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Blue Nile: Breaking Hearts – And Share Value

by Sonya Colberg, Senior Investigative Reporter - 11/20/2014 12:25:19 PM

Diamond seller, Blue Nile (NILE), is in the business of turning romance into cold, hard cash.

As if that isn’t tough enough, the Seattle, Wash. diamond and jewelry retailer is selling online. While the company’s courtship of customers is getting tougher, recent creative hype has blinded investors into buying into the dream and pushing the market cap to a stunning $400 million.

But this love story is doomed. Here are some highlights on why TheStreetSweeper believes the diamond company will quickly lose its sparkle once again:

*Diamonds are a girl’s best friend: Online cheap won’t cut it.

NILE’s core engagement business is at risk partially because a woman may feel a slight wave of disappointment when Prince Charming shows up with a diamond – and it’s from a Wal-Mart-esque online store.

NILE execs admitted during a summertime William Blair stock conference, in fact, that the biggest problem is getting men to buy engagement rings online because there’s “a trust component and then there’s a relationship component.”

CEO Harvey Kanter added that the company must convince customers that online buying is better.

“I think that that -- the reason why growth rates haven't been sustainably high has been that we still have to get a lot of the market to understand that,” he said.

*NILE’s recent “test:” Weakening business model.

Mr. Kanter said NILE is now “testing” a brick-and-mortar store in Rhode Island and in Seattle. This appears to be a test of the idea that customers may consider buying engagement diamonds online less satisfying and riskier than seeing and touching them in a store first.

Keep in mind that the reason NILE can sell jewelry cheaper is because, as an online company, it has been able to avoid the costs of physical buildings, utilities and sales people of traditional jewelry stores. And now it’s trying to compete in brick-and-mortar with thousands of established jewelry stores.

*Competition is growing: Threatens NILE’s market share.

 NILE’s rivals continue to offer online customers more diamond for their dollar. This PriceScope chart shows that the diamond competition is growing and NILE no longer offers the best price – a factor that an astute, cost-conscious man can find with an internet search.

The chart shows, for example, virtually the same .95 carat diamond sold by NILE can now be bought from Solomon Brothers and Eternity Diamonds for $1,800 to $1,900 less.

The chart lists more than a dozen vendors in the space where NILE is scratching to remain relevant. But as NILE’s filings state, numerous online jewelry businesses are flooding the space and now include everything from Costco to Amazon, and QVC to Wal-Mart, and James Allen to Tiffany. And these giants have the megabucks to spend on advertising to acquire more and more customers.

*Setting the stage: Management runs off.

Stubble-faced founder Mark C. Vadon resigned as chairman and director in his 15th year with NILE on Dec. 31, 2013.

 A frustrated, Birkenstock-footed engagement ring buyer and recent Stanford grad in 1999, Mr. Vadon joined the growing dot-com boom after he bought a diamond ring from a mom-and-pop business that sold jewelry online. He stopped by the Seattle store one day for a chat and ended up scratching out a $5 million offer on a napkin. Mr. Vadon didn’t have that kind of money but the country was in the midst of dot-com fever and investors turned him into an instant executive.

Though he initially overspent the company’s new-found cash, Mr. Vadon learned quickly. He piloted his so-called “evil empire” through rugged waters and the dot-com bust that sunk many companies and investments.

But Mr. Vadon began selling his shares of NILE in August 2013, as he bought Home Depot stock, and stepped out the door in December just before NILE sales and profit began dropping significantly. The company's chart below shows this decline:

When management started running, the stock price ran down, too, as the next chart shows.  Despite the recent uptick, the price still rests at about $34 – or about 27 percent below - the $48 per share price on the day Mr. Vadon left.


 

NILE’s chief accounting officer resigned just months before Mr. Vadon left. The company has endured a heavy management turnover trend, including a succession of six chief financial officers in four years, even one who quit before he started his first day.

*One reason fleeing managers knew what they were doing: Negative operating cash

Alarmingly, NILE’s total free cash flow last quarter turned negative again at $ –5.0 million, compared with the December 2013 positive number of $55.9 million. It has been negative in three of the last five quarters.  See the chart below.

Directly from NILE’s recent SEC filing, cash from operations compared unfavorably with the last nine months of 2013.

Indeed, net income is dropping dramatically, as shown on page 15 of NILE’s SEC filing.  At just $1.65 million, quarterly net income dropped to 57 percent of net income the previous year.

That’s an eye-popping $1.25 million decline. That’s also a steeper net income drop than the drop NILE reported in 2011, when then-CEO Diane Irvine suddenly resigned and the stock dropped 27 percent overnight.

*Insiders yelling: “Sell!”

When the stock price rebounded a bit following recent hype about designers joining NILE and a mixed quarterly report, Jon Sainsbury, international president, quickly sold 1,000 shares of his freshly exercised options. And it would make sense if more insider sales are announced in coming weeks with this little uptick after 10 months of generally declining prices.

In fact, during the past year alone, insiders have done nothing but sell, sell, sell. Perhaps signaling either a lack of trust in the business or in the sustainability of the stock price or both, Mr. Vadon and his former fellow officers and directors have sold over $3 million worth of stock.

Yep, in just one year, $3 million worth of NILE shares sold by insiders.

Investors may find positive and negative viewpoints on NILE here.

*Conclusion:

Numerous negative, thoroughly unromantic signs lurk ahead for this online diamond and jewelry retailer. Though NILE took advantage of its early break into the online jewelry business, the company’s dramatically dropping net income, desperate experiment with traditional storefronts, weakening business model, departing leadership and insider selling strongly suggest NILE is losing market share.

NILE shouldn’t just be selling big, shiny rocks. It should be part of the touch and feel experience integral to each love story. But the company will only find it increasingly difficult to romance the customer through a cold computer or smartphone screen.

So, all these issues combined will ultimately leave NILE shareholders waiting at the altar with their hands full of cheap, lackluster shares – and no sparkly diamond ring.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in NILE and stand to profit on any future declines in the stock price. 

Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to  scolberg@thestreetsweeper.org.

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