Blue Nile

Blue Nile Inc is an online retailer of diamonds and fine jewelry. Today, its share price rose 35% after its announcement to be privatized.

Blue Nile - Website - 2016-11-07.PNG

My experience

Will you buy diamonds, which can cost thousands to tens of thousands of dollars online? I did! That was 2012.

An ex-colleague of mine recommended me to check out blue nile when I wanted to buy a diamond ring to propose. He gave me a 3-minute crash course on how to check diamond quality: 4 Cs: Carat, Cut, Clarity and Color. He also briefed me his “research” on brands of diamond rings in retail stores: Cartier, Tiffany, Lee Hwa, Soo Kee, etc.

Blue Nile allows you to search for the diamonds you want by listing each of the 4 Cs and the price. You can adjust the filter to suit your budget. Note, you need to have a budget in mind, otherwise, you can always pay more and more for incremental better quality.

After buying it, I brought it to a local jewelry store. The manager could tell that it’s from Blue Nile and kindly helped me check the quality. She confirmed that it’s real and the quality was as stated.

blue-nile-search-2016-11-07

Financials

I realized that Blue Nile is public listed. Here’s the 10-year financial result. Revenue was growing at CAGR of 9-11% over the past 10 years. That’s very good.

BUT, the margin was compressing. EBIT margin fell from 8% in 2006 to just 3.4% in 2015. As a result, operating income in 2015 was even lower than that in 2006. Free Cash Flow also fell by more than half over the 10-year period.

blue-nile-financials-10y-fy15

blue-nile-profitability-10y-fy15

Source: Morningstar

However, the Company was actively buying back shares. The number of shares outstanding fell from 17 millions to 11.6 millions now. With lower book value, the ROE soared. This is the case where rising ROE and revenue do not create value to the shareholders because the overall free cash flow was actually falling. Remember, the value of a Company is created from the cash flow.  Do not think investing is as easy as buying companies with high and rising ROE.

With falling net profit and FCF, its share price went no where.

Blue Nile - Share Price - 2016-11-07.PNG

Valuation

Its valuation is like diamond, pricey! It was trading at P/E of above 50x most of the time in the past 10 years. The revenue was growing at double-digit growth rate and the market was bullish on its prospect. However, the falling margin kept disappointing the market, and that’s reflected in the share price performance. After so many years of disappointing margin, the valuation remains so expensive, just like diamonds. That’s why I never bought the shares.

blue-nile-valuation-10y-2016-11-07

Privatisation

Today, the Company announced its plan to go private in a 500 million cash deal. The price is up ~35% today or 84% from the 52-week low, which took place in February. That’s a rather high premium in my opinion.

The sum of net profit over the past 10 years totaled just 120m with last year’s net profit being just 10.5m. At 500m valuation, how long will it take to earn back the capital? The acquirer, Bain Capital Private Equity and Bow Street LLC must be very bullish on the prospect of Blue Nile. I believe they must have planned restructuring, cost cutting and expansion for Blue Nile for the next several years.

Despite a 84% rise over the past 9 months, today’s price is just 15% higher than the level 10 years ago. After factoring in the inflation, the Company is actually destroying the value for shareholders.

For consumers, I believe it’s creating value though. If you want to buy diamond rings, go check out the website. I’m not particular about the brand of diamonds. No one knows if the diamond ring you are wearing is from Tiffany or Cartier or some unknown brand.

 

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