The Rise and Fall of Surfstitch

Surfstitch (SRF) is on online surfing clothing retailer started in 2008 on Sydney's Northern Beaches. The company grew aggressively, expanding internationally through the acquisition of both European online retailer Surfdome.com and North American retailer Swell.com. In late 2014, the company went public through an ASX IPO at an offer price of $1.00 per share. With a total of 83 million shares issued, this equated to a market cap of $83m. The accounts for 2014 showed total revenue of $60m, not bad for a young company, and a small loss before tax of $0.5m. More important than the revenue itself, however, was the revenue growth of 23%. Clearly, if growth continued at anything like this rate, the company would have revenue in the hundreds of millions in short time.  

The stock performed very well for the first year, climbing to a high of $2.13 in late 2015, despite the company undertaking a capital raising in May of 2015 to pay for further acquisitions. The acquisitions, which included Stab Magazine (an online surf magazine) and Magicseaweed (an online surf forecasting and reporting website), were expected to be earnings accretive, as well as providing revenue growth and enhanced margins with the full benefit being realised in the 2016 financial year.

The 2015 annual report confirmed that things were firmly on track for the company. Total sales were up a further 30%, to $199m, and EBITDA was $7.7, up 51% on prospectus guidance. Even more impressive, forecast EBITDA growth expectations for FY16 were 100%+. A further acquisition in late 2015 of an action and extreme sport production company cost SRF a further $15m and shortly after, SRF acquired Surf Hardware International for $23.7m. These brought the total value of acquisitions in the year since the IPO to approximately $57m!

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Things started to unravel for SRF in February this year upon the release of its accounts for the half year ended 31 December 2015. Although revenue grew massively, to $144m, profit after tax was only $0.959m. The market clearly didn't like the result, with the share price dropping 34% on the day. In March 2016, the CEO, Justin Cameron, departed unexpectedly and in May 2016, SRF announced that trading conditions were leading to higher advertising costs which would bring EBITDA for FY16 down to between $2 and $3 million. The share price dropped further on this news, breaking below the IPO price for the first time and trading throughout May at around $0.5.

With the share price drifting lower since then, today's FY16 financial results have proved to be another disappointment. Underlying EBITDA came in at -$18.8m and non-cash impairments of $99.3m were flagged. All of this led to a massive statutory net loss after tax of $154.7m. This happened despite revenue growth of 18% over the prior year. Hopefully this comes as a lesson to overenthusiastic young companies who try to grow revenue at all costs.

Clearly the problems for this company are a result of its aggressive acquisition strategy and its desire for revenue regardless of the effect on profits. From an outside perspective, it appears as though some, perhaps most, of the acquisitions weren't well thought out. The company itself has now admitted that the $23.7m purchase of Surf Hardware International was a mistake. Investors should also take some of the blame for these purchases. Through the process of participating in the multiple capital raisings that have been performed by SRF, they enabled the company to grow beyond its means with easy access to fresh capital. The chickens are now coming home to roost as the bloated company struggles to get its operation under control. The real shame is that the original online surf clothing business appears to be a good business that would likely have maintained its profitability if management just focussed on growing it through primarily organic means. The share price is down 50% today to $0.115.

This article was written by William O'Loughlin – Local Investment Analyst, Rivkin Securities Pty Ltd. Enquiries can be made via william.oloughlin@rivkin.com.au or by phoning +612 8302 3600.