Blue Apron and other meal kits: company or feature?

In this update to our Q3 2017 sector report on Meal Kits, we consider whether what ails meal kits is an issue of expectations. These companies — Blue Apron, Hello Fresh, Chef’d, etc. — are organized as corporations with shareholders, public and private, seeking a return on capital invested in building businesses that generate and return economic profits.

But, can these companies do so — and on their own?

The results thus far, using Blue Apron and Hello Fresh (for which there are reported financials) as proxies for the industry, are mixed at best. And so, while we can see a path to greater profitability through consolidation and some vertical integration, we wonder whether for these businesses to truly “work” they will need to be acquired by someone for whom they are a feature. And those acquirers are the grocers.

This is a big opportunity, regardless of how it is approached. The average American family spent ~$2,600 per year on groceries used for cooking meals, which leads to a market opportunity of over $300bn. Consumers are spending an incredibly large amount of money each year buying products in ways that haven’t changed since the first self-service grocery store was introduced in 1916.

Noting that, this is where we stand.

1. Blue Apron blues. Blue Apron, the largest U.S. meal kit provider, went public on June 28th, 2017, and has subsequently lost almost half its market capitalization, falling from $10 per share on June 29th to $5.38 today. The company is now valued at approximately $800mm net of cash on its balance sheet, which is a 60% discount to where it was valued in 2015 (~$2b) as part of a $135m financing round.
2. Crowded space. As of today, $842.8m in venture capital funding has been invested across 11 companies in leading startups (two of whom have not disclosed funding).
3. AMZN enters the offline grocery category through the acquisition of Whole Foods. On June 16, 2017, Amazon announced that it was acquiring Whole Foods for $13.4b or 0.8x projected 2017 revenue. The acquisition caused a tectonic shift in the grocery market. Amazon is the world’s largest e-commerce store. Due to Amazon’s sheer scale and position in the expanding trend of e-commerce, its acquisition of Whole Foods cemented its status as a presence in and threat to the retail food business.
4. Amazon again. Amazon’s — perhaps relatedly — is also interested in meal kits. In mid-July, reports swirled that Amazon had filed a meal kit-related trademark. In the application, the company suggested pretty direct competition with services like Blue Apron and others, noting that customers will receive “prepared food kits … ready for cooking and assembly as a meal.” The Verge then noted a day later that Amazon had already begun selling these kits in Seattle (and perhaps other geographies).

Taking all that into account, private investors (including Amazon) continue to be bullish on the space, while public investors, largely based on Blue Apron’s financial performance, have thrown in the towel. So where do we go from here?

High CAC and Lower LTV in tandem is a disaster.

Consolidation?

There will most certainly be consolidation. There are too many players doing very similar things, and the impact on these companies’ financial performance is two-fold:

1. higher customer acquisition/retention costs
2. price competition leading to lower margins

High CAC and Lower LTV in tandem is a disaster.

Through consolidation (and some inevitable attrition), price competition may moderate, allowing companies in this space to generate greater gross margins. Currently, Blue Apron’s reported gross margin is ~30%, while Hello Fresh’s margin after COGS and Fulfillment Expenses is 22%. Neither margin suggests significant willingness to pay on the part of consumers.

While potentially reducing price competition and lifting gross margins, consolidation may have other benefits through cost reductions and redundancy removal. Using Blue Apron and Hello Fresh as examples illustrates the potential for profitability improvement through consolidation and cost reduction.

Vertical integration?

In March 2017, Blue Apron acquired Bill Niman’s BN Ranch. We think, in theory, vertical integration would allow for much greater profitability. The history of acquiring products from other companies, paying them a margin, and then packaging those third party products in a subscription box is not positive. The challenge with vertical integration is the significant number of products — produced by many different vendors in many different places — that make up the ingredients in a reasonably diverse set of meals. Does Blue Apron need to own chicken farmers, fish farms, ranches, and on and on? Is this even feasible?

And so, along those lines, being acquired by a grocer is vertical integration of a sort. Those ingredients are already being acquired at scale. Now they can be packaged and sent to grocers’ customers at a moderately higher margin than they would garner in store (to account for convenience, discovery, and other meal kit value propositions).

Mark Suster defined Feature Not A Company as:

“For me it is a useful shorthand for a very clever set of product features that in my mind would be hard to remain a stand-alone business or themselves to generate enough revenue to justify the company’s existence.”

This sounds like meal kits.