Initial public offerings (IPOs) of note have been a relative rarity in the UK this year but The Hut Group, or THG (THG) as it is officially called, brought some glitz to London’s new issues market earlier this month.

City brokers have been all over the float, the UK’s biggest by money raised since Worldpay in 2015, and investors have piled in in their droves. The company, which was launched in 2004 by founder Matthew Moulding and initially scaled up using private equity cash, pitched its IPO at a fixed £4.5 billion market valuation before new money.

However, the success of its pre-market parade around City institutions saw it raise £1.88 billion, £920 million of fresh funding plus another £961 million for existing shareholders, that set the market capitalisation at £5.4 billion.

The 500p IPO starting share price jumped 25% on its debut to close at 625p on day one.

In 2019 THG made £111.3 million of earnings before interest, tax, depreciation and amortisation (EBITDA) on £1.14 billion revenue, 29% and 24% up on 2018 respectively. That’s impressive growth, no doubt, but it does imply pretty eye-watering valuation multiples.

Based on our back of envelope £5.1 billion enterprise value (EV) calculation, it puts the stock on about 4.5-times EV/sales and an EV/EBITDA of more than 46-times.

Whether the business deserves this valuation, and what sort on upside potential remains on the table will probably depend on your point of view about whether THG is a run-of-the-mill online retailer, or a more exciting tech company.

TECH VERSUS RETAIL

THG has two main parts to the business, selling beauty products through Lookfantastic and other websites, and Myprotein in sports nutrition. Both are sold internationally. Between them THG Beauty and THG Nutrition generated 78% of 2019 revenues, so about £890 million of the £1.14 billion.

Tech platform Ingenuity is the third leg (more on this later) while the rest of the business is a long tail of smaller commercial propositions in the beauty and nutrition space (plus some other assets like hotels and a gym).

The company anticipates that both beauty and nutrition growth in the coming few years will outstrip the high single-digit or so compound average growth of their wider industry segments. First half 2020 (to 30 June) revenue growth was 56% and 30% respectively.

Myprotein, for example, has delivered averaged 45% yearly compound growth since it was acquired in 2011, according to analysis by Liberum.

Yet it is neither beauty nor nutrition that has got investors hot under the collar, it is its small but potentially exciting platform THG Ingenuity which gives the company its tech slant.

Ingenuity has been sold as a solution to third parties much in the same way that Ocado’s (OCDO) online groceries platform is sold to global supermarkets.

It is effectively a ready-made online sales platform for businesses and brands eager to go digital. It’s a full service that covers everything from designing your website to taking the payments and delivering your goods. Product manufacturing can even be managed if a client wants it.

It has more than 1,000 brands as clients, including Coca-Cola, Johnson & Johnson, Homebase and Kelloggs.

That makes Ingenuity perhaps more readily comparable to New York-listed Shopify, the giant of the space valued at $111 billion. In the second quarter Shopify grew revenues 71% to $714.3 million and reported adjusted net income of $129.4 million, up from $10.7 million on 2019’s second quarter.

By contrast, Ingenuity is tiny, with £128 million revenue for the whole of 2019, or about 11% of THG’s total. Management forecast revenue growth of 20% to 25% for the group as a whole over the medium term (out to 2024, according to Liberum).

Ingenuity is seen as the capital-light growth lever, forecast to grow at 40% primarily as a result of increasing mix of e-commerce revenues as global brand owners accelerate their adoption of direct to consumer strategies.

WHERE DID THE GROWTH GO?

In that context it is puzzling that the tech platform’s growth evaporated in the first half of 2020. Ingenuity reported £61 million revenues in the first six months of the year, which was basically flat on last year.

Coronavirus slamming the brakes on this part of the business might make some sense as companies pulled the plug on investment and stored cash. However, this would fly in the face of the large bank of evidence that companies have been bending over backwards to speed up digital plans as a way to help adapt to a post-Covid reality.

There are other red flags beyond Ingenuity’s surprising growth arrest. Founder Matthew Moulding will hold the positions of both chief executive and executive chairman, flouting the UK Corporate Governance Code.

The IPO also saw THG property transferred to a company personally owned by Moulding called Kingsmead.

Moulding also retains a founder share that means he can block takeovers and resolutions while retaining voting powers. This is an unusual structure for a listed company and means THG will not be eligible for entry to the FTSE 100 or any other indices.

INCENTIVES QUESTIONED

A final risk is Moulding’s incentive package, where he will be entitled to a £700 million payout if the company’s market value reaches £7.25 billion in two years’ time. Basing executive pay on the firm’s market value is risky as it can encourage management to make value-destructive acquisitions or starve the business of investment to meet targets.

Economic uncertainty remains a concern for investors and there’s worry that tech stocks are in an unsustainable bubble. THG’s valuation will do little to ease those worries. At best we believe that investors should demand more evidence of consistent execution as a public company before considering an investment in the shares.

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