Revolve (NYSE: RVLV) describes itself as an “on-line, on-trend fashion company” but they are really more of a technology-focused marketing and distribution channel in the fashion industry. The founders are not from the fashion world and the current team is much more technology than fashion focused.

The “Influencer” Thing is Real

In the old deciding what style to have and what clothes to buy might spring from friends, movies/TV, fashion magazines or even going to a retail store to try things on and get advice. Of course the new model has to be online, mobile friendly and built with modern e-commerce processing and fulfillment services.

Revolve has done something unique – they have figured out how to leverage influencers to build a large, profitable online fashion apparel business with a mere $15M of outside capital. Indeed the company has been mostly profitable during their past 16 years of operations.

The target market is younger, aspirational females.The strategy is to create a “trusted brand” for the discovery of new styles and apparel. We’ve all groaned at this “influencer” economy and laughed at the insanity of the Fyre debacle. Revolve has done a fair job of monetizing this trend and learning out to turn these trends into sales.

Three things stand out testifying to the value of their approach:

1. 89% of sales are from prior year’s customers.
2. 79% of net sales are at full price.
3. 52% gross margins.

Selling close to 80% of merchandise at full price is an especially enticing data point for anyone in the retail business. Other online fashion retailers like FarFetch ($FTCH), the pending TheRealReal ($REAL), Gilt (Private) and RuLaLa (Private) have models based on selling discounted merchandize.

The fashion industry is staggeringly inefficient and margin-challenged. We’ve already seen some innovative and successful companies like Stitch Fix ($SFIX) find ways to cater to segments of the market using data and new sales models (in the case of Stitch Fix the subscription model) to create a new position. The numbers are getting significant – last quarter Stitch Fix posted net revenue of $370M, net income of $12M and adjusted EBITDA of $19.2M with 3 million active customers.

The Revolve Business

Revolve engages in a few parallel strategies that interact to generate sales:

1. Resolve engages heavily with “influencers” who have followings that are a good fit for the typical Resolve customer. These efforts are part of an overall social media strategy that also includes special in-real-life events that build brand awareness and boost the value of Resolve influencers.
2. They have “parameterized” clothing to a much greater extent than anyone else – instead of a dozen or so they code up to 60. For example instead of a sleeve being “long or short” they track sleeve type and sleeve detail. By doing this for every main attribute they can create many more specific styles based on demand.
3. By cross indexing millions of customer interactions with hundreds of thousands of styles and these parameters Resolve is able to gain unique insight into the specific designs and articles of clothing that customers want now. In the past this was largely a guessing game.
4. Revolve has created their own in-house brands to satisfy clients and enable them to generate better gross margins than if they were just selling 3rd party merchandise. Rather than simply private label they have worked to make these brands desirable and recognizable to their customer base.
5. They’ve built their own infrastructure. Instead of relying on third parties which can undermine the customer experience Resolve has built their own. This gives them greater control to deliver accurate orders and turn around returned merchandise for resale.

What results is a business that is not driven by traditional fashion and apparel processes. Essentially the clothing is an emergent property of the data and approach to creating products from current customer behavior and input from influencers. We tried to capture it with this diagram:

Revolve focuses on “emerging brands” rather than the major ones. This also gives them an easier job of creating their own labels over time which drive better gross margins and more control over product design.

The “Forward” Folly

Despite all their success they have had an albatross in the shape of their “FORWARD” brand which is aimed at the “luxury” category in a similar way that a bevy of other online companies do – FarFetch, RuLaLa, Gilt, and TheRealReal.

They don’t really come clean with this problem but it’s only 12% of sales now. They did take some explicit action to resize inventory in the FORWARD business.

But a quick look at the existing FORWARD site suggests it remains very out of touch with their core market and full of questionable yet expensive products. At least on the other “luxury” sites you’re getting brands like Gucci, Hermes, Versace, Armani, etc. A quick scan of the “featured fashions for men” left me scratching my head.

The question is why don’t they simply get rid of it?

Valuation and Stock Conclusion

Despite FORWARD this company has built a great business. It’s at least as good as Stitch Fix and maybe better. They do appear to be putting a greater emphasis on really applying data science to fashion design and not just pay it lip service.

The results have been excellent and the high returns on invested capital are rare in apparel business, especially outside of the big brands.

Our PFV suggests the shares should trade near $30 in the after-market. The valuation might be high for a “clothing company” but it’s low for a technology marketing company.

We will see what the market decides.