By Aryan Mehra (University of Western Ontario), Charlie Solnik (California Polytechnic State University), Chirag Gupta (NYU Stern)
This report was initially written on September 9th, 2020.
Overview of the Deal
The week of August 24th, British e-commerce company, The Hut Group (THG), announced its plans to sell $1.2 billion worth of new shares in an IPO that could possibly be the biggest UK IPO this year. With only seven companies having issued an IPO this year, THG is attempting to take full advantage of the UK's languishing stock market. The company aimed for September 16 to launch its offering and was successful in doing so. This IPO is not a regular IPO by any means as it includes some special features such as a founder’s share and will be a fixed price offering.
Found in 2004, the beauty and luxury retailer has grown to become one of the few Unicorns in London through continued strategic acquisitions of e-commerce companies. Private investors such as Blackrock and Merian Global Investors have been enjoying the company's accelerated growth, and this IPO will be sure to attract strong demand as everyone else looks to get a piece of the company.
Despite bright prospects, the IPO is prone to fundamental risks as the UK economy has been taking a beating, GDP is down 22.1% in the first half of 2020 owing to the uncertainty surrounding Brexit. While investors do have extra cash, those looking to invest in British equities may get caught up in a value trap if Brexit negotiations go south. Even with high valuations at the moment, UK companies' earning growth potential may dissipate post-Brexit. While this IPO is poised to be London’s biggest this year, it will still face its fair share of challenges leading up to and post IPO.
Macroeconomic Trends
The UK economy has been one of the hardest-hit global economies in the world with its GDP shrinking by 22.1% in the first half of 2020, the most of any G7 economy. Additionally, the UK is engaged in negotiations with the European Union regarding the terms of Brexit which can lead to high currency fluctuations in the future. If a deal does not go through with Brexit, we may see the pound fall to as low as $1.14 as it did back in March 2020. However, the more likely scenario is that the pound will trend upwards once a deal is agreed upon. The value of the pound is very important in regards to foreign investment. A lower pound would mean it's cheaper for investors outside of the UK to purchase UK stocks and bonds - which would not only boost the country’s reeling economy, but also be great for companies such as The Hut Group. The Hut Group primarily sells products within the beauty space, products which are not essential in the midst of a global pandemic. Lower disposable income and a hurting economy pose potential risks to investors of The Hut Group. In the short-term, sales may take a hit. However, this can be offset through the company’s other major source of revenue which is selling its proprietary e-commerce software.
Companies have searched for alternative ways to navigate all of the uncertainty and volatility that has been haunting most financial markets since early March. Companies have turned to Special Purpose Acquisition Companies (SPAC’s), Direct Listings, and Traditional IPO’s to raise capital and keep costs low, such as investment banking advisory fees. The COVID-19 pandemic slowed many companies’ plans to go public. Direct Listings no longer seem viable as the current economic climate has made it difficult for companies to find large institutional investors, and companies are now unfreezing their plans to go public and turning to IPO’s.
More specifically, the UK has seen significantly decreased IPO activity with approximately two times as many companies going public by this time last year. This decline in primary market offerings can again be attributed to the COVID-19 pandemic. In attempts to stimulate their economies, many countries around the world are lowering interest rates. Low-interest rate environments have historically led to the delay of IPOs, and history seems to be repeating itself with the recent lack of IPOs in the UK.
Company Overview
The Hut Group is a British e-commerce company that was founded in 2004. The company operates over 100 websites and sells everything from Healthcare to Beauty products. THG has strategically acquired Zavvi, IdealShape and GLOSSYBOX and expanded globally. Even though THG is based in the UK, most of the company’s revenue comes from customers outside the UK. Along with acquiring companies, THG sells its proprietary e-commerce technology to other customers such as Nestle.
IPO Details
The Hut Group is looking to sell £920 million ($1.2 billion) worth of new shares. Existing Private shareholders will be reducing their stake in the company by an undisclosed amount, leading to a minimum free float of 20% before any new capital is raised. Matt Moulding, the Chief Executive Officer of the company, stated that he doesn't plan to sell any of his shares in the IPO, retaining a 25.1% stake in the company. This is a positive sign that leadership sees strong long-term prospects for the company well after the IPO. The most interesting part about this IPO is it will include a founder’s share (AKA a golden share) for Matt Moulding. This founder’s share will give him the power to veto any hostile takeover attempt for the next three years. THG has seen a lot of interest from outside buyers, but the founder is not looking for a quick payday; instead, he is looking to turn the company into a major player in the e-commerce market.
The founder’s share does come with a catch. This feature prevents the company from being eligible to have a premium listing on the London Stock Exchange. In turn, THG cannot be included in key UK indexes. When a company is included in an index fund, managers and other investors that follow the index are forced to buy companies in that index. Since THG will not be eligible to be in an index, such as the FTSE 100, THG will miss out on a lucrative opportunity. This may not be a dealbreaker, but could hurt demand. Additionally, the shares will be sold at a fixed price – meaning investors will know the price of the offering before its issued. This is important because fixed-price listings tend to be undervalued to their market value which garners strong demand for the IPO.
Figure 1: The Hut Group Post IPO Stock Price Chart (Google Finance)
THG started trading on September 16 at a price of 500p/share, and quickly soared to a price of 658.3p, a gain of over 30% from its IPO price. As expected, this surge showed investors were waiting to get a stake in the company. However, on Friday September 18, two days after THG went public, the share price started to steady off at about the 580p to 590p range. Trading volume has also started to soften as initial excitement starts to relax. The big question with The Hut Group is whether investors perceive the company as a consumer retail company leveraging technology, or as a technology company servicing the retail sector. It will be interesting to see whether or not the initial valuation was correct as of the surge in price points to money that was left on the table for THG.
Projections and Assumptions
Why was this deal done?
The Hut Group’s decision to go public stems primarily from its business model’s recent success in the current economic climate. Due to COVID-19, many customers are now turning to online shopping as a means of getting products they would normally purchase from brick-and-mortar retailers. According to the Office for National Statistics (ONS), online penetration in the UK has soared to almost 32% by the end of June from less than 19% a year earlier. The Hut Group, being one of the largest digital players in their market, is well equipped to meet the needs of its customers, whereas many other its other competitors lack the online infrastructure to serve their customers. Thanks to their newfound success, it makes sense that The Hut Group would try to take advantage of its strong value proposition and the lack of competing offers in the IPO market right now. It won’t have to compete for investor’s attention considering how few IPOs are in the pipeline.
The Hut Group has yet to provide specifics on how they intend to spend the funds raised through the IPO, but much of its rapid expansion over the last 15 years has been driven by an aggressive artificial growth strategy of acquisitions that shows no signs of stopping. In fact, The Hut Group has said it has already identified a “pipeline of attractive acquisition opportunities” which could very well indicate their intentions for the funds.
Short Term Analysis
With only seven companies having issued new equity offerings this year in the UK, The Hut Group’s IPO will be hotly anticipated. The COVID-19 pandemic has helped boost THG’s sales, with revenue growing to £676 million, translating into top-line growth of 36% in the first half of 2020. Even with the concern that THG will miss out on benefits due to ineligibility to be in a UK index, having a fixed price and coming into this IPO with strong sales figures should mitigate concerns potential investors have. Management has indicated they are targeting overall revenue growth of 20-25% in the medium term which is very plausible as this estimate follows previous years’ sales growth.
With disposable income of consumers low due to current economic conditions, THG’s beauty, luxury and other non-essential items will be a hard sell to most consumers, meaning sales could fall in the short-term. With all the volatility in the financial markets and more to follow post-Brexit, The Hut Group’s shares will most likely follow this volatility. Many analysts and investors are worried about a potential second wave of COVID-19 infections, leading to more prolonged lockdowns which in turn could hurt THG as most of its products are non-essentials. However, even with these concerns in mind, The Hut Group has a very strong technological component to its business in the form of its e-commerce software. And with traditional retail having a hard time surviving current conditions, THG may be able to fill a very crucial need for many retail businesses. If the company can leverage its partnerships and continue to attract new ones, then it should be able to navigate these turbulent times well.
At the end of 2019, THG completed a capital raising of over £1 billion. £600 million of that was a term loan B which received £150 million of excess demand after three weeks of marketing. This demand carried over into the company’s equity offering as investors looked to take part in the company’s accelerated growth and strong growth prospects. Overall, in the short-term, it should be no surprise that this IPO will garner demand and led to a large share price increase on day one of trading.
Figure 2: The Hut Group Revenue (Annual Report)
Long Term Analysis
THG has partnered with companies such as Nestle Health Science and Burt’s Bees and is poised to acquire more companies in the Global Beauty and Care space. THG's primary goal is to continue to expand internationally. Expect THG to use the proceeds from this new IPO to acquire and develop additional retail e-commerce companies to expand its growing portfolio.
The COVID-19 pandemic has sent shockwaves to the retail industry, sending retailers such as JC Penny into bankruptcy. Foreseeably, companies must look to emphasize e-commerce rather than brick and mortar stores. THG is in a favourable position to capitalize on this due to their proprietary e-commerce technology which many companies are sure to turn to. The UK has not produced many Unicorns, but THG valuing itself at almost $6 billion is here for the long haul. The high investor confidence in THG is warranted. In the long-run, investors are sure to get value as the company continues to grow and will look to return value through dividends or share buybacks.
The Hut Group has a very scalable business model with its retail software. As mentioned before, how the company does will depend on if it positions itself as more of a technology-oriented company rather than as a traditional retailer. The surge in the share price on day one of trading showed investors see promising things from the company, but the big question is whether THG will be able to sustain this. E-commerce retailers such as Amazon have been syphoning off revenue from brick and mortar retailers and THG looks poised to do the same. Another interesting development is that THG is working on rebranding Language Connect, its in-house translation agency into THG Fluently. A big part of the company’s IPO marketing was an emphasis on international expansion.
Financial Ratio Analysis
Table 1: Financial Ratios of The Hut Group (Capital IQ)
Last few years have seen declining Return on Assets and Return on Capital, signifying less efficient use of its resources. This could be attributable to the large increase in assets in the past few years. Additionally, LTM performance has rebounded thanks to e-commerce trends
Gross profit and SG&A Margins have seen a consistent growth of about 10 percentage points each. This shows that the increasing SG&A costs are being used effectively to generate sales as gross profit is moving in line with SG&A
Debt to Equity saw a rapid rise beginning three years ago, but since has returned to more healthy levels. This debt was most likely used to fund acquisitions, and a return to healthier debt/equity levels implies successful acquisitions
Risks and Uncertainties
The largest threat to The Hut Group is the threat that other e-commerce giants pose to their business. The Hut Group offers its proprietary e-commerce platform to numerous retailers. However, the possibility for a company like Amazon to step in and undercut The Hut Group could seriously affect their business. It appears The Hut Group has realized this imminent threat and has responded accordingly by concentrating their efforts more heavily on acquisitions and diversifying their subsidiaries. With brand acquisitions, the company is able to profit either way, regardless of whether or not the products are listed on their in-house e-commerce platform. With other acquisitions, The Hut Group is able to diversify its business and ensure that they will be able to generate revenue no matter the market conditions or competition. Just in the last three years, the company has acquired over five new brands, three spas, an online translation company, a web hosting firm, and a retail video and photographic company.
While THG has seen large revenue growth recently, it is unsure whether or not these new highs are sustainable. As of right now, the majority of THG’s 35.8% YoY revenue growth from the previous year comes from their Beauty and Nutrition segments. Seeing as revenue growth is primarily fueled by THG’s retail offerings and not their technology and licensing model, their future performance will likely be more impacted by trends in the retail space. This could mean a reining in of their growth as e-commerce trends potentially regress with a return to in-person shopping post-COVID. THG is currently priced with high growth expectations, with its multiples being more comparable to a technology company rather than a retail company. Thus, a potential return to a pre-COVID retail status quo could have significant adverse impacts as far as shareholder value goes.