IPO Market – The market to float new companies, or Initial Public Offerings (IPOs), is cyclical. Currently, the UK IPO market is running hot. While secondary raises to fix balance sheets characterised 2020, the main feature for this year is the torrent of IPOs. From our discussions with corporate brokers and advisers, we understand that the IPO pipeline indicates strong deal flow for at least the rest of this year and into 2022, assuming investors have the appetite.
IPO Scepticism – Many investors are sceptical about IPOs. They question the motives for offering shares, the quality of the underlying businesses and the claims they and their promoters make to justify valuations sought. The UK debut of Deliveroo is an example of why such scepticism is understandable. Hot markets often bring out unsuitable candidates. However, we believe that the IPO market helps uncover attractive long term investment opportunities, provided one is prepared to be patient and selective.
Experts Say – Broker Liberum recently published a longitudinal study covering the last 30 years of IPO activity in the UK, Europe, and the USA, which has some valuable insights. The first is that the best time to buy IPOs is in the 24 months after a period of financial crisis or turmoil. Second, they identified that companies often experience a decline in net margins 3-4 years after an IPO, usually resulting from under-investment in the business under previous private equity ownership. And finally, the study identified IPOs from the UK as better long-term performers than those from either the US or other European markets, suggesting that the UK regime of governance is effective.
Dowgate Approach – The Liberum study supports our view that the current spate of UK IPOs represents a promising hunting ground for new high-quality growth companies. However, there are essential factors we always consider before committing our clients capital to any transaction. We assess the motives for the IPO and the sustainability of the company’s revenue and earnings over the long term and how aligned management strategy and incentives are to our interests as shareholders. Additionally, we consider governance and capital allocation policies that are in place. Finally, we look at the deal structure, and the appropriateness of the intermediaries and advisers engaged in the transaction, the proposed valuation and how the deal will be priced and allocated. Of all the IPOs we have engaged with this year, we believe The Artisanal Spirits Company (TASC) typifies much of what we like to see in a robust UK IPO candidate.
Founding Beliefs – The main operating business of TASC is The Scotch Malt Whisky Society (TSMWS), an Edinburgh members’ club that traces its roots back to the late 1970s. Founder Philip Hills persuaded some of his friends to form a syndicate to acquire some single casks of malt whisky. Over the years, the club grew in scale. Still, it continued to adopt the same ethos of a members’ syndicate for those who enjoyed unique limited editions of high-quality single cask malts.
Under New Ownership – In 2004, distiller Glenmorangie bought TSMWS. In the same year, French luxury goods conglomerate LVMH acquired Glenmorangie. Over time it became apparent that TSMWS was non-core to their plans. Hence in 2014, LVMH sold TSMWS to a group of private investors. In 2018 further investment was made into the business by Inverleith, a locally based private equity investor, which proved transformational. The new investment enabled TSMWS to double revenues, quadruple the scale of its stock of casks, and grow the proportion of sales to overseas’ members from under 25% to nearly 70%.
Subscriber Adoption- TASC has many attractive features for an IPO. It is not a new company but has built up and evolved a strong position in a niche market over many years. TSMWS sits nicely in the trend towards drinks premiumisation and products with an authentic provenance. The subscription-based direct to consumer (DTC) model is another attractive secular growth driver.
Aspirational Luxury – TSMWS selects casks from over 100 primary producers. Then they actively manage the maturation process, which is key to developing multiple flavours before bottling the finished product to retail directly to members. Its product prices typically range from £45 to over £1,500 per bottle.
Unique Product Differentiation – TSMWS releases dozens of new whiskies per month. A key differentiator is the SMWS policy of not revealing the distillery’s name on the label. This policy encourages the consumer exclusively on the unique flavour of each batch. Importantly, by protecting the identity of the original producer, SMWS products do not compete for brand recognition with its partner distillers.
Omni Channel Experience – In the UK, members of The Scotch Malt Whisky Society subscribe to a membership fee of £65 per year. For this, members enjoy the benefits of tasting events, the award-winning “Unfiltered” magazine, members-only access to the Group’s hospitality venues and, most importantly, exclusive access to new whiskies and spirits released and featured in the monthly magazine. The TSMWS venues reflect the ethos of the membership experience and act as a “shop window” for current and potential new members. There are four physical locations in the UK (The Vaults, Farringdon in London, Queen Street in central Edinburgh and Bath Street in Glasgow). Members can drink and purchase whisky or sample high-quality food. To replicate the UK membership experience overseas, the Group has developed a global network of over 100 selected partner bars in more than 20 countries.
Financially Robust – With its unique business model, TSMWS enjoys some desirable financial characteristics. TSMWS produces gross margins of circa 60%, which we would expect to grow over the next few years as the business scales. The membership metrics are also impressive. The average annual revenue per member is £531 with a member retention rate of 70 per cent and an average lifetime value (“LTV”) of £932. The average member acquisition cost (“CPA”) of £65 equates to the joining fee. The 28,000 members are from over 30 countries. International members now comprised 51.6 per cent of the total and offer much higher LTVs and annual average spend than the more mature UK membership.
Inflation Hedge – Intriguingly, TSMWS has an attractive store of value on its balance sheet in the form of its cask and bottled inventory. This inventory stands at a book cost of £21m and represents over 14 000 casks of spirit (each a specific new product), and is the equivalent to 26 years of supply at current turnover levels. Today’s average price per bottle implies a retail price inventory value of c£330m. This stock position is likely to prove an attractive hedge against the impact of higher inflation.
Solid Growth – Artisanal’s broker forecasts a 10% membership CAGR over the next five years to c.45,000, which flows through to a projected doubling of sales to £33.2m and £5.3m EBITDA. Their indicative long-range 10-year sales forecast is £58.9m, which results in £15.7m of EBITDA and a £13.1m PBT. Over this longer time frame, Artisanal can expand its high-end drinks subscription model to adjacent markets. They already have plans for an American Malt Whisky Society and have explored artisan gin and rum options. Altogether Artisanal has the hallmarks of a quality long term compounding equity story.
Test of Time – While it is hard to argue that Artisanal is in a cutting-edge product category, it is a disruptor. It has attractive niche characteristics which deliver strong financial returns. The management team has multiple expansion options from which they can test and learn their way to long term growth.
The recent strength of the UK IPO market has inevitably brought forward some unsuitable candidates for listing and many that will carry the burden of being overvalued at IPO. The IPO of Artisanal came at a time of very high deal activity in the London market. Valued at a market capitalisation of just £78m, Artisanal was seen as too illiquid or simply not a priority for multi-cap equity managers. However, we see these factors as an opportunity to get a decent position. Liberum’s IPO study suggests that given the timing of Artisanal’s IPO, and its sensible governance structure, this company should survive the test of time. We believe it will and have positioned our portfolios accordingly.
Dowgate Wealth’s holding in the above stock: 2,782,058 shares (reported on 24/06/21)
Written by Jeremy McKeown
