Rent the Runway (NASDAQ:RENT) has an interesting business model that I believe can be quite effective, especially with economic growth slowing and many consumers looking to reduce their spending.
The company has steadily grown and is becoming more profitable, while the firm appears to utilize effective marketing techniques and the valuation of Rent the Runway stock is quite low. Moreover, I believe that the firm could eventually become a takeover target for a larger company.
On the negative side, the retailer does have a relatively low barrier to entry and a rather high debt load. Therefore, I recommend that risk-tolerant investors looking for a name that can both thrive during a recession and potentially get acquired buy a small amount of the shares.
An Intriguing Business Model and Improving Metrics
Rent the Runway allows consumers to rent designer clothing for a subscription fee of as little as $89 per month. For $89 per month, the company’s users can rent five items at a time.
Due to the current high inflation levels, many consumers do not have a great deal of disposable income and consequently are unable to purchase a significant amount of designer clothes. That’s because these clothes can be extremely costly. But conversely, a high proportion of consumers can afford to pay $89 per month to satisfy their craving for designer clothing and their desire to impress their peers and colleagues.
Meanwhile, many of the company’s financial metrics improved last quarter. For example, its operating loss sank to $15.2 million compared to $20.4 million during the same period a year earlier. Rent the Runway’s EBITDA loss also shrank to just $60,000 from $7 million in Q1 2023. And importantly, the firm believes it can break even on a free cash flow basis this year thanks to cost cutting and “a wide range of revenue growth strategies.”
Moreover, the size of Rent’s active user base has generally steadily increased over the last few years, climbing from 107,000 in Q3 of 2021 to 136,000 last quarter.
A Potential Takeover Target
Rent notes it uses many different types of marketing techniques, including “earned media,” “influencer marketing” and “visual storytelling.” The company also noted it utilizes multiple types of emails and text messages. I was impressed by the attractiveness of the company’s eye-catching marketing photos. Moreover, the steady increases of Rent’s user base indicates its marketing techniques have indeed been quite effective.
On the valuation front, Rent the Runway stock has an extraordinarily low price-to-sales valuation of just 0.3 times.
That valuation is especially tiny because Rent could very well become a takeover target. After all, many brick-and-mortar retailers are struggling to build up their e-commerce businesses. As a result, I believe a large number of them would love the idea of obtaining Rent’s list of consumers who are obviously willing to pay significant amounts of money for apparel that they select online.
What’s more, with the synergies that Rent would have with a sizeable retailer, Rent’s business would probably immediately generate significant, positive cash flow for an acquirer.
The Negative Aspects
Rent has relatively low barriers to entry as any apparel retailer could immediately start allowing its customer base to rent clothes online. Consequently, Rent could quickly be hit with very detrimental competition.
Another negative factor is the retailer’s high debt load. Specifically, the firm had net debt of about $280 million as of the end of Q1. On the other hand, its current ratio of 1.6 indicates that it shouldn’t have trouble staying afloat for the near-to-medium term. Still, its high debt does create some risk for longer-term investors.
On the date of publication, Larry Ramer did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines