the SEC questions internet sales hype
According to the Wall Street Journal, the SEC recently sent inquiry letters to a bunch of retailers asking them to quantify claims managements were making in quarterly earnings conference calls about internet sales and internet sales growth. Fifth & Pacific (Kate Spade, Juicy Couture…), for example, told investors it had a “ravenously growing” web business. Others tossed around numbers like up 30%.
On the other hand, while online sales in the US may be growing faster than revenues from bricks-and-mortar operations, they’re still only in posting increases in (low) double digits, and make up less than 6% of total retail. So the SEC was concerned that the company talk might be more hype than reality. Why no disclosure of internet sales as a percentage of total sales?
The SEC got two types of reply:
—equivocation. Some retailers said they don’t disclose the size of online sales because they’re “omnichannel” firms. An individual customer may sometimes visit a store, sometimes order from a desktop at work, sometimes buy from a smartphone on the train going home in the evening. It’s the total customer relationship that counts, they said, not the way someone may buy any particular item. Translation: online sales are almost non-existent, but we know shareholders will react badly if we say so.
—confession, sort of. Others said that online sales were “immaterial,” meaning no more than a couple of percentage points of total sales.
there’s information here
Why not just say so?
…because it sounds bad.
Why bring up internet sales in the first place?
…because we have no other good things to say.
look at the income statement
I could have told you that, just from taking a quick look at company income statements.
Here’s my reasoning:
–if a company’s internet sales are growing at, say, 20% and comprise 10% of total sales, then they’ll contribute 2% to overall sales growth. Because online sales are free of many of the costs of bricks-and-mortar stores, like salespeoples’ salaries and rent, they should carry (much) higher margins than sales in physical stores. Therefore, if internet sales are big, we should see accelerating sales growth and rising margins.
Take Target (TGT) as an example. Aggregate sales are growing at about a 3% annual rate with no signs of acceleration. Operating margins are flat to down. If online sales contributed 2/3 of total growth, TGT would have to disclose that …and margins would be heading up noticeably. Therefore, internet sales can’t be anything close to 10%–or even 5%–of TGT’s business.
By the way, TGT’s response to the SEC was that its internet sales are immaterial.
why the SEC investigation?
Every company is going to try to spin the facts of its performance in a favorable way. Just take a look at the 10-K, where management can go to jail if disclosure is incomplete or counterfactual. It’s chock full of dire warnings of what might go wrong. It’s also in dense print with no pictures. Compare that with the annual report, where every page is glossy, every face is smiling and the skies are always blue.
Also, retailers are marketers, after all, so we should expect an unusually rosy portrayal of results and prospects from them.
Still, there are limits. Even if the border line is a bit fuzzy, there comes a point where positive spin becomes deception, where touting the fantastic prospects of a currently minuscule business becomes fraud–especially if it’s in an area like online where Wall Street is intensely interested.
I interpret the SEC letters a warnings to the companies involved that they have been treading dangerously close to that line, and may even have stepped over it. Expect a much more 10-K-ish assessment from now on.