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Why I’m bearish on this FTSE 250 company (which started as a bet!)

In 1999 John Roberts was bet a pound by a friend in the pub that he couldn’t start up a company. In 2014 Roberts made £86 million when he sold part of his holding in AO World (LSE: AO) to list on the London stock exchange, and you could perhaps agree with him that ‘all the best businesses start in pubs’! However, since the company listed, the share price has dropped by over two thirds and has never made a profit as a public company…

Misplaced loyalty

AO World sells a variety of appliances online, although white goods are what’s best associated with the brand. The problem with white goods is that they don’t need to be replaced very often. The best online businesses like Ocado, ASOS and Boohoo (LSE: BOO)all rely on repeat business, but if you only sell goods that need to be replaced every 5-10 years then I’m not sure customer loyalty is quite so important.

AO has been running a high growth strategy where the company deliberately operates at a loss to gain market share. This is a viable strategy that is used by Amazon and Netflix among others in the online space to ‘land grab’ before raising prices to generate enormous profits. This works for businesses that strongly benefit from customer loyalty but I’m not sure this applies to the products that AO is selling. At the moment AO is simply selling its products for less than they are worth, so it makes sense that revenue and sales are growing. As the investing adage goes, ‘revenue is vanity, profit is sanity’.

Betting on Europe

The company has used fundraising to expand into Germany and the Netherlands where it has applied the same strategy to grow revenues by running at losses. But until the company is able to demonstrate it can generate profits off these revenues, I don’t think they add up to much. With some companies starting to be hit by Brexit uncertainty, I think this could add to the difficulties they are having in Europe.

John Roberts stepped down as CEO in 2017, but two years later he is back in the hot seat after his replacement stepped down from the role. After 20 years as a company, AO is still raising new capital to fund losses and there is only one way that I’d bet this company will go. It looks like The Times may have had the last laugh when they commented at the time of the company listing “on no account should any readers buy shares in this business”.

A better option?

If I was looking to buy a fast growing online business I’d prefer to buy Boohoo. It may have a high valuation but it has proved that its expansion is funded by profits rather than shareholders capital. The price has been volatile recently as shareholders have grown concerned about the management prioritising its own investments ahead of shareholders’ interests, but I still think the growth justifies the premium price. The company has grown profits (not just revenue) for the past 6 years, and looks good to continue growing!

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Robert Faulkner does not have a position in any company mentioned. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended boohoo group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.