It’s been a dramatic few weeks for THG (LSE: THG), also known as The Hut Group. The share price has slid dramatically, losing almost three quarters of the price at which it floated earlier this year (at the time of writing this article yesterday).
This type of situation can sometimes present a buying opportunity. Below I consider whether the collapse in the THG share price makes this an attractive time to add it to my portfolio.
THG and its problems
There have been several drivers for the falling THG share price. Things basically started with City concerns about the group’s corporate governance structure. The company moved to reassure investors and made some changes, but it seemed the remedy was worse than the illness in some ways. An investor relations presentation perceived as tone deaf was badly received, further hurting sentiment about the shares. On top of that, it was announced this week that the company’s largest institutional shareholder, Blackrock, has cut its position by half.
That might sound like boardroom stuff, detached from the fundamentals of business performance. But in fact one of the core points of contention goes to the heart of valuing THG. For many UK customers, The Hut Group and its brands such as Glossybox and Skinstore are the most familiar parts of THG. But as well as running its own direct to consumer brand sales, the company operates a platform known as Ingenuity. Ingenuity enables both The Hut Group and third parties to market, warehouse, and ship products directly to consumers.
From a bullish perspective, THG looks a lot like a smaller Amazon. Not only does it have a substantial operation of its own, its platform could allow it to bring in revenues from third-party customers. That’s exactly how the American e-commerce giant has developed key revenue streams such as Amazon Web Services. But from a bearish perspective — which is the one taken by some City analysts at the moment — THG looks like a black box. The proprietary e-commerce business is brutally competitive, and the potential appeal of the Ingenuity platform is hard to quantify.
Separating the issues
I think there’s something to be said for both points of view. The past couple of months have shown that THG is struggling to behave in a way that befits a publicly listed company. That’s disappointing but not surprising – it was built privately over many years before listing this year. I expect the company’s corporate governance and investor relations to fall more into line with City norms in coming months and years. I don’t think THG or its board will have a choice, as investor dissatisfaction has clearly been running high.
But away from how the company is run, what of its business prospects? Here I am more optimistic. If Ingenuity really does scale up to be a popular third-party e-commerce platform, its potential is enormous. The success of THG’s own brands suggests that it has the know how and market understanding to make Ingenuity work.
Strong performance
One of the company’s shareholders is Japanese investment firm Softbank. THG is currently rolling out Ingenuity for some of Softbank’s brands. While critics have pointed at a lack of progress in a mooted partnership with Nestle, in the first half new clients for Ingenuity included Coca-Cola Europacific Partners, Mondelez International, and Swedish Match. While those clients on their own may not be transformative, I think their custom shows that Ingenuity has real appeal to sophisticated global customers.
The group’s revenue grew 42% in its first half compared to the equivalent period last year. The beauty division revenue growth was 56%, which is extremely strong. But the Ingenuity division also grew strongly. Its £86m revenue in the six months represented growth of 40%.
The company is still loss-making. In its first half, the reported loss was £17m. But strong revenue growth could help it build scale. Over time it could use that to improve its profitability, just like Amazon has done.
Valuing the THG share price
The THG flotation in the spring already seems like a distant memory. The THG share price has tanked since then. Frankly I don’t think that is a great advertisement for the London market, given that this was one of the most prominent UK tech listings in recent memory.
However, could that tumble present a buying opportunity for my portfolio?
As I reckon THG should largely resolve its corporate governance challenges over time, in valuing the company I am looking primarily at its financial potential. Given that it is currently loss-making, it is impossible to value the firm based on earnings. Instead I need to look at what I see as its potential.
I like THG’s revenue growth potential. It has proven its business model and the current growth rates are excellent. For the full year, the company expects revenue growth of 38%-41% excluding exchange rate impacts. I think that sort of growth could continue for some years to come, and may even grow, as the company increasingly has the benefits of scale.
The Ingenuity opportunity
I also think the Ingenuity platform could turn out to be a real game changer for THG. Looking at companies such as Clipper Logistics, one sees the investor appeal of e-commerce solutions providers right now. But whereas Clipper focusses mostly on the back end side of e-commerce, THG’s Ingenuity offering allows it to offer customers help both creating demand on the front end and fulfilling it on the back end.
Nonetheless, there’s still a valuation conundrum here. I expect revenue to grow strongly, and I think that could translate into future profits. But for now it’s hard to foresee profitability in the next several years. So the investment case for THG right now rests largely on buying into its business model and its ability to execute.
My next move on the THG share price
I do see real potential in THG although I think there are also risks. Competitors could develop platforms that threaten profit margins for Ingenuity. The company’s cash burn could lead to shareholders being diluted. Management time spent dealing with the fallout of investor discontent could distract executives from running the business, hurting sales.
But the main reason I’m not buying THG right now is because I don’t see a clear path to profitability. Like Amazon in its early days, as the company grows, its capital needs may also grow. That could hurt the chance of revenues being turned into profits any time soon. So, despite the THG share price tempting me, I won’t be buying it for my portfolio at the moment.
