GigaCloud Technology: Why I’m Shorting the Storm (NASDAQ:GCT)

investment thesis

GigaCloud technology (NASDAQ:GCT) is a battlefield stock. In the same way, because many stocks become battlegrounds at some point, this battleground business is unduly sold.

Here I want to address the first 3 arguments being made against GigaCloud. More specifically, I address the issue that it is a fraud, insider selling, and that the business has no moat.

Here’s why I’m super bullish on GCT and continue to believe the stock’s price target is $60 per share through the summer of 2025.

Quick recap

GigaCloud technology is a stock I’m very bullish on. And even though I strongly believe in its prospects, the stock has continued to sell off since my recent article. And as it sold, the comments kept coming.

Here I put the first 3 recurring comments.

1) The company is a fraud

When people say the company is a fraud, they are often simply saying that the stock price has dropped a lot since they bought it. But fear builds on itself, and people keep selling at first, then capitulating. And that’s how markets have worked since the dawn of time.

Plus, it didn’t help that this is mostly a Chinese company. And if that wasn’t enough, the CFO suddenly left. What a perfect storm. Oh, and did I mention the GCT auditor is Chinese? Yes, a perfect short film, or so it seems.

The new CFO, who spent nearly a decade at PwC, didn’t help matters, at least from a market perspective, as the stock continued to sell off.

Here I reject the claims that GCT is a three-fact fraud.

1. SA and their team literally went to GigaCloud’s main warehouse. And he took the picture.
2. GCT spent about $88 million buying Noble House and Wondersign in 2023. If GCT hasn’t figured out how to forge cash to buy these two businesses, these purchases are proof that GCT is in a strong position to buy business After all, there are legal aspects to making sure a business has the means to support its acquisition.
3. GigaCloud has no debt on its balance sheet. It’s difficult to run a business that “doesn’t make money” without taking on debt. Common sense, indeed.

2) Insider selling

Insider selling of GCT has been intense. This consideration cannot be denied.

But context matters.

There were two main people who sold the GigaCloud Technology. This is CEO Larry Wu and Frank Lin.

Let us shed more light on this matter. Frank Lin is a principal at GCT and general partner of DCM, a technology venture capital firm. Venture capital firms are not the type of investors who stay with a company for the company’s long-term prospects.

Venture capital firms invest in many early-stage companies, knowing that not all will succeed. They make informed decisions by researching companies with strong growth potential. As these companies grow and grow in value, venture capital firms sell their shares. This strategy allows them to make money even if some investments don’t work.

If you go to the DCM website, you can see other investments that DCM has made.

For example, Matterport (MTTR). And you can go on Matterport’s proxy statement and you can see that DCM is indeed a key shareholder of Matterport.

Going forward, even after all the sales, DCM still owns about 4 million shares, or about 10% of GCT. That’s about $80 million worth of stock after selling off all these months and after the stock hit a recent low on Friday.

To repeat, look at the DCM website, you can see many other familiar names, for example, Hims & Hers (HIMS) and other names with a large increase. DCM invests in high growth and unproven businesses. That’s their setup.

Also, keep in mind that Frank Lin has been at GCT longer than most people have invested in companies. Not to mention GCT.

As you can see above, Frank Lin has been with GCT since 2006. Can you imagine how much his firm benefited from GCT when it was selling at $30 per share? GigaCloud was most likely DCM’s biggest home run. And if DCM didn’t sell or diversify its portfolio, why would it charge anything to its LPs?

This is not their business model. I hope this clears things up a bit.

Similar arguments could be made about CEO Larry Wu. I don’t know how many companies you follow on a regular basis, but come on, there aren’t many companies that I know where The CEO doesn’t even make $300,000 a year in compensation.

I know of 3 abnormal CEOs, but they are just people like Warren Buffett, who is among the richest people in the world and is more of a statement than anything else.

If Larry Wu does not sell any shares in his company, then he is not rewarded. Is that what shareholders want? A CEO who is not properly motivated?

3) The business has no moat

This last point I don’t have much to counter. This is true. GCT is a mail order house. It is an online marketplace designed for companies dealing with large, non-standard and bulky products. There are countless similar companies around the world doing just that.

That’s like saying Amazon ( AMZN ) is a retailer and therefore has no value. Although, to be clear, people have been making these kinds of arguments about Amazon for years. And yet, I’m not saying GCT is the next Amazon. But simply to note that growing a profitable business is difficult.

Here’s how GCT’s free cash flow profile has played out over the past 3 quarters:

• Q4 2023: $47 million
• Q1 2024: $20 million
• Q2 2024: $18 million

The market didn’t like that Q4 saw free cash flow so strong and that the following quarters saw GigaCloud’s free cash flow decline. This clearly demonstrates how cyclical the business is.

And to further reiterate that claim, this is what the GigaCloud 10-K states:

We believe that sales of home furnishings and other large package items are subject to modest seasonality. We expect the last quarter of the year to be the most active.

Retail business is cyclical. Just like Amazon. And yet the business is clearly very profitable.

While most US companies pursue growth, with profitability as an afterthought, the main question in my mind is how much free cash flow will GCT earn in 2024?

For my part, I expect to see at least $90 million to $100 million in free cash flow this year.

In the first half of 2024, GCT earned $67 million, which is impressive considering it’s not their peak period. If we project that Q3 2024 will earn 15% more than the $43 million it earned last year, it would be around $50 million. For Q4 2024, if it grows even 15%, it would be around $54 million. That adds up to about $142 million for the year.

Now, to leave myself a large margin of safety, we can assume that GCT could earn less than this estimate. So we might expect free cash flow in 2024 to be around $90 million and $100 million.

That puts the debt-free business, with about 25% of its market capitalization made up of cash and marketable securities, at a price of about 8x pure free cash flow.

All told, I think paying close to 20 times next year’s free cash flow will be a more reasonable multiple for GCT, or around $2.5 billion, or $60 per share.

Now, as we look around, that’s a big discount to most other established retail businesses.

You’d expect GCT to trade at a deep discount to other companies like Costco ( COST ). But when you consider GCT’s extraordinary growth rates, with Q3 2024 expected revenue growth rates of around 60%, I find it quite surprising how cheap its stock is.

Investment risks to consider

GigaCloud operates in the competitive e-commerce sector and will continue to face challenges as it tries to make its way into the market.

With numerous established players dominating the landscape, GigaCloud may struggle to differentiate itself and maintain its very strong growth. After all, some of its biggest customers, such as Walmart ( WMT ) , Amazon and Wayfair ( W ) , have plenty of alternatives to choose from, leaving GigaCloud Technology without much pricing power.

I would counter that claim by saying that its active buyers have clearly increased over the past twelve months.

• Q1 2023: 13%
• Q2 2023: 7%
• Q3 2023: 10%
• Q4 2023: 21%
• Q1 2024: 29%
• Q2 2024: 67%.

And yet, its buyers will always chase the cheapest price and have limited loyalty to any e-commerce platform.

conclusion

In short, my confidence in GigaCloud’s potential comes from three key points.

First, despite allegations of fraud, the company has demonstrated its legitimacy through substantial acquisitions and a debt-free balance sheet, which are not characteristics of a fraudulent business.

Second, insider selling, especially by venture capital investors, is not a sign of weakness, but a typical strategy for such firms to make profits and diversify their portfolios.

Finally, while GigaCloud lacks a traditional moat, its strong cash flow and growing number of active buyers point to a solid and growing business. Given these factors, I strongly believe that GigaCloud is undervalued, justifying a price target of $60 per share through the summer of 2025.