The global retail sector is gargantuan, with about $30 Trillion in sales, the US makes up about 15% of this. The retail sector has been facing both revenue and margin compression as it is squeezed by rapidly growing e-commerce players. The future looks bleak unless the retail experience fundamentally changes. The digitization of retailers is looking to be the solution. It has the potential to increase revenues and margins for retailers while bettering the customer experience, a win-win. As this industry evolves, there will be a blurring between the retail and e-commerce experiences. Amazon’s acquisition of Wholefoods, and the multiple investments of Alibaba, Tencent, and JD.com in retail chains have demonstrated that physical points of sale will be at the core of tomorrow’s omnichannel offerings. Some components involved in this digital transformation will include electronic shelf-edge labels, self-checkout terminals, shelf-scanning robots.
An electronic shelf label (ESL) is simply a digital price tag. It is a shopper-facing technology that has features such as dynamic pricing, tap to buy, and accessible web pages. In the United States, there is hardly any penetration of ESLs, whereas in countries such as France there is a 30-40% penetration rate-globally it is estimated at a 5% penetration. We are defining penetration to be the number of ESLs divided by the total number of paper price tags. ESLs drive greater in-store efficiencies due to factors such as less labor cost in switching out paper price tags. Although this isn’t a big deal for a small store, imagine a Walmart that has 100-150k SKUs per store, changing those tags out is a herculean task. Here is an anecdote about changing paper price tags- safe to say, it is the poster boy of drudgery. Price changes are also occurring twice as frequently as they used to five years ago and this acceleration is even faster in nonfood sectors that face steeper competition from the e-commerce players.
Employees would also be freed up to do other value add activities such as bettering the customer experience, a departure from the customer experience today in which you think you have stumbled into a deserted store. Displays make microweb pages available and with a tap of a smartphone, the ESL customers can conveniently access reviews and other useful data about the product. Other advantages of ESLs are dynamic pricing, giving retailers increased agility to get rid of soon-to-be-obsolete technology or close to expired goods. Dynamic Pricing allows for other uses such as increasing price for high-demand products. A perfect use pricescase would have been the great toilet paper run of 2020. Increasing prices on toilet paper would have helped manage inventories by stemming demand and increased margins for retailers.
So how do employees like it? They can’t get enough of ESLs, posting images such as the one below.
We believe two factors will be axiomatic for the acceleration of ESL adoption: Low cost ESLs and increased data transmission. Low-cost ESLs (keeping all else equal) will enable widespread adoption as the payback period for retailers is dramatically shortened. Retail is an incredibly low margin business ( typically around 1-3%) and low payback periods are a necessity. Retailers, generally not the most technical savvy bunch, struggle to break free from the inertia of budget cycles. Decreasing the payback period would help overcome this inertia. Data transmission or communication will continue to increase between customers and retailers at the point of sale. Retailers will be able to leverage more and more data about customers to drive revenue and profitability. For example, there are now video rails that can promote advertisements at the POS, all vying for the customers’ attention. This digital real estate will be incredibly valuable as time continues.
ESLs and other add-ons such as shelf monitoring have significant effects on retailers’ margins, approximate impacts to retailers are charted below. Estimates show both revenues and net margins can increase by about 5%. A rough analysis of the impact ESLs can have shows an increase of greater than $50 Billion added to the bottom line for global retail. We arrived at this using simplistic assumptions such as using 26T as the total global revenue and using an average margin of around two percent. As for the number of paper price tags out there that can be replaced- estimates for the grocery sector alone are around 10 Billion. This would put the TAM for ESLs between $20-50 Billion.
Background
Currently, the two companies that are the market leaders are Pricer (PRIC-B:OSLO) and Ses Imagotag (SESL:FR). SES is the ESL market leader with about 250mm ESLs installed to date, this is about a 50% market share. By revenue, SES is about 50% larger than Pricer and by bookings, it is about 3x the size. They have gained market share at the expense of Pricer, who was the previous market leader until 2012. The CEO Thierry Gadou is relentlessly focused on reducing the cost and effort to install ESLs for retailers-calling it the Total Cost of Ownership (TCO). This covers everything from plug n play to reducing IT costs through using the cloud, preventative maintenance etc. SES has been growing revenues at about a 21% CAGR for the last 10 years (graph shown below) and its annual bookings have grown at about a 33% CAGR! This has been primarily through Europe up until 2017 when SES entered the US and Asia markets.
SES began its foray in the United States back in 2017 and has been gaining ground slowly until 2019, when it won an exclusive nationwide partnership with Kohls (1100 stores). SES has also recently partnered with Walmart Canada in over 300 stores in April of this year. SES customers include 11 clients among the top 50 North American retailers and 4 among the Top 10. SES has consistently been the leading innovator in the ESL space, first rolling out NFC technology, then cloud-based solutions, the first four colored ESL, and more recently introduced value add services such as the AdShelf (advertising video rail) and shelf monitoring. SES is typically ahead of Pricer by about two years with innovations. SES also spends about 4x what Pricer does on R&D. In 2018, SES came up with Operation Leapfrog, a plan to increase their advantage over competitors. It is seldom that companies set ambitious and specific KPIs and publicly commit to them. Below were metrics they set out to achieve by the end of 2022.
VUSION 2022, a 5-year strategic plan driven by BOE’s investment to:
- Accelerate the global adoption of digital labels thanks to increased ROI for retailers
- Strengthen SES-imagotag’s leadership in the digitalization market physical commerce by 2022
- a doubling of customers within the Top 2000 of global distribution
- an installed base of 500 million connected electronic labels
- revenue of 800 M € achieved
- 50% in Europe and 50% in Asia-Pacific / Americas
- > 20% revenue in software, data and services
- 20% EBITDA margin
The pandemic has delayed the achievability of these goals by about 1 year. If SES can achieve this, it would represent greater than a 40% CAGR over the next three years. It is important to add that while revenues stalled (only growing by 11%), order entries did not, increasing 34% yoy.
SES’s business started off as a mediocre one, primarily selling hardware. However, their growing SAAS offering- named VUSION – fundamentally changes their business model for the better. These offerings enable retailers the ability to dynamically price their products, monitor inventory on the shelves, and more recently play advertisements on installed video rails. We suspect that limited real estate at the point of sale will be highly sought after in the coming years.
“In the future, advertising spending by brands will gravitate more and more towards points of sale and store shelves for greater effectiveness and impact.” Marketing Director – Nestlé
VUSION is the culmination of five years of R&D and acquisitions (Imagotag, Findbox, PervasiveDisplaysInc, MarketHub). SES has also partnered with Cisco-Meraki, HP-Aruba, Huawei, Mist, Lancom, and Microsoft Azure for retailers to be able to connect seamlessly to ESLs. This is a key differentiation point of the VUSION platform. VUSION has been strongly received with revenues growing at double the revenue of their hardware business since 2018. Vusion has been growing at around a 65% CAGR and currently makes up 13% of total revenue. This cloud based solution has been rolled out to about 4,000 of their stores they have a presence in or about 20% of their total footprint. Even if software makes a small portion of SES hardware sales (say 5% per store per year) , this business could be generating 150mm in recurring revenue very quickly. SES’s 20% SAAS goal by 2023 puts them at about 160mm revenue generation. Having a large ESL footprint, SES can charge less for both their hardware and software components than their competitors. Wright’s law and a growing SAAS segment will provide SES with an inflection point in growth and profitability. At its current valuation, SES is trading at about 6x 2023 EBIT which we think is significantly understating the value of this business by multiples.
Both of the below graphs from the SES FY 20 presentation show a growing portion of the revenue stream coming from value-add software and “maintenance” on their installed base. Both growing revenue streams are significantly higher margin than their initial ESL install revenue base. Usually, this method of upselling is not the best way to conduct business however given the razor-thin margins of retailers, the extremely low install margin is needed to demonstrate the value add of ESLs. Retailers can then build conviction in ESLs, increasing their willingness to spend on other add ons.
Other partnerships SES has made have been on the manufacturing side. In Dec 2017, BOE Technology partnered with SES, acquiring 60% of the company in the process at about a ten percent premium. BOE Technology is a leading Chinese semiconductor display firm based in China. They partnered with SES to get their foot in the door of the retail sector and SES benefited from access to the Chinese market and their manufacturing capability. Asia is typically a very tough industry to break into unless you have some heavy hitting partners. Here is what PWM, the de facto leader in gas station technology electronic displays said about the Chinese market.
“The Chinese market is hardly regulated so there is still a lot of potential. With China, as a foreign company in a market dominated by national players, it all depends on the local partner you have in the country. That’s what will determine your success – a good, connected partner that sees the benefits of working with a Western supplier”
SES has an exclusive supply contract with BOE’s manufacturing facility in Chongqing that has a production capacity of 150mm ESL. This contract extends until Jan 2024. This factory can produce half of SES total production needs for the foreseeable future. Their partnership with BOE in Chongqing also gives SES an advantage in terms of the transportation of their goods. This is because Chongqing connects to almost all of Europe by rail via the Silk Road. Shipment by rail to London from Chongqing is almost twice as fast as shipment by sea (18 days vs 30 days) and cheaper than air freight. One can see the effects of this with the marked increase of transportation costs Pricer incurred whereas SES hardly saw an increase. The other half of SES’s production needs is subcontracted to a manufacturer in Eastern Europe. Based on nameplate capacity (> 300 mm ESLS), SES can meet ESL demand for the next 5 years.
Valuations
As the e-commerce and retail worlds blend, the retail experience will begin to offer a much better customer experience with features such as tap to pay, dynamic pricing, and convenient access to product info. Employees will be able to spend more time helping customers, an advantage that retail will always have. We believe as ESL adoption evolves, the main selling point of ESLs today, which is the cost of labor to replace paper price tags, will be the smallest contributor to the aggregate value that ESLs bring to retailers and customers. Given the acceleration of these trends, SES’s dominant position in this space, and their increasing profitability, we believe SES to be at a minimum worth double its current valuation.
Catalysts
The continued reduction of ESL costs will accelerate retail demand and could perhaps cause an asymptote in demand past a certain level. As the manufacturing scale of ESLs increases, this will increase the odds of this happening.
The convergence of e-commerce players with retail will lead to more digitization at the store level as the customer experience becomes blended. Amazon Fresh stores are an example of this.
An increase in costs such as employee wages or higher taxes will incent retailers to look more closely at other methods.
Risks
BOE Technology recently sold 1.3mm shares to supposedly increase the liquidity of SES ( it only trades about $600k/ day). If BOE was to liquidate their entire position, this could present a short-term stock overhang and more importantly would present a risk to SES’s future Asian revenues if BOE was to sever the business relationship. This is the biggest risk to SES at the moment.
More share dilution could occur. SES has diluted its outstanding shares by about 30% over the last 4 years. There has been no dilution for over a year and we would be surprised if there is any further dilution given that the CEO, Gadou, owns about ten mm worth of shares or about 20x his annual salary, and BOE owns 60% of the company.
The larger retailers could turn to ESLs and add ons being done in house. Kroger experimented with this in 2018. We ascribe a lower risk to this.
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