Chinese company Ruhnn Holding Limited (NASDAQ:RUHN) went public last Wednesday, and has struggled mightily over the last week. It first lowered its expected IPO total from $200 million to $125 million. After debuting at a share price of $11.50, Ruhn's has fallen in value over the last several days, closing Monday's trading at just $7.05.
Some investors may look at Ruhn's struggles and believe that there is an opportunity to buy low. But Chinese IPOs into the United States have a mixed record at best, and there are multiple reasons to be skeptical of Ruhn's long-term finances and its market's potential.
The Future of KOL
Ruhn's entire business is based around a concept called key opinion leaders (KOL) or influencers. In its SEC report, Ruhnn defines KOLs as "individuals who have the power to engage and impact people within a specific community or field" such as corporate training, fashion, or medicine. While KOLs can include professors or experts who never go online, Ruhnn clearly means KOLs as social media superstars who can influence others through social media to purchase certain goods with their expertise and credibility.
Social media KOLs exist in the Western world, as popular YouTube stars will often review products or advertise events. But marketing firm MavSocial points out that KOL marketing is more influential in China for a variety of cultural reasons such as less trust in brands and a greater acceptance with being sold to on social media.
Ruhnn steps into this KOL market by essentially functioning as a talent agency. In the company's own words, Ruhnn created a KOL ecosystem in China "by connecting a large number of KOLs and their fans to create a vast network and connecting this network to a large number of businesses." On one end, Ruhnn can find young, promising KOLs, coach them to become more successful, and then link them up with businesses interested in using KOLs to advertise their products.
But there are multiple problems with this approach. First, there are concerns about the viability of KOL over the long term. Ruhnn claims that the total market size of internet KOL e-commerce and advertising and marketing services is "expected to increase from RMB80.8 billion in 2017 to RMB462.6 billion in 2022," a nearly six-fold increase.
However, it is easy to imagine a scenario where Chinese netizens get inundated with KOLs being paid to hawk various goods and end up turned off with the concept altogether. The South China Morning Post warns that businesses interested in KOLs should seek out local Chinese voices who can tell a genuine and passionate story.
And even if the KOL market continues to grow, Ruhnn remains highly dependent on a few influential KOLs. Ruhnn states that it had 113 KOLs in its network as of December 31, 2018. But Ruhnn also admits that just one KOL, a fashion model named Zhang Dayi, has accounted for over half of its revenue going back to 2017. As it will take time for other KOLs to reach the popularity of Zhang and other top-tier KOLs, Ruhnn states that "our top-tier KOLs will continue to contribute to the majority of our total net revenues in the near future."
KOL's Problematic Finances
In addition to concerns about the long-term viability of the KOL market and Ruhn's ability to take advantage of said market, this company's finances have some major problems.
Most rising tech-based IPOs can at least point to high revenue growth, but Ruhnn cannot. Ruhnn's total net revenue did rise from RMB547 million in its 2017 fiscal year to RMB947 million ($137 million) in its 2018 fiscal year, an increase of over 63%. But keep in mind that its fiscal year ends on March 31, which means that we are really looking at growth from 2016 to 2017. And from the first nine months of 2017 compared to the first nine months of 2018, Ruhn's total revenue grew by just 14%.
A key thing to note is that much of this growth comes from Ruhn's much smaller services sector, which had a revenue of RMB100.3 million ($14 million) in the first three quarters of 2018. In this sector, Ruhnn aims to help businesses and KOLs as opposed to its product sales sector where it takes a cut from the sale of KOL-backed online stores. The services sector is relatively more profitable when cost of revenue is factored in, but it will be years before it makes up a significant portion of Ruhn's business.
The rest of Ruhn's financial numbers are problematic. Ruhnn reported a net loss of RMB57 million ($8.3 million) in the first three quarters of 2018, up from RMB12.5 million in the same time period in 2017. Furthermore, Ruhnn has just $22 million in cash and $100 million in total assets against $123 million in total liabilities. Even if the KOL market grows despite the aforementioned concerns, there is little in Ruhn's financial record to indicate that it will be able to jumpstart its high revenue growth of 2016 anytime soon.
Ruhnn may be able to benefit if the KOL market does continue to grow, and it could benefit if tensions lower between the United States and China. But given the failure of past Chinese IPOs in the United States, Ruhnn had to show investors something amazing to be worth it and instead has a massive slew of problems.
Investors should look elsewhere and not view Ruhn's struggles as an opportunity to buy low. And while Chinese IPOs are always tempting, investors should rarely give them the benefit of the doubt.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.