Summary
After consistently beating analyst's expectations, Blue Nile may be poised to disappoint shareholders when it announces its 3rd quarter numbers in early November 2007. Here's why.
Analysis
Citigroup analyst downgraded Blue Nile from hold to “SELL” which prompted some buyers to bid the stock down further. Trading at $100.50 about a week earlier, the stock dropped to the low $80’s in afternoon trading on twice the normal volume. Blue Nile has consistently beat market expectations through out 2007. Now analysts believe the company will likely achieve the low end of its earnings projections which means there is a meaningful probability third quarter earnings could be less.
Analyst’s indirect research suggests unit sales may have dropped between 3% and 14% in the quarter. That isn’t an unreasonable given economic turmoil over the summer period including the sub-prime mortgage market collapse and the perceived liquidity crisis in the banking system during the early part of the quarter.
Higher commodity prices for both gold, platinum, and large loose diamonds may have put additional pressure on margins too. Gold and platinum increased about 13.5% and 7.8% respectively in the quarter. In previous quarters, Blue Nile absorbed most of its higher commodity costs and benefited from higher unit sales. Whether that strategy will work this quarter in the midst of the economic turmoil is problematic at best.
Another point, with about 33% of the on-line jewelry market share, Blue Nile's numbers probably have nowhere to go but down. DeBeers' luxury retail arm seems committed to growing large diamond sales on-line and Tiffany has about a 15.5% market share. With no other sustainable competitive advantage other than low price and Internet jewelry sales topping out at about 3% of total sales, current shareholder value can only be conserved it the company diversifies or finds a buyer.
Blue Nile’s management has hinted that it wants to attract more women to its site, increase the variety of merchandise sold, and merchandise lower price point merchandise to grow sales. Most of those ideas are at odds with the metrics of the company’s current model. Whether their current cost structure could absorb the incremental costs arising from such a diversification or a single Internet site could successfully communicate so broad a marketing message is doubtful.
As far as a buyout is concerned, fundamentally neither the company’s current earnings nor management's 5-7 year earnings estimate supports a buyout at today's multiples. However, if a deal could be done, it probably would be with an established Internet portal that could justify the valuation because of the advertising value attributed to the company's customer base and site viewers. Clearly, Blue Nile has access to a unique, cross section of the high-end, luxury market which traditionally has been hard to reach and even harder to sell. Today, Blue Nile's customers may have the greatest value to a potential buyer and be the company's only real asset.
