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Blue Nile Needs to Up-Sell

Posted on Friday, Dec 14th 2007

Back in May I rated Blue Nile (NILE), the leading online retailer of diamonds and fine jewelry, very well in terms of Web 3.0. Blue Nile takes the approach of providing in-depth educational content and vertical search tools that aim to make consumers feel in control of the jewelry shopping process. Many males will admit privately not knowing the first thing about how to judge a diamond much less an emerald. And many have been burned in their youth buying a brownstone (a cheap quality diamond and called brown due to lack of clarity) and finding out after the fact.

Blue Nile announced Q3 earnings on November 6, 2007. Net sales increased, earnings per share increased, operating income increased and guidance was raised. Management reported Q3 net sales increased 26.5% to $67.4 million versus $53.2 million in 2006 Q3. In addition, operating income rose 67.3% to $3.6 million versus $2.2 million YoY. Q3 net income totaled $3 million, or $0.18 per diluted share versus $1.8 million, or $0.11 per diluted share, in the prior year. As a result net income per diluted share increased 63.6% YoY. And, SG&A expenses decreased, as a percentage of net sales (14.5% for Q3 versus 15.5% in 2006). Significant growth was pegged in international sales (Canada & UK), which totaled $4.5 million, an increase of 104.5% YoY. Blue Nile’s overseas venture to the UK seems to have paid handsomely. However, critics note the growth figures are a bit fudged. Starting from nothing or minimal numbers makes anything look like 100% growth or so the argument goes.

Blue Nile’s Q4 2007 guidance put net sales between $109 and $115 million. The annual 2007 guidance pegged net sales between $316 – $322 million. Based on this information, Blue Nile’s share price is currently floating above $73 with a market cap of almost $1.2 billion and 16 million shares outstanding. Is the stock overvalued for its performance? Maybe, but that view is speculative at best.

The real question of value is the company direction. Clearly Blue Nile’s current approach has been profitable and growing. My key question remains why is the company stuck in the engagement ring business? With a brand as strong as what it has created, the broader diamond jewelry business should be within reach. People buy engagement rings once in their life (may be twice), but they buy jewelry at least another 5-50 other times.

I just see a clear and compelling up-sell strategy that leverages Blue Nile’s brand and customer base, and that concerns me. I have suggested that Amazon buys the company, and if they do, I bet, they will figure out a much more compelling up-sell strategy using Community and Personalization, Web 3.0 tools that NILE is not using well at the moment.

Blue Nile is a company that I really like. If they figured out the up-sell issue, I would have given them a BUY rating.

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