Blue Nile, Inc. (NILE)

Let's see here ... we've got a company that sells diamonds and fine jewelry online. Sounds like a crazy idea to me, but the site looks well laid out and they seem to be profitable, so I won't question the basic business model. What I don't quite understand is the market's insane valuation of this. This is a luxury retailer operating in the worst environment for luxury retailers since at least the 1970s (and maybe the worst since the Great Depression). I'm looking at the financials and I don't quite see the phenomenal growth that others are seeing. So what leads people to conclude that this company is worth $40+?

Net tangible assets are worth roughly $1.59 per share, so the Price/NTA ratio is 25. That's very steep, even for a high-growth company! But as far as the growth goes --- where's the beef! Top-line revenues declined 7.5% from FY '07 to FY '08. Sure revenues grew 26.5% from FY '06 to FY '07, but that was back before the economic collapse! For the 1st Quarter of FY '09, revenues declined another 11.5% year-over-year!

Even assuming that they could somehow move back to FY '07 profitability and grow free cash flows at a phenomenal 5% rate annually for the rest of eternity, I still only come up with a valuation of around $21! What kind of absurd level of growth do they need to have in order to reach the $40?!!!!

I can see no other factors that might lead to skewed results in income. For instance, their cost structure is highly variable and their gross margins are only 20%. Given that, they have to increase incremental revenues very significantly in order to raise the bottom line significantly. This isn't like a high-tech firm with high-fixed costs that looks unprofitable, but just a slight bit of incremental revenue could make the bottom line skyrocket. It also appears their SG&A expenses have been increasing over time.

Even if I increase the initial year forecast on my DCF analysis to $2 in FCFs per share (I initially used $1.10 per share which might be an exaggeration itself) and still use my 5% growth rate, I only come up with a valuation of $36.25 per share.

Realistically speaking, this company should probably be valued closer to $18. Not sure where, why, or how Mr. Market came up with the $40 pricepoint so --- I'm redthumbing!