Mattress seller eve Sleep (LON: EVE) is a great example of how overhyped companies can gain a fancy valuation, but the share price will slump when they get nowhere near to meeting expectations.

A Channel 4 programme brought eve Sleep to the attention of the consumer and investing public. That may have prompted an earlier flotation than might have happened, although it is difficult to know. This was certainly an immature business.

High hopes, low results

In 2016, prior to flotation, revenues were £12m and losses were nearly as high. Yet, when the company joined AIM in May 2017 it was valued at £139.7m at 101p a share. The placing raised £34.9m, which is well above the current market capitalisation at 7.55p a share, even though further cash has been raised.

The latest interim revenues and loss are both lower. eve Sleep has switched broker from Peel Hunt to finnCap so there are no updated forecasts. finnCap refers to consensus EBITDA of -£8.7m and believes that revenues will be below the £35.3m expected. That revenues number is not much different to the 2018 figure, although the loss is lower.

Of course, those are current expectations. In its initiation research in June 2017, Peel Hunt forecast 2019 revenues of £113.7m and pre-tax profit of £1.5m (EBITDA of £2.7m).  To achieve those revenues eve Sleep would have needed to gain a market share in excess of 10% and/or significantly grow revenues in Europe. Even one year ago, revenues were expected to be £56m in 2019.

Marketing

Like Purplebricks, eve Sleep needed to spend millions of pounds to achieve growth. In fairness to Purplebricks, it may have cost more money than expected but it has achieved UK revenues reasonably near to those it forecast at the time of flotation.

That is certainly not the case for eve Sleep. Attempts to move into too many markets did not help.

In the 2018 figures, the company said that marketing efficiency had improved from 61.5% to 56.8%. In other words, every £100 generated cost £56.80 in marketing costs. That is before any manufacturing and distribution costs, let alone other overheads.

The core markets marketing efficiency was 54.3%, so even removing markets where it did badly, the marketing cost was still more than one-half of the revenue generated.

No wonder people are well aware of the brand, but that is no good if it does not make any money.

Strategy

Management is broadening the range of products under the eve brand. They are also trying to improve the e-commerce website in order to make it easier and more straightforward for consumers.

There is talk of growing revenues in a “sustainable way”. Undoubtedly, retail trading conditions are not ideal, but stopping inefficient marketing spending will help.                              

There is still £12.5m left in the bank, but that will not last long without further sharp reductions in the loss. It means that the company can hang on for a while. Woodford Investment Management still owns 31.2% of the company and that could hamper investor sentiment.  

It seems inevitable that more cash will be required, even with more realistic growth expectations. There may be short-term trading opportunities in the shares, but the risks outweigh any medium-term attractions.