled their money from the time of Cannell’s first involvement.

In other words, Cannell has been here before. And it seems exceptionally unlikely that the fund manager, who per Bloomberg started the fund in 1992 with $600,000 in assets under management, growing AUM to a current ~$800 million, can’t do the basic math surrounding liquidation value.

That raises the question, what exactly, is the angle here? Is it a hope that the effort itself might drive a huge rally, allowing Cannell to exit? WISH, after all, was a meme stock during 2021. But retail traders seem unlikely to flood into a liquidation story. And taking a ~$3.5 million position on a semi-pump and dump after three successful decades in the business seems exceptionally unlikely. Cannell would seem to have a different motivation.

Is There Value In WISH?

The question is whether Cannell sees the possibility for a path akin to the one that Infospace took. Unsurprisingly, ContextLogic has a massive amount of NOL carryforwards: nearly $2.6 billion worth. Those assets are so valuable that even in a change of control, they’d be worth something. Section 382 of the tax code substantially limits how an acquirer can utilize NOLs, but to oversimplify it, a company can basically acquire the company and receive annual benefits equal to those of an investment in a long-term tax-exempt government bond⁴.

And if ContextLogic could, under new management, use remaining cash to find a profitable business, however small, the company could have (without exaggeration) decades of essentially zero cash taxes. There’s real potential value in that path as well.

To be sure, the Infospace route is not guaranteed to succeed. But the situation with ContextLogic is different enough to suggest some promise. The legacy business isn’t just challenged; it’s nearly impossible to imagine it ever turning a profit. Net cash isn’t two-thirds of market cap, but five times market cap. And the carryforwards at ContextLogic are more valuable than those at Infospace.

In fact, if new management can get installed, it’s almost difficult not to create some value. Even assuming the business isn’t shut down until the end of 2024, there’s probably still some cash left (considering cost savings on the way) and the NOLs are valuable enough that the company in that scenario could be sold for more than the current $100 million-plus market cap. Should management change happen sooner, more cash is protected. It’s not impossible (though increasingly unlikely) that another meme stock rally occurs at some point in the next twelve months. (Short interest is still 17% of the float.)

To be sure, such a change actually has to happen. And it is curious that Cannell asked for a liquidation of ContextLogic, the company, and an ensuing, immediate return of cash to shareholders, instead of a liquidation of Wish, the operating business, and an effort to utilize the NOLs.

Perhaps the demand for a liquidation of the company was seen as a better negotiating tactic. If management won’t take a guaranteed near-term $7-$8, it’s easier to paint that management team as conflicted, entrenched, delusional, or all of the above.

But what is pretty clear about WISH is that, under new management that is willing to dump the operating business, almost anyone can create some kind of shareholder value from here. Even accounting for cash burn, even assuming that the Wish business is simply not viable, WISH has real value in the right hands. Cash will clear market cap even a few quarters from now, and an exit for cash on the balance sheet plus ‘free’ tax assets or something like that would absolutely be viable.

The problem with WISH right now is that such a bull case isn’t enough. Cannell’s campaign is a tiny first step toward salvaging shareholder value, and it’s not clear what will happen with the activist’s deadline now passed. Cash burn is such that each month that goes by is material to shareholder value. Assuming current liquidation value of $200 million, the cushion is essentially erased in five months at most.

That said, there are scenarios in which WISH, despite its awful performance as a stock and a business, has upside from Wednesday’s close of $4.47. And those scenarios provide reasons to avoid a seemingly foolproof “short to zero” case. Cannell is surely not the only firm who understands that there’s value to be had in the company, even if there is so obviously no value to be had in the business.

---

As of this writing, Vince Martin has no positions in any securities mentioned.

Disclaimer: The information in this newsletter is not and should not be construed as investment advice. Overlooked Alpha is for information, entertainment purposes only. Contributors are not registered financial advisors and do not purport to tell or recommend which securities customers should buy or sell for themselves. We strive to provide accurate analysis but mistakes and errors do occur. No warranty is made to the accuracy, completeness or correctness of the information provided. The information in the publication may become outdated and there is no obligation to update any such information. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Contributors may hold or acquire securities covered in this publication, and may purchase or sell such securities at any time, including security positions that are inconsistent or contrary to positions mentioned in this publication, all without prior notice to any of the subscribers to this publication. Investors should make their own decisions regarding the prospects of any company discussed herein based on such investors’ own review of publicly available information and should not rely on the information contained herein.

1. Core marketplace excludes logistics revenue as well as ProductBoost, an advertising tool.

2. A ‘net net’ usually, though not always, is defined as a stock where NCAV is greater than market cap. We’ve talked about net-nets a few times recently, most notably in our deep dive on NETGEAR NTGR 0.00%↑.

3. One notable distinction was that TheStreet had preferred stockholders with a liquidation preference who could essentially block any sale, since they were entitled to roughly $14 per common share, while TST at the time traded below $2. It took TheStreet nearly three years to finally make a deal that retired the preferred stock.

4. The limitation is equal to the federal long-term tax-exempt rate times the price paid for the loss-making business.