Nobody has done a better job at making “meal kits” an actual category in the grocery business. Blue Apron generated an astonishing $795M in revenue last year. That was up from $340M in 2015 and just $78M in 2014. They had to give away lots of meals to get there and they were still losing money in 2016 ($55M) but they could have easily been profitable last year if they wanted to be.

So what’s the rub? Future growth will be harder to come by. Blue Apron knows it which is why they have been adding categories like wine and kitchen wares to their offering. Besides old-fashioned churn it seems that remaining customers tend to spend less over time. Adding to these challenging dynamics is increasing competition - not so much from other meal kit companies like Sun Basket and HelloFresh but the big players. Think Stop & Shop/Peapod, Amazon Fresh and imagine a combination of Whole Foods and GrubHub offering a menu of meal kits that can be delivered the same day.

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Order trends from customers

Unlike direct competitors, these larger players already have the infrastructure and supply chain which means they only need to add some packaging to create and sustain their own meal kit product lines. If Amazon introduced their own offering and promoted it the Blue Apron business would take a direct hit.

These are not mutually exclusive businesses. There will always be lots of niche businesses in an $800B (US) grocery market. But not many large and profitable ones.

So who is going to buy Blue Apron?

My favorite idea is another “cooking experience company, Williams-Sonoma (WSM). The reasons for a WSM deal are:

1. Brand resonance - Both WSM and APRN are targeting the “cooking experience” rather than just food.
2. Converging businesses - WSM has added food items and even a wine club to their kitchen wares and retail operations while APRN has added kitchen wares and wine to their service.
3. Growth & recurring revenues - APRN is growing rapidly and is large enough to “move the needle” on the entire WSM business. It also has the advantage of bringing recurring customer revenues to the WSM model.
4. Survival for APRN - Blue Apron has done a great job of building this new market. However growth beyond their “core customer” will be difficult. And ultimately the large grocers will use their existing infrastructure and operating efficiency to move in and take it when it is large enough.

The big question is valuation. The company did confirm a $2B valuation last year so investors are likely to be looking for something higher in the IPO or in an acquisition. This might be tough to swing for Williams-Sonoma with their $4B market cap.

Blue Apron has some debt too. A substantial portion of the IPO proceeds will be used to pay it down. As of March 31, 2017 the company had $311M in liabilities and $194M in convertible preferred stock on the balance sheet.

Other options include the massive and now very voracious (when it comes to commerce) Walmart. The direct consumer relationships Blue Apron are certainly valuable but beyond that it becomes more questionable for a large player given that they have substantial resources and logistics.

IPO Positioning

The company is positioning themselves as a provider of “cooking experiences” which is apt. Many pundits have mistakenly labeled them a “lazy” consumer product like GrubHub (GRUB). Having used the service for a year I can say that it is certainly not a low effort product. Blue Apron does save you time shopping but their meals still demand full and careful preparation.

Revenues for 2016 more than doubled to $795M. Losses also increased from $47M in 2015 to $55M in 2016. A major question for investors in a business like this is gross margin. APRN has improved gross margin from 23% in 2015 to 33% for 2016. In Q1 2017 GM was 31%.

Blue Apron cites delivery of 159 million meals and 25 million “paid orders.” In Q1 they delivered 4.3 million orders to 1.036 million customers in the US. It’s no secret that Blue Apron has to give away quite a few free meals to entice customers onto the platform but it’s a normal (if expensive) cost of growing the business.

The big question for Blue Apron is the churn rate and what customers spend over the long term. We expect the company is working hard on coming up with numbers that show things in the best possible light. However, from what we have seen so far the trends are troubling. According to some casual analysis at The Information customers at Blue Apron tend to spend less over time. One analyst suggests a “decay curve” of 50% every six months. Another snapshot analysis says that newish customers spend $68/month and older customers (>36 months) spend only $26/month.

Even if customers do “decay” it can still be a good business but the rates, margins, and acquisition costs are critical. Our concern is that Blue Apron may find additional progress on efficiency and margins difficult. The “low hanging fruit” has been picked and competition is intensifying.

The Market

The grocery is gigantic ($800B in the US alone) and slow growing - about the same as GDP. Online grocery has become a real trend. After many false starts the online grocery segment is growing fast and seeing new offerings like Amazon Pantry and Amazon Fresh.

Blue Apron defines their market as “online grocery” and sees the current market size as about $10B with expected growth of 8.5% per year. The category is pretty broadly defined and includes “fresh and packaged foods, hot, soft and alcoholic drinks” sourced from “retailers, variety stores, warehouse clubs, mass merchandisers and internet retailers.”

But Blue Apron supplies “meals in a box” that is a subset of this overall market. Since they have added other product categories like wines and kitchen utensils their market opportunity is some combination of food plus wine plus kitchen accessories.

On the positive side, the meal kit business is booming. All of the companies are spending lots of venture money but they are growing their customer counts and revenues rapidly. Besides Blue Apron other private firms like Sun Basket are doing very well. Sun Basket focuses on delivering more specialized meals that can be gluten-free, paleo or vegetarian. Like Blue Apron they have to give away free meals to get new customers.

There are about a dozen funded “meal kit delivery” startups — some of the more well known include Sun Basket, HelloFresh, Plated, and Chef'd — and there are scores of much smaller regional players that are more like clubs than real businesses.

How might Blue Apron succeed on their own?

It will come down to execution and growing their niche. As the category leader in the business, they could copy and add successful categories like “quick one-pan meals” or ones specialized for vegan, paleo or gluten-free diets. The company has made major investments in marketing and infrastructure that should be leveraged with more products.

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Major investments beg for more product

Blue Apron could also address special situations like “birthday cake in a box,” or “impress a date in a box” or “dinner party for six in a box” that could be fairly high margin. These are also great opportunities to bundle extra items like pans, candles, kitchen wares, wine, table settings with the food.

More innovation in terms of additional products like wine and kitchen wares would help. So far they are undistinguished and lack imagination. If they can differentiate their add-on offerings more they could be more compelling and aid in customer acquisition.

Blue Apron does have fairly high gross margins relative to other meal kit companies and they could be profitable if they wanted to do. This will help them versus their direct competitors.

Longer term the end-game is unclear. Will Blue Apron establish physical stores? Will they vertically integrate into food production or even farms? Will they be an “Amazon of the kitchen” like Wayfair (W) is trying to be the “Amazon of furniture.” If so how will they compete with Amazon Pantry and Amazon Fresh in five years?

Maybe Blue Apron will retreat and focus on their own brand of products and let others handle the last mile and logistics?

If they want to do it all they will be wanting (needing) some help soon.