Blue Nile Inc (NILE) Combines the Best of, Inc. (AMZN), Tiffany & Co. (TIF), Inc. (NASDAQ:AMZN) and Tiffany & Co. (NYSE:TIF) are two of the most respected names in retail. Although their respective approaches to business are vastly different, both have achieved enormous success.

Blue Nile Inc (NASDAQ:NILE) is an under-the-radar jewelry and diamond retailer that takes Tiffany’s business model and mashes it with the efficiencies of Amazon’s online model. This has enabled it to grow profitably over the last decade. In addition, the market currently offers Blue Nile at a bargain price if it can continue to leverage its efficiencies to beat out the competition.

Great model Inc. (AMZN)The hallmark of Blue Nile Inc (NASDAQ:NILE)’s strategy is its ability to collect cash from customers before it pays its suppliers. Blue Nile achieves this by holding only a small amount of inventory, requiring quick payment from customers, and negotiating longer payment cycles with suppliers. As a result, Blue Nile actually earns money every time it purchases new inventory.

This is far different from Tiffany’s model. Tiffany orders inventory from its suppliers, ships the inventory to a distribution facility, ships the inventory from the distribution facility to its stores, the jewelry sits in the stores waiting for a customer to buy it, then Tiffany has to wait for the customer to pay cash after purchasing it (for customers who buy on credit). In all, it takes about 1.3 yearsfor Tiffany to collect cash from a sale after inventory has been purchased!

Meanwhile, Blue Nile Inc (NASDAQ:NILE) collects cash so quickly that its customers pay 80 days before the company has to pay its suppliers. This is even better than, Inc. (NASDAQ:AMZN), which has a cash conversion cycle of negative 36 days.

In addition, Blue Nile’s online business model allows it to grow with much less investment than it takes Tiffany to grow. Whereas Tiffany expands by purchasing high-end real estate to build brick-and-mortar stores, Blue Nile’s Amazon-like online strategy allows it to grow with hardly any additional capital. This leads to much higher returns on capital.

Cheap based on past free cash flow

Over the last ten years, Blue Nile Inc (NASDAQ:NILE) averaged a 10.43% free cash flow margin. If you apply the long-term average margin to current sales of $400 million, you get ‘normal’ free cash flow of about $42 million.

$42 million in free cash flow is nearly a 10% yield on the stock’s current market capitalization. In other words, if the company were to return $42 million in free cash flow to shareholders each year, investors who buy today would earn a 10% annual return on investment. This is a really good deal in today’s market — if the company can keep it up.

Potential problems

However,, Inc. (NASDAQ:AMZN) — the king of retail — also competes in the jewelry and diamonds market. In fact, it has a much larger selection of products than Blue Nile Inc (NASDAQ:NILE) at both the high end of the market and the low end.

This is partly due to Amazon’s valuable platform via which numerous third-party sellers distribute their products. This arrangement allows Amazon to earn significant fee income from third-party sales without having to hold inventory. About 40% of Amazon’s unit volume comes from third-party sellers, so it gets a significant advantage that Blue Nile can never match.

In addition, Blue Nile’s high returns on capital will surely attract more attention from competitors. Although it would be difficult for new entrants to make a dent in Blue Nile’s profitability, established players like Tiffany and, Inc. (NASDAQ:AMZN) may wield their significant buying power to completely disrupt Blue Nile’s business.

Bottom line

Blue Nile Inc (NASDAQ:NILE) trades at such a low price because investors believe there is a significant change that the company will be overcome by competition from Amazon, as well as traditional retailers like Tiffany as they grow larger online presences.

Investors who correctly determine whether Blue Nile’s competitors’ efforts will succeed will make a lot of money one way or the other.

Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends and Blue Nile. The Motley Fool owns shares of