GigaCloud Technology: Why I'm Fading the Storm of Shorts (NASDAQ:GCT)

Investment thesis

GigaCloud Technology (NASDAQ:GCT) is a disputed stock. Similarly, as many stocks become battlegrounds at some point, this disputed business is being sold unjustifiably.

Here I want To address the three main arguments that bears are making against GigaCloud. More specifically, I address the issue of it being a fraud, insider selling, and the company having no moat.

This is why I am super bullish on GCT and still believe the target price for this stock is $60 per share by summer 2025.

Quick summary

GigaCloud Technology is a stock that I find very positive and while I strongly believe in its prospects, the stock has continued to fall since my recent article and in line with that fall, the comments have continued to appear.

Here I leave the 3 most recurrent comments.

1) The company is a fraud

When people say that a company is a fraud, they often simply mean that the stock price has dropped a lot since they bought it. But fear builds up and people keep selling first and then capitulating. And that's how markets have worked since the beginning of time.

It didn't help that it's mostly a Chinese company. And to top it off, the CFO suddenly left. What a perfect storm! Oh, and did I mention that the GCT auditor is Chinese? Yeah, a perfect bet, or so it seems.

The new CFO, who spent nearly a decade at PwC, hasn't helped matters, at least from a market perspective, as the stock has continued to fall.

Here I refute the claims that GCT is a fraud with three facts.

1. SA and his team literally went to GigaCloud's main warehouse and took the photo.
2. GCT spent approximately $88 million on the purchase of Noble House and Wondersign in 2023. Unless GCT has figured out how to fake cash to buy these two companies, these acquisitions are proof that GCT is in a strong position to buy companies. After all, there are legal aspects to making sure a company has the means to back up its acquisition.
3. GigaCloud has no debt on its balance sheet. It's hard to run a business that “doesn't make money” without taking on debt. It's just a matter of common sense, really.

2) Insider trading

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

But context matters.

Two prominent individuals have sold their shares in GigaCloud Technology: CEO Larry Wu and Frank Lin.

Let's shed some more light on this issue. Frank Lin is a director at GCT and a general partner at DCM, a venture capital firm in the technology sector. Venture capital firms are not the kind of investors who stick with a company for its long-term prospects.

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

If you continue DCM On this website you can see other investments that DCM has made.

For example, Matterport (MTTR). And you can go to the Statement of Power Matterport and verify that DCM is in fact a key shareholder of Matterport.

Moving forward, even after all the selling, DCM still owns about 4 million shares or roughly 10% of GCT. That amounts to about $80 million worth of stock after selling all these months and after the stock hit a recent low on Friday.

To repeat, look at DCM's website, you will see many other well-known names, for example Hims & Hers (HIMS) and other high growth names. DCM invests in high growth and unproven companies. That's their setup.

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

As you can see above, Frank Lin has been with GCT since 2006. Can you imagine how much profit your company made on GCT when it was selling at $30 per share? GigaCloud was probably DCM's biggest success. And if DCM didn't sell and diversified its portfolio, why would they charge their LPs anything?

That's not their business model. I hope this clarifies things a bit.

Similar arguments could be made about CEO Larry Wu. I don't know how many companies you regularly follow, but believe me, I don't know many companies where the The CEO doesn't even make $300,000 a year in compensation.

I know three atypical CEOs, but they are people like Warren Buffett, who are among the richest people in the world, and it's more of a statement than anything else.

If Larry Wu does not sell any shares of his company, then he will not receive any reward. Is that what shareholders want? A CEO who doesn't receive adequate incentives?

3) The business has no moat

I don't have much to object to on this last point. It's true. GCT is a mail order company. It's an online marketplace designed for companies that deal with large, non-standard and bulky products. There are countless similar companies around the world that deal with precisely that.

It's like saying that Amazon (AMZN) is a retailer and therefore has no value. Although, to be clear, people have made these kinds of arguments about Amazon for many years. And yet, I'm not saying that GCT is the next Amazon. I simply want to point out that it's hard to grow a profitable business.

This is how GCT's free cash flow profile has progressed over the last 3 quarters:

• Q4 2023: $47 million
• First quarter of 2024: $20 million
• Second quarter of 2024: $18 million

The market was not pleased that the fourth quarter free cash flow was so strong and that in the following quarters GigaCloud's free cash flow declined. This clearly demonstrates how cyclical the business is.

And to further echo this statement, here's what GigaCloud's 10-K says:

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

Retail is cyclical, just like Amazon, and yet it is clearly a very profitable business.

While most US-based companies are looking for growth, with profitability as an afterthought, the main question on my mind is how much free cash flow will GCT generate in 2024?

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

In the first half of 2024, GCT earned $67 million, which is impressive considering it is not its peak period. If we project that in the third quarter of 2024 it will earn 15% more than the $43 million it earned last year, that would be about $50 million. For the fourth quarter of 2024, if it also grows by 15%, that would be about $54 million. That adds up to approximately $142 million for the year.

Now, to give myself a wide margin of safety, we can assume that GCT could earn less than this estimate. Therefore, it is possible to expect its free cash flow in 2024 to be around $90-100 million.

This puts the business debt-free, with approximately 25% of its market capitalization made up of cash and marketable securities, priced at approximately 8 times clean free cash flow.

Overall, I think paying closer to 20 times next year's free cash flow would be a more reasonable multiple for GCT, or around $2.5 billion or $60 per share.

Now, if we look around, this is a huge discount compared to most other established retail businesses.

You would expect GCT to trade at a deep discount to other companies, such as Costco (COST). But considering GCT’s tremendous growth rates, with revenue growth expected to be around 60% in Q3 2024, I am surprised at 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 attempts to gain a foothold in the market.

With numerous established players dominating the landscape, GigaCloud may struggle to differentiate itself and maintain its strong growth. After all, some of its largest 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 this claim by stating that their active buyers have clearly increased over the past twelve months.

• First quarter of 2023: 13%
• Second quarter of 2023: 7%
• Third quarter of 2023: 10%
• Fourth quarter of 2023: 21%
• First quarter of 2024: 29%
• Second quarter of 2024: 67%.

And yet, your buyers will always look for the cheapest price and have limited loyalty to any one e-commerce platform.

The final result

In summary, my confidence in GigaCloud’s potential stems from three key points.

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

Secondly, insider trading, particularly by private equity investors, is not a sign of weakness, but a typical strategy of such companies to make profits and diversify their portfolios.

Finally, while GigaCloud lacks a traditional competitive advantage, its strong cash flow and growing number of active buyers indicate that it is a solid and growing business. Given these factors, I strongly believe that GigaCloud is undervalued, justifying a $60 per share price target for summer 2025.