As the festive season kicks off, a wave of internet startups are expected to hit the markets. Following the success of Zomato, FSN E-Commerce Ventures, the company behind the cosmetics e-commerce retailer Nykaa is set to launch its initial public offering (IPO) on October 28.

The Falguini Nayar-led company stands out from the pack of internet startups, turning profitable in FY21. But that’s not all. Nykaa’s revenue doubled between FY19-21 with a positive EBITDA as of March 2021. Valuations for internet companies are never cheap, but Nykaa’s ask isn’t as high as its listed competitors. The company also operates two markets set for massive growth — online beauty and personal care, and online fashion retail. Should investors bet big on the e-commerce company?

Sanjay Nayar and institutional investors sell shares through the OFS

Nykaa’s promoters are Falguni Nayar, the founder and CEO of the company and her husband Sanjay Nayar, the CEO of private equity firm KKR. The promoter group consists of the promoters’ children and group companies. Together, the promoter and promoter group hold a 53.6% stake.

The e-commerce company has a range of domestic and international institutional investors. Harindarpal Banga, the CEO of The Caravel Group, holds a 9% stake in the company. Hero Group founder Sunil Kant Munjal holds 4% of the company. Other prominent individual investors include Narotam Sekhsaria, the founder of Ambuja Cements, Rishabh Mariwala, son of Marico founder Harsh Mariwala, and Bollywood actresses Katrina Kaif and Alia Bhatt. Institutional investors include TPG Capital, JM Financial, and Fidelity Investments, among others.

Nykaa’s IPO is worth Rs 5,351 crore, and it’s the biggest IPO this year since Zomato raised Rs 9,375 crore in July 2021. The IPO is divided into a fresh issue of 56 lakh equity shares worth Rs 630 crore and an offer for sale (OFS) of 4.2 crore equity shares worth Rs 4,720 crore. The price band is Rs 1,085-1,125 and at the upper end, Nykaa will be valued at Rs 55,000 crore or $7.5 billion.

Through the IPO, the promoter and promoter group will marginally reduce their stake to 52.6% from 53.6% as Sanjay Nayar will sell 48 lakh shares. The company’s institutional investors will reduce their stake to 13.1% from 16% as TPG Capital and JM Financial will sell 54 lakh and 9.1 lakh shares respectively. Other investors selling shares are Harindarpal Singh, Narotam Sekhsaria, Rishabh Mariwala, among others. Post the IPO, the public will hold a 10% stake in Nykaa.

Valuations for internet-based businesses are not cheap. The loss-making Zomato commanded a valuation of 26 times its FY21 sales, much higher than international peers Uber, Deliveroo, and Just Eat. Nykaa is no different. As of this writing, Zomato is valued at 50 times its FY21 sales. Taking the upper band of the IPO of Rs 1,125 per share, Nykaa’s IPO is priced at 21 times its FY21 sales. However, this is much cheaper than domestic listed internet companies.

Of the Rs 630 crore that will be raised through the fresh issue, the company will spend Rs 234 crore (37% of the proceeds) on marketing to acquire new customers and increase retention. Around Rs 156 crore (24.8%) will be used to reduce debt and Rs 84 crore for capital expenditure (capex) across its e-commerce platform (Nykaa E-Retail) and physical outlets (FSN Brands).

There’s money in makeup, but fashion retail is the unsung star

Founded in 2012 by Falguni Nayar, Nykaa is an e-commerce company that primarily sells beauty and personal care products. In 2018, the company set up Nykaa Fashion, its fashion retail e-commerce subsidiary. The company also has in-house brands in cosmetics (beauty and makeup accessories), skincare, fashion retail (western and ethnic wear), and jewellery segments that it sells through its beauty and personal care and fashion retail e-commerce platforms.

The company also operates physical stores through its subsidiaries — Nykaa Luxe, Nykaa On-Trend (beauty and personal care), and Nykaa Kiosks set up in malls and public spaces. As of August 2021, Nykaa operated 80 physical stores in 40 cities. The company also has a loyalty program called Nykaa Prive (similar to Amazon Prime) with 21 lakh members as of March 2021. Customers become Prive members if they spend more than Rs 7,500 on Nykaa’s platforms in a calendar year.

While the company is primarily known for its beauty and personal care offerings, the fashion retail segment’s numbers saw higher growth over the past three years. The company received just short of 2 crore orders in the year, 87% of the orders were for its beauty and personal care vertical. However, its fashion segment’s orders doubled to 24 lakh orders (12% of orders) in the year. In Q1FY22 the company received over 71 lakh total orders, 3.3X the orders in Q1FY21, 17% of orders were for fashion retail products.

Another positive trend is consumers’ increasing appetite for online shopping. In FY19, the average order value (AOV) for beauty products was Rs 1,400 and Rs 650 for fashion retail products. By FY21, AOV for beauty products jumped by 36% to Rs 1,960 per order and fashion products by 4.2X to Rs 2,700 per order.

Nykaa’s gross merchandise value (GMV), a measure of total goods sold by e-commerce companies including discounts and fees, was Rs 4,046 crore in FY21, a 50% growth against the previous year. On a two-year basis, the company’s GMV is up by 2.5X. The growth was higher in the fashion segment, with FY21’s fashion retail GMV at Rs 665 crore, a 2.6X growth YoY. 

The fashion retail business contributed 27% of Q1FY22 GMV, up from 2% GMV contribution in FY19. 

Consistent revenue growth with thin profits

In FY21, Nykaa’s revenues were Rs 2,441 crore, a 38% growth due to higher order volumes after the first wave of the pandemic. In Q1FY21, during the national lockdown, revenues were just Rs 289 crore, which jumped by 2.8X to Rs 817 crore in Q1FY22.

Nykaa recorded a net profit of Rs 62 crore in FY21 against a net loss of Rs 16 crore a year ago. The company’s bottom line improved because advertising expenses fell 16% to Rs 170 crore and finance costs by 31% to Rs 31 crore.

In FY21, many technology and internet services companies decreased their staff costs by delaying pay hikes, stopping promotions, and cutting recruitment. However, Nykaa’s staff costs rose by 45% in FY21 to Rs Rs 283 crore as it increased its workforce by 22%. In Q1FY22, staff costs were Rs 88 crore, a 58% growth YoY. 

For the past three years, Nykaa’s EBITDA was positive. In FY21, EBITDA was Rs 173 crore, a 90% jump YoY due to higher revenues. EBITDA margins were 7.1% in FY21 and 4% at the end of Q1FY22. 

Free cash positive and adequate cash reserves for acquisitions

In FY21, the total debt was Rs 187 crore, down by 30% YoY, with a debt-to-equity ratio of 0.38 times. Nearly 95% of this debt is short term borrowings payable within a year. Between March to July 2021, Nykaa’s debt rose by 43% to Rs 285 crore. However, with a fund raise of over Rs 200 crore from existing investors, Nykaa’s equity rose by 42%. This allowed the company to maintain a debt-to-equity ratio of 0.38 as of June 2021.

After two years of not generating any free cash flows, the company turned free cash flow positive in FY21. During the pandemic year, Nykaa’s operating cash flows were Rs 150 crore, a significant rise from operating cash flows of less than Rs 7 crore a year ago. The company generated free cash flows of Rs 108 crore in FY21. 

In Q1FY22, the company spent Rs 16 crore in capex, a 4X YoY growth and hence had negative free cash flows.

So far, Nykaa acquired one company in each fashion accessory segment to expand its growth — Twenty Dresses (fashion retail) in 2019, Dot and Key (skincare products), and Pipa Bella (jewellery) in 2021. These acquisitions strengthened its online brand portfolio. 

Going forward, the company will have a decent cash reserve to fuel further acquisitions. As of June 2021, the company’s cash and cash equivalents was Rs 385 crore, more than double of what it was a year ago. 

Big market, and bigger opportunity

Falguni Nayar in the pre-IPO discussion with analysts said that the market opportunity for Nykaa is worth $152 billion (Rs 11.4 lakh crore). This is based on the expected growth in the two main industries Nykaa operates in — beauty & personal care, and fashion. India’s beauty and personal care market is expected to grow at a compounded annual growth rate (CAGR) of 15% to Rs 2 lakh crore ($28 billion) between FY22-25. The expected growth of the fashion industry is much higher at a 23% CAGR, valuing the industry at Rs 8.7 lakh crore ($125 billion) in that time.

Nykaa expects this growth to be captured by organized retail companies using e-commerce channels. As of August 2021, online sales account for less than 12% of the fashion retail market and less than 10% of the beauty and personal care market. However, Nykaa will face stiff competition from the likes of Amazon India, Flipkart, Flipkart-owned Myntra, PayTM mall in online fashion retail and Purplle, and Myglamm in online beauty and personal care.

The company’s main vertical, beauty and personal care, performed well with a 55% growth in total orders placed between FY19 to FY21. But the vertical that will drive revenue growth in the future is expected to be fashion retail. Between FY19-21, Nykaa’s fashion segment’s total orders placed jumped 5X and its AOV is nearly 40% higher than the main beauty and personal care segment’s AOV.

With this growth outlook, the company’s fundamentals look stable. Debt levels are low with debt at 0.38 times equity, cash flows positive as of FY21, and a decent cash balance even before the fresh issue worth Rs 630 crore in the IPO. With India’s appetite for online shopping rising, Nykaa is seeking a high valuation for its profitable e-commerce business.