So-Young International IPO: 138% Y/Y Revenue Growth And Apax Is A Shareholder

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About: So-Young International (SY)
by: Bilbao Asset Management
Summary

So-Young International Inc. uses an online platform to provide information about products and services on the Chinese medical aesthetics market.

Frost & Sullivan notes that the aggregate value of transactions in 2018 was $306 million, 33.1% of the total amount paid in the medical aesthetics market in China.

As of December 31, 2018, CFO was equal to $28 million. It is also quite convenient that the CFO increased by 119% in 2018.

The proceeds should be used to invest in R&D, brand promotion, content offering and other purposes.

The company was incorporated in the Cayman Islands, where securities laws are not that developed. In addition, the company is expected to be controlled after the IPO goes live.

In 2018, So-Young International (SY) reported revenue growth of more than 138% y/y. In addition, large money manager Apax holds a large stake in the company. This fact should be sufficient to attract the attention of growth investors. On the top of it, value investors should also appreciate the company as it reported positive and growing CFO and FCF in 2018. With other e-commerce platforms trading at 0.5x-6.5x forward sales, So-Young International should trade at more than 6.5x forward sales as its revenue growth and growth profit margin are larger than that of competitors. Having mentioned these positive facts, investors should also be aware that So-Young International is expected to be a controlled company and is incorporated in the Cayman Islands. As a result, minority shareholders would not be as protected as in the United States.

Source: Prospectus

Source: Prospectus

Business

Based in Beijing, China, So-Young International Inc. uses an online platform to provide information about products and services on the Chinese medical aesthetics market.

The business model is divided into three segments. One component offers professional content and distributes it through social media. In addition, So-Young International offers a social community where users can upload content. Finally, the company also provides online reservation services for medical aesthetic treatment.

So-Young International casts its online platform as the number 1 online destination for assessing, evaluating and reserving medical aesthetic services in China. Some of the figures given in the prospectus are impressive. The company notes that the website receives 240 million average monthly views. In addition, Frost & Sullivan notes that the aggregate value of transactions in 2018 was $306 million, 33.1% of the total value of transactions in the medical aesthetics market in China.

The most important aspect is the way the company obtains revenues. According to the prospectus, in 2018, information service fees was reported to be 67% of the total amount of revenues, and service fees charged to medical aesthetic service providers represented 33% of the total amount of revenues.

Market Opportunity

The market opportunity is large and growing at a fast pace. Frost & Sullivan notes that the medical aesthetic services industry reached $17.7 billion in 2018 and could reach $52.4 billion by 2023. The market size should grow at a CAGR of 24.2% from 2018 to 2023, which is very appealing. Keep in mind that even if the management does not perform, market growth should enhance the company’s revenue growth in the coming years.

Solid Balance Sheet

As of December 31, 2018, with an asset/liability ratio of 4.4x, $175 million in cash and term deposits, the company’s financial situation is very stable. In addition, 90% of the total amount of assets is comprised of cash and short-term investments. So-Young International reports a large amount of liquidity, which should please IPO investors. The image below provides a list of assets:

Source: Prospectus

On the liabilities front, it seems ideal that the company does not report large financial debt. Only $0.135 million due to related parties may be considered as debt. The table below provides further details on the liabilities reported in the IPO materials:

Source: Prospectus

A list of contractual obligations is also shown below. Note that the company reports operation lease obligations of only RMB 267 million or $39.8 million. With $175 million in cash and term deposits, analysts should not fear these obligations. The company has sufficient liquidity to pay them:

Source: Prospectus

Revenue Growth And FCF Generation

As of December 31, 2018, So-Young International reported revenue growth of 138% y/y, which should impress IPO investors. The gross profit margin is also appealing. With revenue of $89 million, So-Young International reports a gross profit of $76.4 million.

With that said, the income from operations is not that large. As of December 31, 2018, the company reported income from operations worth $7.14 million. In 2018, So-Young International spent a total of $44 million in sales and marketing expenses. As of today, the company needs to advertise quite a bit to generate sales. This may change in the future. The image below provides the top of the P&L:

Source: Prospectus

So-Young International Inc. should not only be see interest from growth investors but also please value investors as it is generating positive CFO and FCF. As of December 31, 2018, CFO was equal to $28 million and FCF was equal to approximately the same figure. It is also quite convenient that the CFO increased by 119% in 2018. Additionally, in 2016, the CFO was negative. The image below provides the cash flow statement reported for the IPO:

Source: Prospectus

Use Of Proceeds

The market should appreciate the use of proceeds. The company does not expect to use the money from the IPO to acquire shares from existing shareholders or to pay the debt. As shown in the lines below, the proceeds will be used to invest in R&D, brand promotion, content offering and other purposes:

Source: Prospectus

Stockholders

The list of shareholders reveals that one shareholder owns a significant amount of class B shares, which gives this individual control of the entity.

With that said, there are several well-known private equities owning large stakes. Youthful Acquisition L.P. is controlled by a large fund called Apax, which has raised $51 billion since 1981. In addition, there is Orchid, which reports $4 billion in assets under management. The fact that these institutional investors decided to trust So-Young International Inc. is appealing. The image below provides further details on this matter:

Source: Prospectus

Two Share Classes, Controlled Company And Incorporated In Cayman Islands

There are two features that investors may not appreciate. The company expects to have two types of shares after the IPO goes live, class A and class B shares. Each Class A ordinary share provides one vote, and each Class B ordinary share provides thirty votes and is convertible into one Class A ordinary share at any time by the holders thereof. IPO investors can acquire Class A shares, but not Class B shares. This is not ideal. It means that existing shareholders are trying to protect their ownership. If the management does not perform, hiring a new one could be difficult on this name.

In addition, the company expects to be controlled after the IPO, which is another detrimental feature. Read the lines below for further details on this matter:

“Upon the completion of this offering, our outstanding shares will consist of Class A ordinary shares and Class B ordinary shares, and we will be a “controlled company” as defined under the Nasdaq Stock Market Rules because Mr. Xing Jin, our co-founder, chairman of the board of directors and chief executive officer, will beneficially own all of our then issued Class B ordinary shares.” Source: Prospectus

As a result of the equity structure, the Board of Directors is expected to be controlled, which means that directors may make decisions to benefit the largest shareholder. Such decisions may go against the interests of minority shareholders. As shown in the lines below, So-Young International may elect a non-independent Board of Directors:

“For example, we may rely on the exemption from the corporate governance rule that a majority of our board of directors must be independent directors. As a result, you may not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.” Source: Prospectus

In addition, for investors located in the United States, it is detrimental that the company was incorporated in the Cayman Islands. It means that the company's corporate affairs are being governed by Companies Law of the Cayman Islands, which offers less protection to shareholders than that in the U.S.

Valuation

So-Young International does not mention the name of any competitor in the prospectus. The lines below provide further details on this matter.

Source: Prospectus

Since no Chinese medical aesthetic service platforms are trading in the United States, let’s use Chinese e-commerce platforms and search engines.

As shown in the image below, other Chinese companies trading in the United States have an EV/Forward sales ratio of 0.5x-6.5x. However, these other online competitors report revenue growth of 23% to 30% y/y and a gross profit margin of less than 50%. So-Young International reports both larger revenue growth and gross profit margin. It means that So-Young International should trade at more than 6.5x forward sales. The images below provide further details on the valuation of peers. Note that these companies are very large compared to So-Young International. With that said, using these peers is better than not using peers at all.

Source: Ycharts

As of December 31, 2018, So-Young International reported revenue growth of 138% y/y, which should impress IPO investors. With this figure in mind, assuming forward sales of $178 million seems reasonable. Using a ratio of 6.5x forward sales, the total enterprise value should be equal to more than $1.157 billion.

Conclusion

Reporting revenue growth of 138% y/y and with Apax as a shareholder, So-Young International should attract growth investors. With other e-commerce platforms trading at more than 0.5x-6.5x forward sales, So-Young International should trade at a minimum of 6.5x forward sales. Keep in mind that both the revenue growth and the gross profit margin of the company are larger than that of peers. Having mentioned these great features, investors should also be aware that the company was incorporated in the Cayman Islands, where securities laws are not that developed. In addition, the company is expected to be controlled after the IPO goes live. Investors should understand these detrimental features well before touching the shares of So-Young International.

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.