📍 TLDR

• Amid a sharp rally in speculative stocks, ROVR has gained 60%, including 17% just last week.

• Valuation is potentially reasonable in the context of current performance.

• But the pet services platform is set for decelerating growth as travel normalizes, and the model has long-term question marks.

• This business simply isn't that strong. Betting the company can't hold a $1 billion market cap seems like a winning trade.

It’s no secret that the SPAC (special purpose acquisition company) bubble of 2020-2021 brought a number of questionable companies to the public markets. By our count, there have been at least four bankruptcies already (including one filing last week). Given that the results of the trend include the creation of six separate “air taxi” stocks, many more will no doubt follow.

But one of the underappreciated aspects of the SPAC boom is that it also created public companies that simply shouldn’t be public. Rover ROVR 0.00 looks like one of those companies.

The business is fine as far as it goes. The problem for the stock is that it simply can’t go that far. Rover is a niche business that belongs with a middle-market private equity firm, not on the public markets. Add in a near 60% rally from September lows, a questionable valuation and a clear near-term risk, and ROVR looks like a short.

Introducing Rover

Founded in 2011, Rover operates an online platform that allows providers to offer boarding, pet sitting, and dog walking services. Think Uber UBER 0.00 but for pet services. (Indeed, Rover was one of the many “Uber for X” models that were all the rage in venture capital markets last decade.)

Per the most recent investor presentation, through the first nine months of 2022, 70% of GBV (gross booking value) came from overnight services. Those include boarding (the pet stays in the provider’s home) or house-sitting (the provider visits the pet’s home). The remaining 30% came from daytime offerings including drop-in visits, dog walking, and “doggy day care”.

It’s a market that Rover dominates, at least as far as online platforms go. The one major rival would be Wag! Group PET 0.00, which readers will be stunned to learn also went the SPAC route (its merger closed in August). But year-to-date, Rover’s bookings have been nine times that of Wag! Group. Wag! also offers pet insurance and other services; Rover’s most recent presentation claims that credit card data shows that, excluding insurance, its bookings are 13x as high.

Rover went public last year via a merger with SPAC True Wind Capital. The merger valued Rover at $1.35 billion and closed in August. ROVR stock gained initially, though as the calendar turned the stock fell off the table, closing Friday just below $5:

Valuation First

At Friday’s close, Rover has a fully diluted market capitalization just shy of $1 billion ($989 million). Net cash of $235 million leaves an enterprise value of $754 million.

Full-year guidance contemplates revenue of $171-$173 million, implying an EV/revenue multiple of 4.3x-4.4x. Adjusted EBITDA is projected at $16-$18 million, putting EV/EBITDA above 40x.

Admittedly, Rover could grow into that valuation. One of the reasons the “Uber for X” model was so popular (and a core reason why Uber itself went public at a valuation of $82 billion) is that incremental margins for a platform business should be hugely attractive. And Rover is growing at a nice clip, with full-year revenue expected to increase 57% at the midpoint of guidance.

Peer comparisons, however, are not terribly bullish.

In 2019, IAC IAC 0.00 acquired Care.com (which operated a similar platform for child and senior care) for just $500 million. That was about 23x post-Q3 guidance for that year's EBITDA, and just under 2.5x revenue. Care.com was facing reputational issues at the time, but the current sum of the parts valuation for IAC hardly suggests the acquisition was a steal.

Wag!, meanwhile, trades closer to 2x revenue, though it’s still running Adjusted EBITDA losses and its much faster revenue growth is being driven by a 2021 launch of services (including insurance).

What we can say on an absolute basis is that ROVR is pricing in consistent, material, growth going forward. The business isn’t really profitable: Adjusted EBITDA guidance is modestly lower than the current run-rate for stock-based compensation (which is excluded from the figure). Because this is a platform model, it will take revenue growth to drive the margin expansion necessary to grow into this valuation, let alone drive upside.

Problems With The Model

Somewhat ironically, Rover highlighted a core issue with the platform in the very first bullet point of the press release announcing its SPAC merger. The company boasted that over 2 million “pet parents” had booked services with more than 500,000 providers.

In other words, the average provider on the platform has attracted about four unique customers. (Updated figures from the most recent presentation suggest this same broad math holds.)

Quite obviously, that’s not tenable — unless those providers are booking services off-platform after using Rover for an initial introduction.

That’s no doubt precisely what has happened. Anecdotally, that’s how my wife and I have used the platform on several different occasions. And Rover’s own figures suggest the problem is real. Net retention is well below 100% of year 1 spend excluding the initial purchase (see p. 67 of the S-1 from last year). And the company most recently boasted that the figure was ~80% (a notable improvement from prior levels, admittedly).

This same criticism was made of the Care.com model, and it’s equally valid here. Without a real base of recurring transactions, it takes a lot of work to simply run in place.

Rover doesn’t have that base. Figures from both 2021 and 2022 suggest the average active user is making roughly one booking a quarter. That’s a particularly low figure given that almost one-third of GBV (more than one-third of transactions) are coming from daytime services, where demand can be far more frequent.

Rover’s historical financials suggest the “Uber for X” model is working out well so far (revenue has grown at an impressive clip, and EBITDA margins have flipped positive). But at a certain point the business will hit a ceiling.

And the core concern is that there’s not much Rover can do about it. The company has taken some share from independent boarding providers and the like, but its ability to expand the overall market is relatively limited.

The company has moved into Canada and Western Europe, but those markets don’t appear to be moving the needle. International revenue was 5% of the total in 2019 and 2021; overseas markets have posted strong results this year but even Rover management has surmised that a slower post-pandemic return to normalcy has been a factor. A virtual dog training offering probably isn’t big enough to be material, even on an incremental basis.

And while market share relative to Wag! (and, now, Care.com) is impressive, it also removes an avenue to growth: Rover essentially is the market. That’s been enough so far, at least fundamentally, but that may change in the not-too-distant future.

The Travel Problem

Perhaps the most important thing to understand about Rover is that it’s not really a pet stock. Rather, it’s a travel stock.

Don’t take our word for it. Rover itself says as much:

source: Rover SPAC merger presentation, February 2021; highlighting by author

We can ignore the insanity of the claimed $69 billion total addressable market. That assumes that a) everyone re-books on Rover instead of directly and b) that pet owners don’t, you know, have friends or family). We’ll focus instead on the highlighted footnote, which reads:

We estimate that leisure/non-business travel represents ~85-87% of our GBV. We also estimate that domestic travel represents ~90% of all trips taken.

Overnight is 70% of GBV; leisure is ~85% of that. That in turn suggests that ~60% of demand comes from leisure travel.

To be fair, management knows this fact. The outlook for the broader travel industry has been discussed extensively of late, particularly on this month’s Q3 call. But the seemingly impressive revenue growth this year is no doubt benefiting substantially from travel demand, in terms of what consumers are doing this year and the soft comparison created by what they weren’t doing last year.

Where the benefit perhaps has been largest is in terms of ABV (average booking value). The figure was $142 in Q3, and $141 year-to-date. That’s a big jump from pre-pandemic levels: per the S-1, the figure for 2019 was ~$106

Some of that increase is coming from pricing, which in Q3, drove two-thirds of a 15% year-over-year increase in ABV. Rover management expects that trend to slow down. But units (ie, length of stay) drove about one-third of the year-over-year growth, and likely have accounted for at least a similar proportion over the multi-year trend.

There seems a high likelihood that at least the units part of ABV growth is going to reverse. Travel demand has been elevated this year, even if (admittedly) domestic flight traffic hasn’t quite returned to 2019 levels. Given the reliance on overnight stays, that in turn suggests a headwind (no pun intended) to 2023 performance.

At the lows, when ROVR traded at a low- to mid-20s multiple to EBITDA, that deceleration perhaps was priced in. At 40x-plus, it simply isn’t.

Whether investors are jumping onto ROVR because Q3 numbers (and full-year guidance) impressed, or if the stock is benefiting from broader positioning tailwinds isn’t clear. (We’d argue it’s a bit of both.) But it also doesn’t really matter.

Rover’s Q3 strength didn’t come from dead-on execution. The external environment was simply heavily in the company’s favor. At 40x-plus EBITDA, the market is pricing ROVR as if 2023 and 2024 will be much the same. That seems highly unlikely to be the case.

Why Short Rover?

Admittedly, after the past few sessions, there’s an argument that there are “better shorts elsewhere”. A good number of possible targets

But for its part, ROVR gained 17% — a significant move particularly given cash on the balance sheet. Rover’s enterprise value in fact increased 24%. Last week also shows the risk of being short in such a volatile market.

We’re not, at the moment, trying to hit home runs from the short side. The time for that strategy appears to have passed. Singles and doubles are absolutely acceptable. In that environment, shorting a company that has a fairly obvious ceiling on growth (no matter what Rover management says about its TAM) offers less risk than going after a highly leveraged play or a “busted growth” story that investors can still find a way to talk themselves into.

Beyond a further no-news rally, the one clear risk seems to be a sale. There’s a logical acquirer here in Petco Health and Wellness WOOF 0.00. Petco continues to build out an end-to-end offering for pets (online and in-store sales, grooming, veterinary care, etc.) Rover would seem to fit nicely with that strategic plan.

Indeed, the two companies announced a partnership at the beginning of the year. In a strategic acquisition, Petco could slash G&A and aggressively cross-sell Rover services.

It doesn’t seem like the timing is right for a deal, however. Petco still has a heavily leveraged balance sheet. Based on guidance, net debt is about 2.6x EBITDA. A cash deal for Rover, assuming a premium to Friday’s close, would get that net leverage ratio almost certainly above 4x. A cash-and-stock deal would dilute WOOF shareholders near an all-time low.

Petco aside, it’s difficult to see a logical buyer. It’s too early in the growth cycle for private equity; there simply isn’t enough (or, to the point, any) free cash flow. The opportunity likely isn’t big enough for Chewy CHWY 0.00 .

Being short anything in this market has its risks. So does being long. The risks here look acceptable in the context of potentially material rewards, even if ROVR is unlikely to be a portfolio-making short over the next twelve months.

Looking For Downside

That said, there’s still a case for material gains from the short side. Based on PET and the Care.com deal, neither a sub-3x revenue multiple nor a mid-20s EBITDA multiple seem out of line. Even looking to 2023, and even based on analyst consensus for the year, both suggest 10-15% fundamental downside simply from multiple compression.

There’s also room for guidance to disappoint. As strong as Rover’s 2022 appears, performance is well below what the company projected at the time of the SPAC merger last February. Wall Street’s projection for 30% revenue growth in particular looks aggressive. Even some presumed help from lower work-from-home activity seems likely to be offset (and then some) by reduced travel demand and a tough comparison

This is a tough business to peg perfectly from a fundamental perspective. But it’s also a stock that was at $4 a month ago. What’s changed seems to be a strong earnings report and a more bullish broad market. Neither really changes the mid-term case for a short here.

Admittedly, a short does lack a near-term catalyst (barring an unsurprising reversal in these kinds of stocks after the performance last week). Q4 earnings will be closely watched for 2023 guidance, but the release didn’t arrive until early March this year.

Given the steepness of the recent rally, however, and the potential for a reversal, the lack of a specific catalyst doesn’t seem to break the short case. Being short a travel-exposed de-SPAC after the past week is itself a decent enough argument.

A straight short has plenty of borrow and a reasonable rate (sub-2%). The options market actually looks intriguing and surprisingly liquid. The February 5 call last traded at 70 cents, requiring another 14% upside move in the stock with expiration likely coming before the Q4 release.

All told, it does seem like a reckoning is going to arrive here at some point. Between retention and demand concerns, growth seems likely to slow in 2023. Whether investors understand that fact or not, ROVR is no longer priced as if those risks loom.

As of this writing, Vince Martin has no positions in any securities mentioned. He may initiate a short position in ROVR this week.

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