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THG - “Ecommerce in a box for global brands” - shares £1 below last year’s rejected bid

February 2023

Investing in shares may lose you all or some of your money. Past performance is no indication of future performance. Some of the shares recommended here may be small company shares, which can be relatively illiquid and hard to trade and this makes such shares more risky than other investments.

There are signs of reviving interest in European online retail shares, which sucked the whole of last year (eg. Bank of America this month turned from arch bear to telling investors to buy the entire challenged group including Asos, Boo, Zalando and THG). In the case of deeply out-of-favour THG, its shares have plummeted to 63p from a 2021 peak above 700p, buffeted by a dismal procession of profit warnings.  

Over the past 17 years, THG has developed a proprietary driven technology platform, branded Ingenuity. Originally created to provide an in- house technology platform for its existing Nutrition and Beauty ecommerce businesses, since 2018 THG has been monetising this platform with an array of large, global partners such as Matalan, Pentland Group and Homebase.

BofA’s positive view of prospects for all the pure online retailers is supported by the fact that share prices have stopped falling; even when companies report below consensus results, they have gone up as the market starts to look forward. At the same time, major costs that contributed to sizeable downgrades during the past 18 months are now becoming tailwinds and with EBITDA down from £161m to £100m for the year just ended, you don’t need to be a rocket scientist to expect bounceback to the prior year’s £151m.


THG margins strengthening

In particular, it is freight rates and whey costs reverting to normality that provide relief and anchor a stronger EBITDA / cashflow in 2023. It is within this context that THG reiterates a mid-term target for 9%+ EBITDA margin, versus the expected 3.1-4.1% it saw in H2 and the 3% in H1. It has expectations for being broadly free cash flow neutral in FY2023, and significantly free cash flow positive in FY 2024.

THG was established by current chief executive Matthew Moulding (and one other in 2004 who now heads Ingenuity), when it launched as an online retailer of entertainment products, establishing its cloud and hosting infrastructure at the time. Moulding quickly realised that beauty products offered better prospects than entertainment because not only did these enjoy higher gross margins but they also had a “high average selling price per gram transported” as well as ultra low rates of return (contrast the sub 1% returns at THG relative to return rates of c40% typically for clothing).

THG quickly identified Lookfantastic as the best way to enter the beauty segment and bought it in 2010. A year later it extended into Sports Nutrition, with the acquisition of Myprotein adding a second category with the same characteristics to those displayed by beauty.

At that point THG threw in the towel on entertainment products to focus on its two new core verticals. From that base there has been a ‘land and expand’ with other acquisitions (including Mio Skincare, ESPA, Illamasqua and Christophe Robin, Cult Beauty and many more), shifting the beauty division from its original haircare focus to a better-balanced skincare, cosmetics and haircare business. Similarly, it made acquisitions on the Nutrition side including Brighter Foods, a wellness and breakfast food brand. As each business came into the fold it was moved onto the ecommerce platform.

Moulding then began to invest in its ecommerce platforms and completed acquisitions there also (UK2, Hangar 7, Language Connect, Acheson & Acheson) adding more hosting, a  content producer and an online and offline translation company to create a fully integrated technology platform. This enabled the global roll out of its Nutrition and Beauty consumer brands and all it needed was the support of local distribution infrastructure, so in time honoured fashion, it then added 18 warehousing and fulfilment sites including in the US, Singapore, China, Dubai and the UK. Gradually more and more features were added and the core ecommerce solution has had new features including digital marketing and influencer marketing platform plugin, payment gateway plugin supporting 50 local and global payment methods, an ECRM plugin and a fraud gateway.

In 2018, Moulding realised that there was an opportunity to commercialise what had been built by offering Ingenuity to third party brands allowing them to develop their online DTC channels in an as frictionless way as possible and similarly enabling them to expand operations globally and rely on THG’s infrastructure.

The offering has clearly resonated with customers that have not yet fully established digital marketing programmes or those who previously had no strategies for selling directly to consumers (D2C) and the Ingenuity platform has been validated by many client wins. A couple of notable ones were Matalan and Pentland with the latter deal covering nine brands including Berghaus, Speedo, and ellesse. Others clients include Homebase and L’Occitane.


Ingenuity- ecommerce in a box

As I am learning, Ingenuity is a tech stack that basically offers clients a cheaper, better and faster-to-market solution than in-house development. Ingenuity is a full suite of solutions spanning core ecommerce capability, marketing, content, hosting, security, payment providers, couriers, customer services and warehousing/distribution.

As a one-stop solution it reduces the cost and complexity for external customers compared to building these capabilities internally from scratch and then getting them to all work together. Ingenuity prices its platform as a combination of a recurring revenue for the platform and a (low single digit) “take-rate” based on the services that are taken and the gross merchandise volume (GMV) flowing through the platform. Each customer becomes a virtual permanent addition and delivers a high margin and recurring revenue source for Ingenuity. As well as software to customers it also offers digital marketing and brand building services as part of its end-to-end Ingenuity offering.


Owned ecommerce businesses

THG's best calling card in supporting the commercialisation of Ingenuity is not just its customer sites but its ability to develop two strong direct-to-consumer (D2C) businesses of its own. THG's expansion in Sports Nutrition (incorporating Myprotein, Myvitamins, Myvegan), a market worth US$20bn+, has been particularly impressive, with MyProtein growing into the world's leading whey protein online business (and an outright dominant participant in a number of countries).

Unlike in Nutrition, where THG fully operates a proprietary brand model, in Beauty the group distributes both owned and third-party brands. Third party brands include Lancôme, Estee Lauder, MAC, Clinique and YSL whereas its owned brands include Lookfantastic (multinational high-end beauty retail), Glossybox (beauty box subscriptions), MANKIND (male-focused products), HQhair (hair) and SkincareRX, Perricone (specialist skincare).  

 In the year to end December, Ingenuity processed £2.2bn of GMV, which included £1.86bn from THG-owned brands such as Lookfantastic and Myprotein and £208m from Ingenuity (the remaining £200m came from businesses now being reviewed for exit).  Not only will the exit of those businesses eliminate £20-£30m of losses but the bits that then remain are set for a seismic margin rebuild; Jefferies notes that “a c.40% drop in input costs from April 2022 peaks implies at least 25% lower raw material costs in 2023, a £25m/£30m help. In addition, air freight rates have started reducing considerably.”


Softbank interest validated tech stack

Jefferies forecasts EBITDA of c.£100m for the year just ended on a continuing basis, lifting to £145m this year. With few constraints in the operational gearing it can deliver, the broker sets out three scenarios of how quick margins might recover. The base case sets an 85p share price target and the optimistic case sets a 175p target. To my mind the real excitement isn’t about crunching short run numbers but a bigger picture feeling that this one’s days of independence are limited.

Just two years ago, Moulding said he planned to divest Ingenuity into a separate business and at the time also unveiled a new relationship with SoftBank as part of a total US$1.05bn raise at 596p (SoftBank took US$730m and also an option to buy a 19.9% stake of Ingenuity for US$1.6bn). The bottom line was that SoftBank’s option valued Ingenuity at US$4.5bn. Softbank eventually closed its hedge fund (selling its stake to Moulding and Qatar Investments, with the Softbank rainmaker also taking a job offer in the Middle East - Editor). With the whole group now valued at a fraction of the price and Moulding telling shareholders of “multiple approaches” including rejecting one at 170p last year, I am a buyer.


* The writer has a holding

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