Multi-level marketing (MLM), good or bad?

Today's blog post is about Betterware. I think this company is very unique, interesting to do research into, and provides a nice return on investment. Enjoy!

Company description

Betterware de Mexico (BWMX) operates as a direct-to-consumer company. The business specializes in the home organization segment, with a wide product portfolio for daily solutions including organization, kitchen preparation, food containers, smart furniture, among others.

They derive 34% of their sales from the kitchen category. For the home category it’s 19%, bedroom 18%, bathroom 14%, 9% for laundry and cleaning, and 6% for commuting.

Betterware has a distribution network of 66.4k distributors (+108% YoY) and 1.25m associates (+94% YoY) and serves approximately 3 million households throughout Mexico.

Their distribution network works this way:

The distributors order products from the company, then sell them to their associates (each distributor has 20 associates on average) and earn 10-16% on their sales. The other 84-90% goes to Betterware. The associates get a ~24% discount on the products they buy and 1 Betterware point for every Mexican dollar they spend on Betterware products. These points can be redeemed for the company’s products.

When a customer wants to buy a product, even though he/she is not an associate or distributor, he/she can order a product on their website or mobile app. Betterware detects which distributor is nearest to the customer and then the distributor will deliver the item.

The advantages of this unusual distribution network are that the company has zero last-mile costs for its distribution and because these distributors could earn a significant (side-)income and the associates get a significant discount, it’s easy for Betterware to scale. They also enjoy the good word of mouth from the associates and distributions to friends and family, which enhances Betterware’s sales and brand awareness. Lastly, this distribution doesn’t deteriorate the delivery pace and quality, because 98.5% of deliveries to anywhere in the country are on time within 24-48 hours.

Each catalog runs for about six weeks, which means that products are marketed via 9 catalogs throughout the year. Every edition has around 400 items, of which 10-15% are new. The company has both internal and external designers, yielding around 300 new products per year. Its go-to-market strategy can take from five to nine months, on average, breaking down to two to four months for product conceptualization and three to five months for manufacturing.

Of the 200+ third-party manufacturers BWMX works with, most of them are located in China. Specifically, BWMX sources 89% of its products from China, and the remaining 11% is produced domestically. Given China's strategic importance to the company's operations, BWMX operates an office in Ningbo, China, that supervises more than 40 containers shipped weekly to the company's headquarters. The office oversees factory certification, product quality assurance, and product innovation.

BWM’s business model is tailored to Mexico’s unique geographic, demographic, and economic dynamics, where communities are small and scattered across the country, with very low retail penetration and difficult to fulfill last-mile logistics, middle-income consumers are emerging, and historic high consumer confidence was present during 2020.

Additionally, the business model is resilient to economic downturns given low average sales price to consumers and also because being a distributor or associate represents an additional source of income for households. As a result, BWM’s operations are not subject to significant seasonal fluctuations. During the lockdowns, they even gained a lot of customers, distributors, and associates.

Market opportunity

Betterware’s presence in Guatemala continues to exceed expectations. In 1Q21, Guatemala sales increased 382%, with an adjusted EBITDA margin of 24.6% (Don't take the adjusted EBITDA too seriously though). This successful expansion has given Betterware proof that its business model can work outside of Mexico.

In the next two to three years, Betterware plans to expand into Colombia and Peru, which are much larger markets (together 50%-60% the size of Mexico) and can be more meaningful long-term drivers of growth. Overall, the pace of international expansion is expected to be gradual, with the majority of Betterware's near- to medium-term growth coming from further expansion in Mexico, where its penetration is still relatively low at ~20% of total households.

BWMX aims to double its penetration to 40% over the next five years by expanding distributors and associates, as well as through brand awareness and new products.

Betterware has a lot of customers in Mexico and is establishing a recognizable brand.

Therefore, it is easier for them to sell additional services. That’s why they have bought a 60% stake in GuruComm, a mobile virtual network operator, for $2.1MM. They expect to start selling mobile and home internet plans in H2 2021 and home technology solutions in late 2022.

Another possibility could be that Betterware becomes an online platform and let other businesses sell their products on Betterware’s platform. This could be an interesting opportunity because of the reach BWM has with its distributors and associates.

Competition

Betterware has several competitors that are general e-commerce platforms or big retailers but have very different operations. These competitors are Amazon, MercadoLibre, Walmart, and Home Depot. The reasons why Betterware stays successful is because (1) Mexico is an emerging economy, so there are a lot fewer people that are going to buy from Amazon and MercadoLibre, simply because it’s too expensive for most. (2) Mexico has a lot of different communities; the people aren’t crowded in cities. Therefore, delivering products would induce a lot of last-mile costs. Betterware is able to avoid those costs through its unique distribution network.

Then we have a competitor which also uses distributors for selling their products but not in the same way as Betterware does, that’s Tupperware. What made Tupperware unsuccessful is that they had problems with their management which have probably led to bad execution and not fulfilling the need of customers. As a result, their brand name has been damaged and therefore hosting a Tupperware party isn’t as hot/trendy as it used to be. Also, places like Amazon and Dollar General, where you could get the stuff that you could buy from the Tupperware parties more easily and probably cheaper.

On the contrary, Betterware has a strong recognized name (for now at least) and are strengthening their 'brand' name through reaching more customers, expanding their distribution network and keep bringing new and innovative products to the Mexican market.

It is important that management keeps executing well, of course. With experience in the industry, large inside ownership, and a track record of executing well, they are likely to do so in the future as well. And as discussed above, it’s hard for Amazon and MercadoLibre to compete with Betterware for its customers.

Then comes the question of how easy it is for a company like Dollar General or Five Below to attract Betterware’s customers. I don’t have much understanding of the operations of Dollar General or Five Below and whether expanding into the Mexican market would be attractive.

What I do know is that both companies will focus on the American market for some years because the growth opportunities in the near future are in the American market. This will give Betterware time to build a bigger network and expand its customer base.

Then also something to consider is that the culture in Mexico is different from that of the Americans. Betterware would not have been successful if it operated in America because of its unique distribution network. And that might be the other way around as well; that DG and FIVE might not be able to be successful in Mexico.

Competitive advantage

1) Their unusual distribution network

- Economies of scale

• Releasing new products is easier with scale. A wider range of products results in more customers and more sales. As a result, they are able to release more products again and so on.

• Selling additional services will be easier because of their ability to reach a lot of customers.

- The 66.4k distributors and 1.25m associates will promote the products they like to friends and family.

• When transforming into a platform, they will already have a lot of customers.

- Because Mexico has a lot of small communities, no last-mile costs are a big advantage Betterware has relative to a MercadoLibre or an Amazon. Where it’s economically not attractive for Amazon or another company to operate, it is very profitable for Betterware.

2) Building a trusted brand name

Management

Management owns half of the business and still hasn’t sold any stock. Even though the stock has nearly quintupled (5x) since coming public through a SPAC in March 2020. There are also no stock options packages for management, which is a good sign, and the management only benefits from the company’s performance through direct ownership.

ROIC has been continuously above 50% year after year as well. Which is exceptionally high.

Luis Campos has been in the direct-to-consumer business for almost 25 years. He has been chairman of Betterware de México since he bought the Company in 2001. Prior to Betterware, Mr. Campos served as Chairman of Tupperware Americas (1994 – 1999) and has quite some experience in selling through distributors and associates.

Andres Campos is the son of Luis and the CEO of Betterware since 2018. He’s 38 years old and therefore a long runway ahead of him.

Financials

Betterware did $450 million in sales in 2020. The growth over the past year has been ridiculously high, with an average of ~60% per year. The operating margins are high (30%) and increased each year over the past four years. They have $30 million in debt and $27 million in cash. The company’s equity grows at a high pace YoY and their return on capital, equity and assets are very high (77%/56%/31%).

Catalysts

- The company keeps growing at double digits. (20-40%)

- The company has succeeded in the new markets of Colombia and Peru.

- The owners (Campalier) or Promotora Forteza sells a meaningful amount of stock to provide more liquidity because they combined own ~87% of the company.

- The company gets listed in Mexico.

Future expectations

I expect the company to continue growing in the markets where they already operate (Mexico and Guatemala) and expect them to successfully expand into the markets of Colombia and Peru. With all the excess cash they are going to earn, they will increase dividends significantly or expand into services and/or new kinds of products for their existing customers, mainly through acquisitions.

Risks

- The management is not able to expand into new markets successfully.

- A competitor like MercadoLibre and/or Amazon is focussing on selling their stuff to customers in a more effective and/or cheaper way.

- The company not able to add interesting new products successfully.

- A lot of associates and distributors changing their minds and think that the rewards for being an associate or distributor aren’t worth it.

- Low stock liquidity

- Execution risk: In line with opening new markets, the company has stated its desire to accelerate growth via M&A, yet it has no history of successfully integrating acquisitions.

- A new law saying that distributors should be employees of BWM and not self-employed. BWM could get a significant liability under the social benefit laws.

- Campalier not having the same incentives as common shareholders.

Most risks mentioned are either discussed before, unlikely to happen or just minimal risks that aren't going to have a meaningful impact on the company.

Current Valuation

Under the conservative assumption that Betterware is going to maintain its sales of the first quarter and thus doesn’t grow QoQ. Then sales will be $550 million in the first year of our DCF model. Even though Betterware has quite some room to grow, I made another conservative assumption that they will grow between 15-20% for five years and that sales growth will decline to 10% thereafter.

If we also assume that they will just improve operation margins by 2% over the whole ten years because of their increased scale and assume they continue to produce 80% of their operating margins as FCF, use a multiple of 15 in year 10 and a discount rate of 15% (my required rate of return) then we get a valuation of ~$2.555 billion for the company. This results in a ~32% margin of safety and we are likely to enjoy an 18-25% annual return for 10 years.

I use a multiple of 15 in year 10 because by then, they will have a very strong presence in Mexico, Guatemala, Columbia, and Peru. They will have expanded to additional services that leverage Betterware’s big distribution network. As a result, they will convert most of the income in free cash flow and will pay a meaningful dividend while probably growing revenues at ~10% for the years thereafter.

Whereas my assumptions are very conversation, I would not be surprised if the company would perform better than my DCF forecasts.

• Why does this opportunity exist?

There are several possible answers. The stock liquidity is very low because 80% of the company is owned by Proterra or management. This prevents funds from buying into the stock.

Another reason could be that investors are uncertain whether Betterware is able to keep the growth going and not end up like Tupperware. Also, the company isn’t that long public and therefore could be overlooked for now.

• What is the probability that someone like Amazon, MercadoLibre, or someone else is going to copy Betterware and take a lot of market share?

That’s difficult to say. Amazon and MercadoLibre are probably not willing to fight for such a small market. The market might become way bigger in five to ten years, but probably still not big enough for an Amazon. Besides that, an Amazon could focus on the big cities and people in the first or second rank, while Betterware focuses on people in small villages who are in ranks three and four.

That’s not to say that no one will take Betterware on because they have quite big margins and huge growth. If someone else will go after Betterware’s market, they will have to convince people to be their distributors and associates while Betterware already has a huge network. It will be difficult, but it is possible if the products they sell are significantly better or cheaper. I guess that the average cost of products ($5) is already quite cheap and Betterware is trying to improve their products and be innovative. BWM also has a lot of data from their customers which helps them to understand their customers’ needs better and improve the products where needed.

Key take-aways:

Betterware is an online retail platform with a unique distribution network of distributors and associates. This network is very favorable to have in Mexico because Mexico has a lot of small communities that would normally induce expense last-mile costs.

Their network has grown significantly over the last few years and makes it therefore very hard for competitors to compete with Betterware.

The company is financially really healthy, keeps generating significant amounts of free cash flows, has grown revenue and cashflows at 30+% over the past several years, and they are expected to grow at least at 20+% per year in the short to medium term.

History has shown that management is able to run the company well and is good in capital allocation as well. They kept the ROIC over the past several years above 50%. They are also shareholder aligned with a 50% stake in the company.

Even though Betterware has several exciting options for growth in their home market, Guatemala, Peru, and Colombia, they are selling for ~15x the FCF they are going to earn in 2021 and a 30+% margin of safety according to my DCF model.

Last words

Coming back to the title of this write-up: Is multi-level marketing good or bad?

First of all, the MLM model is normally seen as a not-so-favorable business model because the past has shown that some companies use this model to scheme people, their end customers.

I don't think this is the case for BWMX because they sell useful products of decent quality at low prices to Mexican consumers. And because you have a lot of small communities in Mexico, it would be impossible to deliver those products to them using a delivery service. Therefore, this MLM model is excellent for Mexico because otherwise all those small communities couldn't be reached.

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That's it for today. I hope you liked reading this post and also learned something along the way. If you disagree with something or if you think that something I said was just wrong, please don't hesitate and comment below.

Thanks for reading and until next time!