Investors captivated by Adore’s Beauty

Institutional and retail investors have been flocking to the initial public offering (IPO) of Adore Beauty, undeterred by its frothy valuation of 96 times forward earnings and almost four times revenue.

Adore, a pure-play online cosmetics retailer, is embarking on an IPO which would value it at $635.3 million – the largest the ASX has seen this year.

The IPO, which is seeking to raise $269.5 million at $6.75 per share, has been heavily oversubscribed from both institutional and retail investors – a sign that the recent aura surrounding e-commerce stocks remains strong.

Co-founder Kate Morris believes structural changes in e-commerce brought about by COVID has sparked a change in how investors are valuing companies like Adore.

“It’s a big part of why the market is perhaps thinking about the valuations of e-commerce companies differently, because COVID has accelerated that online penetration to such an extent and there’s still so much headroom for growth in Australia,” she says.

Morris also dismisses concerns about Adore’s three major shareholders, including herself, each selling a major portion of their holdings into the IPO, describing it as “a necessary evil”.

“This is my baby and I see this as a really key step in setting up Adore to continue to grow and succeed for another 20 years and beyond that too, but to be able to do that and to make the IPO successful we had to have enough free float,” Morris said.

“We had to sell down to free up enough for all the demand that we had, but both Quadrant and ourselves will be retaining a majority of our shareholding and staying involved with the business, so we’re very much committed to the next chapter.”

Private equity firm Quadrant Growth Fund, which bought a 60 per cent stake in Adore last year, is expecting a health payday as it sells 40 per cent of its stake for a return of $137.2 million.

Morris and her co-founder, James Height, will also be reducing their respective stakes by 40 per cent, bringing them a payday of $45.9 million each.

Upon completion of the IPO, Quadrant will hold a 32.5 per cent in Adore while Morris and Height will hold 10.8 per cent respectively.

The fruits of 20 years’ labour

The co-founders’ substantial payday through Adore’s IPO is the result of 20 years of work which began when Morris noticed a sense of discomfort as women approached her on the cosmetics counter at her university job. 

It seemed a “no-brainer” that women wanted a more private online shopping experience for beauty products, with access to more information and a better range of products. But like most 21-year-olds working part-time, getting the financial backing to bring her idea to life was the issue.

Armed with a $12,000 loan from her boyfriend’s parents and working from her garage in Melbourne, Morris laid the foundations for Adore Beauty with James Height.

Fast forward to today and Adore has climbed to the pinnacle of Australia’s online beauty and personal care market.

Its IPO comes as consumers have swarmed to Adore’s website during COVID lockdowns, with the company now boasting over 590,000 active customers, equating to a 278 per cent rise over the past four years.

“What we saw in lockdown was a lot of people turning to online shopping for the first time and we saw a large influx in new customers at that time, but also, a big increase in buying behaviour from our returning customers as well,” Morris said.

“Everybody was looking for things that were comforting at a time when it felt like the world was going a little bit crazy, things such as skin care treatments, things that you could do at home, skin masks and exfoliators, home treatments, a lot of do-it-yourself hair dye and nail care.”

This was reflected in Adore’s financial results, with revenue rising 65.5 per cent to $121.1 million in the 2020 financial year while earnings before interest, tax, depreciation and amortisation (EBITDA) skyrocketed 205 per cent to $5 million, according to its prospectus.

Importantly for investors, Morris insisted that the COVID-inflicted rush to online beauty products wasn’t an anomaly but rather, a sustained, structural shift.

“The thing that we have also seen, which gives us a lot of confidence that this is really much more of a structural shift towards e-commerce, is the continued behaviour of customers who are in the states where they’re not really locked down,” she said.

“Obviously we’re still seeing a big spike in Victoria because the shops aren’t open, but even in states like WA and Queensland we’re finding that the customers that we acquired during lockdown are continuing to purchase from us.”

Indeed, Adore is expecting to continue on its growth trajectory for the rest of the 2020 calendar year, with its prospectus saying that revenue is forecast to grow 76 per cent to $158.2 million, EBITDA to double to $6.4 million and gross profits to jump 84 per cent to $50.8 million.

Justifying the hype

Adore’s soaring valuation means it must not only sustain its success throughout COVID but have further growth in order to live up to the hype.

Morris explained that the biggest opportunity Adore sees is growth in its existing business which operates in Australia and New Zealand, pointing to analysis undertaken by market research firm Frost & Sullivan.

The data illustrates that in 2019, the addressable market of beauty and personal care products (both online and offline) in Australia was $10.9 billion, with online penetration representing just 7.3 per cent of that.

Before COVID, online penetration was forecast to reach 19.3 per cent in 2024, but now, Frost & Sullivan is anticipating it will reach 24.9 per cent.

This means that the size of Australia’s online beauty and personal care market, which was $797 million in the 2019 calendar year, is expected to grow at a 26 per cent compound annual growth rate in the next four years, reaching a market size of around $3.2 billion in 2024.

According to Morris, this highlights the continued adoption of e-commerce in the beauty and care market which is only going to increase as Australia closes the gap on other countries who are more advanced in the area. 

“If you compare us to the US and the UK, who have always been a few years ahead of Australia in terms of their online penetration and then you have markets like China and Korea where online penetration in this category is at 40 per cent, we think there’s certainly a lot of headroom available in the market that we’re already in,” she said.

As to whether Adore is overvalued, Morris looks to similar ASX-listed e-commerce stocks to justify the hype.

“Where our business is priced is actually at a material discount to Temple & Webster, which is probably the closest comparable in terms of existing e-commerce businesses on the ASX,” she said.

The online furniture and homeware retailer is a handy reference point given its share price has skyrocketed nearly 400 per cent this year and is currently trading at nearly seven times sales.

When asked about whether Adore could replicate the share market performance of Temple & Webster and other e-commerce sharemarket darlings, Morris was unsurprisingly optimistic.

“I don’t see why not, I think the market has realised that e-commerce is a thing and there’s a shortage of really high-quality businesses in this space and particularly on the ASX,” she said.

“Everybody is realising now that if you think about retail businesses, all of the growth that’s projected is not going to come from bricks and mortar, it’s going to come from e-commerce.”

Growth strategy

Morris said growth would come from a mixture of better understand existing customers and acquiring new ones.

This focus is already underway and is reflected in Adore’s marketing and advertising costs which are forecast to more than double from $9.3 million last calendar year to $19.6 million this year.

A lot of this money is being allocated towards analysing existing customers, and with retention rates already at 61 per cent, Morris says the stickiness of Adore’s customer base translates into more frequent purchases and spending higher amounts each time they shop.

“As the years go on and we get a better understanding of that returning customer behaviour, it allows us to be a lot more strategic about the decisions we make in investing in acquiring new customers because we know how much they’re going to be worth to us in later years,” she said.

This is being done through Adore launching its mobile app later this year, enhancing loyalty and rewards programs, and using data to personalise the shopping experience.

Adore has been able to ramp up marketing costs given its ability to simultaneously increase gross margins, which rose from 30 per cent in the 2019 financial year to 31.8 per cent in the 2020 financial year.

Morris said that Adore has future plans for private label brands which will also benefit gross margins over time while the prospect of expanding into new markets is also on the cards.

The closing date of Adore’s retail offer is October 21 and it will commence trading on the ASX on October 27.