Coty's Overblown IPO Emphasizes DS Healthcare's Value

| About: DS Healthcare (DSKX)

A recent, very large public offering of a well-known, but ill-managed, beauty consumer firm drives home the fact that fast-growing DS Healthcare Group, Inc. (NASDAQ:DSKX) remains brutally undervalued.

Coty, Inc. (NYSE:COTY), a retailer of fragrances and cosmetics like Calvin Klein and NYC New York Color, raised $1 billion in an IPO in June, making it the biggest of any consumer products company to be listed in the U.S. Bulls think long-term investors are drawn to this pure play beauty company's prospects for growth, and management promises renewed efforts in skincare. There are plans for expansion in developing areas of Asia and Latin America, booming markets being recognized by other beauty product makers.

Coty, however, is not known for its industry savvy. It posted $320 million in losses from write-downs on acquisitions last year, and despite being in business since 1904, sales are not breaking records. Revenue for the nine months ended March 31, 2013, was flat vs. the prior period. Yet Coty carries a $6.5 billion market capitalization.

The beauty industry is heating up. Nestle (OTCPK:NSRGY) -- the nutrition, health, and wellness giant -- may be selling its 30% share in L'Oreal SA (OTCPK:LRLCY), owner of Lancome's well-established line of skincare, makeup, and fragrance products. Although top-line growth is about 6% yearly, L'Oreal has a market capitalization of $103 billion, meaning the sale could raise over $30 billion. L'Oreal is a recognized brand, but the majority of its offerings are simply reiterations of earlier, somewhat tired items like RevitaLift and Age Perfect.

Last week, Estee Lauder (NYSE:EL) reported a paltry 7% rise in sales for its most recent quarter, predicting a potentially smaller increase for the next sequential period. The gain was led by its skincare line, mainly Advanced Night Repair, which touts a pseudo-scientific theory that skin restores itself during sleep. Yet Estee's market cap is $26 billion.

While its price remains undervalued, DS Healthcare is progressing nicely in its business model. It's doing so first by growing distribution in the $43 billion Brazilian beauty market, through penetration of pharmacy chains CSB Drogaria and Farmalife that own or operate 85 retail locations. Drogaria alone covers over 90% of pharmaceutical products sold to consumers. More regulatory approvals to add to DS Heathcare's popular hair-loss items in Brazil are expected to lead to even greater sales volume in coming quarters.

Next, clinical studies of their products -- a chief competitive factor for them -- have produced more results. Spectral.DNC-S was used in a double-blind study at Miami Dade Medical Center for thinning hair, where 85% of participants showed more hair density. The compound responsible comes from pine bark -- pycnogenol -- long known to increase blood circulation and strengthen blood vessels necessary for the scalp to keep its elasticity. More than $3.5 billion is spent each year by men in the U.S. trying to combat baldness. Spectral.DNC-S will soon be recognized as better-than-industry standard minoxidil because it's less greasy, causes less irritation, and hair growth is stimulated in areas other than just the crown.

A beauty company's success lives or dies on innovation, where new products are launched to appeal to local consumers. As Coty struggles with sales growth, it was product innovation that accounted for nearly 20% of its annual revenue in the past three years. DS Healthcare, by comparison, has been growing sales quickly due to its scientific approach to skin and hair, backed with clinical claims where new items are launched more often. In addition to the news about Spectral.DNC-S, in May the company launched Revita-LT shampoo for blond and other light-color hair, again using science and clinical results to show effectiveness in less hair loss and more growth.

Now that Coty is public, let's review price-to-sales ratios for the peer group. Coty is at 1.4x, L'Oreal at 3.6x, and Estee at 2.6x. Valeant Pharmaceuticals (NYSE:VRX) bought Obagi Medical Products at a 2.9x multiple in March, and last November Allergan, Inc. (NYSE:AGN) paid a much higher 5x for SkinMedica. That lends support to the belief among investors that the beauty and skincare industry is a good place to put money.

Not one of these beauty leaders had sales gains comparable to DS Healthcare, however. In the first six months of 2013, revenue rose 35%. In addition to the companies mentioned above, the high-end dermatology assets of Medicis Pharmaceuticals were purchased last September for $2.6 billion at 3.6x 2011 revenue. Last year, Sun Pharma Industries bought DUSA Pharmaceuticals' small dermatology line for 5.1x 2011 revenues. Looking at an average price-to-sales multiple of these acquisitions and considering the novelty of DS Healthcare's product lines, I believe DS Healthcare's valuation would fall toward the higher end (5x), resulting in a share price of $4.50.

DS Healthcare is building new and richer distribution channels, has furthered the scientific value of its product offerings, and continues to make sales gains. Investors, however, should take note of the risks involved, particularly in micro-cap stocks, which can be numerous. The companies tend to be new, trading volume may be low (which results in greater price swings), and management may be unseasoned. With regard to DS Healthcare, a specific risk would be how well management handles its rapid growth in an environment of larger competitors.

A look at revenue increases over many past quarters, though, should quell fears. This company has products that work and that people like to use. Testimonials abound, from users going back as far as 2008. I am a user of Revita shampoo and have found nothing like it on the market. I believe that it is only a matter of time before DS Healthcare's valuation comes more in line with what comparable companies are fetching, making it a smart investment now at these prices.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in COTY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional Disclosure: I received product samples from DS Healthcare (shampoo and hair treatment) from the company after I wrote an article featuring them.