Global D2C Brand IPOs Have Been Failures, Can Mamaearth IPO Prove to Be Different?

Ever since Honasa Consumer filed a draft prospectus for an initial public offering (IPO), there have been rumours about the company intending to launch the IPO at high valuations.

Reports suggest that the company might launch its IPO at a valuation of $3 billion, which is higher than the last round it raised at $1.2 billion a year ago.

The sharp jump in valuation attracted investor attention, but not in the way the company would have liked.

Where Do The Valuations Stand Compared To Global Peers?

Let’s get the primary investor concern out of the way. The company has faced criticism from investors, media, and popular social media handles, over the valuations, especially after the dismal performance of other newly listed start-ups.

The company’s founders have publicly stated that the company hasn’t yet decided on a valuation. Mamaearth might be late to the IPO party, making it the subject of greater investor scrutiny.

Its global direct-to-consumer (DTC) peers like Warby Parker, Casper, Allbirds and others made use of the euphoric markets of 2021 to launch their successful IPOs. However, these companies have seen a steep drop in their valuations. Allbirds’ stock is down 90 per cent, while Warby Parker is down 70 per cent, and Casper Sleep got acquired at nearly half of its IPO valuations.

At the current level, Warby Parker trades at a multiple of three times compared to its 2021 revenues. Allbirds trades at a multiple of just one time its 2021 revenues. The Honest Company, which is perhaps the most comparable peer since it operates in a similar space as Mamaearth, has seen its stock decline by 84 per cent. Its current market cap stands at just 0.86 times sales.

Mamaearth’s rumoured valuation of Rs 22,000 crore and Rs 943 crore in FY22 sales, takes the price to sales ratio to 23 times sales which are significantly high. Even Mamaearth’s last valuation at $1.2 billion, appears to be frothy when compared to its global peers.

Nevertheless, India is seen as a high-growth market and Honasa’s founders have proved that they can grow the business rapidly.

Why Does Mamaearth Have High Marketing Costs?

Unlike other new-age companies, Mamaearth has a good bottom line and has managed to generate positive cash flow from operations over the last two financial years (FY).

Like all start-ups, Mamaearth has shown spectacular growth from Rs 22 lakh in its first year (2016) to Rs 934 crore in FY22. Between FY20 and FY22, the company reported a revenue compounded annual growth rate (CAGR) of 193 per cent.

While these numbers are staggering when compared to traditional Fast Moving Consumer Goods (FMCG) companies, they must be seen in light of the expenses made to earn these revenues.

Among all of its costs, the advertising expenses stand out in Mamaearth’s income statement. Advertising expenses constituted anywhere between 37 to 41 per cent of Mamaearth’s total revenues. This means that Mamaearth generates approximately Rs 2.5 for every rupee spent on marketing.

This is in sharp contrast to FSN Ecommerce (Nykaa) which generates Rs 12 per rupee in advertising costs or Hindustan Unilever, which generates Rs 11 per rupee in advertising costs.

One might believe that these costs might go lower with time as the brand gets established, and reach similar levels as those of established players.

However, when one compares Mamaearth’s numbers with global DTC companies, it appears that these numbers might continue at these levels. Even Mamaearth’s prospectus hints that advertising costs would increase, and nearly half of the reported Rs 400 crore, that it plans to raise from public investors, would be put into advertising.

Global peers in the DTC space have said that advertising would continue in the range of 40-45 per cent of revenues. If Mamaearth’s comments in the prospectus are any indication, it appears that it would continue its marketing spend at similar levels.

Clearly, the cost of acquiring a customer on the DTC side is quite costly — a fact the company admits. “Due to lower customer acquisition costs, sale of BPC products through offline channels tends to be more profitable as compared to online channels,” it said in the prospectus.

The company also highlighted that the offline channels improve brand profitability, hence mature products are moved through offline distribution channels as well.

Not A Pure D2C Brand Anymore

While D2C might be a buzzword, major D2C brands across the globe are moving to traditional retailing channels as they realise that higher profitability lies in the offline channel. And not only is offline distribution driving profitability, but growth as well.

For Honasa, between FY20 and FY22, online sales grew at a CAGR of 157 per cent while offline sales grew at a CAGR of 424 per cent. Today, offline channels contribute to 35 per cent of sales compared to just 9 per cent in FY20. The shift, while beneficial for the company, would mean that Honasa might not remain a dominantly D2C company.

As Honasa tries to grow its offline channel, larger FMCG companies are snapping up smaller D2C brands to grow their online channels.

Mamaearth would be the first D2C brand to IPO in India and is unlikely to conduct the IPO at a valuation lower than its last round of $1.2 billion.

It would be interesting to see if high valuations are supported by public markets. The valuation could set a benchmark for private market transactions in India as well.

Public market analysts have often highlighted that companies sometimes report strong numbers before IPOs — whether these numbers sustain, would determine the longer-term value creation for shareholders.