Solo Brands: Unique Business Model With A Long Runway Ahead

Solo Brands (NYSE:DTC) is a profitable (on a normalized basis) consumer discretionary business with a super solid core product and several other decent products, a very interesting DTC model with an internal marketing team, a database with ~3.4 million customers, and >60% gross margins. On March 9th, DTC posted strong full-year results, with revenues growing from $39 million in 2019 to $517 million in 2022. The company just entered the international market with a large room for growth ahead.

Products

Solo Stove

DTC’s iconic brand is “Solo Stove”, which is a collection of premium fire pits and related accessories. Through my research, I believe that Solo Stove is the best product in the market: it has a nearly perfect rating on both Amazon and the company’s DTC channel, and simple google research leads to many hobbyist reviews that confirm Solo Stove’s market leadership. For example:

Gorgeous design. Well-made. Nearly indestructible. Burns hotter and lights easier than nearly all other fire pits. Easy to move around your home. Doesn't kill your grass after a single use. (Wired.com)

The one that impressed me the most was a review that recommends “the best alternatives to Solo Stove”, which says “While the Solo Stove reigns supreme, the premium price isn’t for everyone, …” The good “alternatives” listed were all inferior to Solo Stove products that cost ~ $90. DTC perfectly addressed these competitions a couple of months ago by launching a cheap version of its fire pit “MESA”, which cost ~$80.

CNBC also has an article featuring DTC's business history.

Solo Stove has different layers of products to satisfy most customers with different income levels: the MESA that costs $80, the Ranger 2.0 that costs $200, the BonFire that costs ~$300, and the Fukon that costs $460. DTC also constantly launches fire pit accessories such as the Pi Pizza Oven and the Grill based on customer reviews which generate many cross-selling opportunities. These products have received multiple awards, which I am not going to list here.

These traits all indicate one thing: Solo Stove is a wonderful product. They have this 360 airflow and smokeless technique which differentiates them from the others. In the Q3 earnings call, the management said that the “average NPS” of all of their products is 82. Solo Stove has been growing at 132% CAGR since 2016.

Oru Kayak

Oru Kayak is a decent product with a decent reputation and a decent rating on Amazon (4 stars). The key differentiator of this product is its “Foldability”: Most kayaks are either solid and heavy or inflatable, while Oru Kayak can be folded and brought everywhere without needing to fill the air. In this review (Folding Kayaks), Oru Kayak is ranked the best product among 8 competitors. I am not a kayak expert, but Oru does look way better than other foldable kayaks.

ISLE

Although ISLE is a troubled kid financially, it has a product almost as good as Solo Stove. Its paddle boards get almost perfect ratings on Amazon and enjoy a very good reputation among enthusiasts. Its paddle boards are inflatable and very high quality, which is the key differentiator. In this review (Isle Paddle Board Review: Meet the Queen of Inflatable SUPs - Rad Family Travel), ISLE is called the “queen of inflatable paddle boards”

Chubbies

Chubbies shorts are priced at ~$60 a pair and have almost perfect ratings on Amazon. Chubbies recently released the “longs” pants which many customers have been demanding.

According to the prospectus, Chubbies grew sales from 2.4 million in 2012 to 44.1 million in 2020, a 43.8% CAGR. According to the management, Chubbies had a "phenomenon year" in 2022 and has a very solid customer base. I am glad to see this since Chubbies is the least differentiated product in my personal opinion.

Solo Brands’ styles/values of clean, simple, light, etc. gives me the same feeling as MUJI and Lululemon. It’s something that would appeal to teenagers. Just a personal feeling. No scientific evidence.

DTC business model

There are two critical parts of the DTC business model: digital and data.

Digital

In comparison to its competitors, DTC is very independent from large retailers, generating 85% of its revenues from its online DTC channels and only 15% from retail partners. According to the 10-K, Solo brands identify itself as “digital native”. This model benefitted extraordinarily from Covid.

Despite deriving less revenues from them, DTC has a very nice list of partners including Dick’s Sporting Goods, REI, Ace Hardware, Scheels, and Academy Sports & Outdoors. DTC chooses their retail partners carefully "based on their reputation, demographic, and commitment to appropriately learn and showcase Solo Brands’ portfolio of products, provide hands-on customer service, and abide by our terms and conditions, including consistent adherence to our MAP policy.” DTC also sells products on websites of retailers such as Home Depot, Lowe’s and Bass Pro Shops, etc.

A while ago, DTC sued Costco (COST) for patent infringement because Costco made a knock-off fire pit after DTC refused to manufacture it for Costco’s private label. Now DTC has a partnership with Costco, per the Q3 earnings call. This gives me a feeling of how the management thinks of their brands and the DTC model.

DTC's business model is also capital-light since most sales are generated online. I expect the operating leverage to go up with profitability as they scale.

Data

From the DTC model, Solo Brands obtained a valuable database of 3.4 million customers, which grew from 2.1 million in 2020. In the last 3Q earnings call, the management said:

The first is that we have this direct connection with our customers. You talked about it, these 3.4 million customers. But these aren’t just customers that have purchased in a store or whatever. These are customers that have purchased through our site. And so we have their information. We are able to communicate with them and where that comes, in particular, handy is when we talk about our investments into product innovation in particular.

Most manufacturers claim to be customer-oriented, but DTC has the infrastructure to do so. DTC’s management emphasizes customer reviews a lot as part of their DTC strategy. For example, the newly launched 2.0 stove with an ash pan and a removable grade was actually from customer feedback. According to 2Q earnings call:

The first is Solo Stove 2.0 a product that incorporates a removable grade and ash pan in our firepits. This product enhancement, which was launched in mid July, came in response to customer requests to solve the challenge of emptying cash from the firepits and makes our Solo Stove firepits much easier to use. While it's early customer feedback has been positive and we're excited to release product enhancements that remind our customers that we're committed to listening to their feedback.

The management also read some customer reviews in the earnings call which IMO proves that they do care. Over 35% purchase of the newly launched Pi Pizza Oven come from existing customers.

Product innovation

DTC is very strong at launching new products: according to the prospectus, 18% revenues 2020 comes from products launched in 2019. DTC has an innovative pipeline to continuously launch new products, which will be sold through its strong marketing pipeline.

According to the prospectus:

We have a history of disrupting markets by introducing and scaling innovative products and technologies ... we have strengthened our product portfolio to meet evolving customer demands. Our innovation strategy is two-pronged: introduce fundamentally innovative and disruptive franchise products, and support those franchise products with a range of new accessories. For example, in fiscal year 2020, we launched the Grill, which was complemented by a range of accessories that included the Stand, Carry Case, and Grill Tools.... Our Oru brand features a flagship line of lightweight, foldable kayaks. The Oru technology was developed over a decade of relentless testing and design and delivers a customer experience unlike any other kayak product in the market. The product design is lightweight, portable and folds into a small package that appeals to space conscious customers. In late 2019, Oru launched the Inlet, which is Oru’s lightest, most portable, and easiest-to-assemble folding kayak to date. It is designed for recreational kayaking on flat water and is targeted for the growing recreational kayaking market...

As a proof of this, DTC launched 15 new products in 2022, per 4Q22 earnings call.

In-house marketing team

In the last Q3 earnings call, the management said the following, which I find very helpful to understand the importance of an in-house marketing team.

For the most part, we execute all of our marketing with our own internal team versus using outside agencies. And so that's a big proponent to us. In terms of top of funnel... as we're rolling out international markets, you just have to understand that the initial marketing spin and new markets, and frankly, for new products, as well so when we're launching a lot of new skews, that marketing spin tends to be more top of funnel than bottom of funnel in the beginning. It's very, in a new international market, it's very brand building.

...Now, we do expect for those to normalize out and get back to not pandemic levels, but pre-pandemic marketing efficiency levels, for sure, as those international markets and those new products that we're launching become more mature.

So that's kind of how you could expect it, that top of funnel spend will work its way down the funnel, it'll just take some time... expecting more of that to come in 2023. That's what we've modeled.

TAM and other opportunities

DTC makes acquisitions that it can add value to. According to the CFO:

... what we've seen through the acquisitions that we've done already, is that we are really strong at fulfillment and marketing. So the B2C component and the fulfillment side to the fulfillment by Solo are two of our strengths of the platform. And so when we look at M&A targets, we really assess hey, can we drive a lot of value here... if we see the profitability isn't where we want it to be those are two things that are two levers that we can move on pretty quickly.

They have been able to cross-sell the acquired brands:

By the end of the third quarter, 57,000 customers have purchased from more than one brand, and with over 3.4 million customers, we have significant runway to continue to grow this number.

DTC owns many premium brands but 80% of revenues are still from Solo Stove. This is because the brands were newly acquired and haven’t been put into DTC’s sales channel.

According to the prospectus:

Our Oru and ISLE brands operate in the attractive and rapidly growing U.S. paddle sports market, which based on a market study conducted by Ducker, generated estimated retail sales approaching $1 billion in 2020. Despite Oru and ISLE’s rapid growth, their combined fiscal year 2020 revenue represented approximately 3% of this market. We believe this low market penetration rate demonstrates the substantial runway these brands have under our ownership

International expansion

DTC just launched Oru, ISLE, and Chubbies in Europe and Canada in Q2, and is preparing to launch in Australia. This contributes to the growth pipeline of acquiring premium brands and selling them through DTC’s strong international sales channel.

In the 22Q4 earnings call, the CEO expects the international market to be as large as the US market. This presents the most direct path for growth. On the short term momentum, he said the following:

We started seeing strong momentum in our international markets in the second half of Q4 and want to continue pushing profitable growth internationally in 2023. We have significant growth opportunities in our existing countries, and we plan to launch localized e-commerce stores and additional new markets this year. We still believe that in the long-term, our international business has the potential to become the same size as our U.S. business. And our new markets will get us closer to realizing this vision.

Financials

The YoY comp numbers are a bit messy due to half-year acquisitions, and the management not disclosing revenues break-up by brands only makes it worse. Here is my estimation of normalized 2021 results, based on each brand's revenues at the time of acquisition. All figures below can be found in the Prospectus.

• Oru Kayak generated 5.2 million in revenues in the first six months of 2021; full-year 2021 revenues estimate: $10.4 million
• ISLE: 2020 revenues: 20.7 million; first six months of 2021 revenues: 12.1 million; full-year 2021 revenues estimate: $24.2 million
• Chubbies: 2020 revenues. 44.1 million; first six months of 2021 revenues: $49 million; full year 2021 revenues estimate: $98 million
• Solo Stove: 2020 revenues: $133 million; 2021 revenues = 2021 consolidated revenues $403.7 million - revenues from acquisition (provided in 2021 10-K) 41.7 million = $362 million

As a sanity check, if we add the first six months' revenues of all the acquired brands to 2021 reported revenues, we get $403.7 million + $5.2 million + $12.1 million + $49 million = $470 million. Oru was acquired in May, ISLE was acquired in August, and Chubbies was acquired in September. The numbers have to be a little off but it's close. The second number is lower, which makes sense because Chubbies, whose revenues are significantly larger than other brands, was the last one acquired.

In 2022, the company achieved 10% YoY organic growth despite 2021 being an extremely tough comp and generated 5% net margins ex-impairment charges. I believe a 10% margin is achievable at scale, based on comp numbers. In the 2023 guidance, the adjusted EBITDA margins went from ~10% in 2022 to ~17%. While this doesn't represent the EBITDA margins, it is a clear indication of improvement in profitability.

During 2022, DTC’s profitability plunged due to a $30 million impairment charge for ISLE and increasing SGA expenses. The management indicated that much of the SGA inflation is for investments such as (per the 3Q22 earnings call) “data infrastructure analytics, product innovation, marketing and international markets”. management has said that $20 million was used for international market expansion.

Valuation

DTC has a 60% gross margin and should achieve at least 10% net margins at scale (based on comps' 10%-20% net margins) and is trading at 1x sales, which is pretty low compared to comps (2-3x).

If DTC grew its revenues to $1 billion in 10 years (7% CAGR) and traded at 2x sales, the stock price would be $2 billion / 95 million normalized share outstanding (including the up-c structure) = $21, indicating a 16% CAGR over a 10-year period.

70% of DTC is owned by a PE shop which can be a concern. However, I personally am not very worried since I believe the quality of the business matters the most.

Concerns

• So far there is little validation that the cross-selling of the acquired product will be effective.
• DTC might have a large downside if growth stocks continue to lose favor in the market. This can be mitigated by buying at a cheap price.
• Empire building: the past acquisitions were not cheap: According to the Prospectus, Oru’s 2021 annualized earnings were ~$1.8 million, and DTC bought 60% of it for $26 million. Chubbies was acquired for ~3x sales, and ISLE for 2x. The majority of DTC’s shareholders' equity is in goodwill which is a big concern for me. $30 million of ISLE’s goodwill was impaired due deterioration of its expected performance. However, according to the management, ISLE is an exception and other brands are growing well.
• Accounting: Intentionally or not, the management uses some "tricky" accounting methods. For example, they give out “adjusted net income” that excludes the amortization of intangible assets and marks up their inventory.