Rent the Runway IPO Filing: Insights into the Garment Rental Business

The Q4 IPO Season Has Begun

Positive developments are here: the initial public offering (IPO) activity for the fourth quarter is now firmly in progress.

Individuals who favor analyzing IPO filings over tracking funding rounds will note the recent arrival of new S-1 filings from companies like Udemy and Rent the Runway. These two listings are of particular interest, as they represent venture-backed businesses that TechCrunch has previously reported on.

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Today’s analysis will center on the fundamental business performance of each company, examining their revenue streams and recent financial outcomes. We will begin with a detailed look at Rent the Runway, followed by an examination of Udemy. This is an exceptional day with a dual The Exchange publication.

Initially, it’s crucial to assess the pandemic’s influence on Rent the Runway’s financial performance – considering the prolonged period where formal attire was largely unnecessary – and to evaluate the resilience of its gross margins. Furthermore, understanding the expense associated with procuring the inventory and how these costs are reflected in their financial statements is vital.

Prior to going public, Rent the Runway secured substantial equity funding, alongside some debt financing. Their latest significant investment was a $125 million Series F round announced in March 2019. According to Crunchbase, the company maintained a valuation of $1.0 billion following this transaction. Investors included Fidelity, Bain Capital Ventures, Highland Capital Partners, Kleiner Perkins, TCV, and others during its private funding stages. Now, let's analyze its performance as a public entity.

Rent the Runway’s Initial Public Offering Filing Analysis

The Rent the Runway business model is widely recognized: the company acquires high-end apparel, primarily targeting women, and then rents these items to subscribers and individual customers at a fraction of the retail cost. This service appeals to those desiring a diverse wardrobe without the financial commitment of outright ownership.

Recently, I had the opportunity to examine the Rent the Runway offering firsthand, gaining insight into its practical operation. The platform boasts an extensive selection, and accessing designer clothing through rentals can be a genuinely enjoyable experience.

However, assessing its viability as a sustainable business is more complex. A definitive conclusion remains elusive, though initial observations do not strongly suggest success.

The COVID-19 pandemic significantly impacted Rent the Runway’s performance, a predictable outcome given the nature of its service. With social events and outings curtailed, demand for rental clothing diminished. Consequently, the company experienced a revenue decline during its fiscal year 2020, which concluded on January 31, 2021.

While growth during 2020 was unlikely due to the pandemic, a closer look at Rent the Runway’s more recent performance is warranted.

Further analysis reveals another revenue decrease, falling from $88.5 million to $80.2 million between the six-month periods ending July 31, 2020, and 2021. Simultaneously, costs were reduced from $157.2 million to $132.0 million, resulting in a slightly smaller net loss. It’s important to note the substantial interest expenses, which affect the company’s net income and will be revisited later.

Notably, the company does not disclose its gross profit in these calculations. This omission is somewhat unusual.

Our assessment indicates that this is intentional, as the company’s generally accepted accounting principles (GAAP)-compliant gross margin calculations do not present the most favorable picture. Rent the Runway presents gross margins in two ways. The first, which is of primary interest, includes depreciation of rental products. The second does not, and predictably, portrays a more positive financial outlook.

The difference between gross profit with and without depreciation is considerable.

Rent the Runway records purchases of rental inventory as investing cash flow, while depreciation of these items is reflected in operating cash flow. For instance, during fiscal year 2019 (ending January 31, 2020), the company invested $117.7 million in clothing purchases and recognized $76.1 million in rental product depreciation and write-off expenses. Acquiring and maintaining a large inventory of high-end clothing is costly, and normal wear and tear from rentals contributes to these expenses.

Therefore, when evaluating Rent the Runway’s overall profitability, we believe depreciation costs should not be disregarded, as they represent an outflow of cash from investments. More specifically, they reflect how the company’s clothing purchases impact its operating results. These costs are significant.

The situation becomes increasingly challenging upon further examination. The company carries a substantial debt load of approximately $381.8 million in long-term debt. Servicing this debt is expensive and negatively impacts Rent the Runway’s operating performance. While debt is not inherently detrimental, such a significant burden is problematic for a company facing profitability challenges.

On a more positive note, the quarter ending July 31, 2021, represented Rent the Runway’s highest revenue period since April 30, 2020. Furthermore, the $15.0 million in “rental product depreciation and revenue share” was the lowest recorded for any single quarter within the available data. Despite this, the company still incurred a net loss of $42.4 million during that three-month period.

Determining the Company's Value

An accurate valuation of the company remains elusive. Its future growth is significantly tied to the pace at which global travel, office work, and social activities resume to pre-pandemic levels.

Furthermore, achieving profitability hinges on the ability to extend the lifespan of garments and simultaneously reduce acquisition costs. The existing debt load also presents a considerable concern.

IPO Pricing as an Indicator

The initial price range established for the company’s IPO will be a key indicator of prevailing market attitudes. It’s important to note that a $1 billion valuation equates to 5.4 times the company’s current annualized revenue, based on its latest quarterly earnings of $46.7 million.

Your assessment of whether this multiple is high or low will be instrumental in forming an opinion once the company announces its IPO price.

Key Considerations

• Travel & Social Trends: The speed of recovery in these sectors is crucial.
• Cost Management: Successfully lowering clothing acquisition costs is vital.
• Product Durability: Extending garment life impacts profitability.
• Debt Levels: Existing financial obligations require careful consideration.

These factors will collectively influence the company’s long-term financial performance and, consequently, its overall worth.