DNY59
DNY59
Here at Moats and Monopolies, we do things a little bit differently. We write exclusively about companies that we own in our publicly shared portfolio, which beat the S&P 500 by nearly 10% in 2023.
We are generally long-only quality investors, but occasionally the allure of the turnaround reels us in, particularly when we feel the market has thrown out the baby with the bathwater. After 2023 Q3 earnings, The Beauty Health Company (NASDAQ:SKIN) fell by over 60% and we initiated a buy at a cost price of $1.45. It has slowly crept back up since then and popped this week on earnings, before again retreating.
In this article, we give a brief overview of the company and then dive deeper into Monday's earnings call to see what has some investors jumping back in again and whether there is genuine grounds for optimism.
We have followed The Beauty Health Company since IPO, intrigued with its business to business 'Razor and Blade' model selling high end facial devices and the proprietary consumables that are needed for them to function. We also liked how they sold customisable 'boosters' that added different experiences to consumers. Our first article, in May last year, gave a more detailed overview of the business as well as the network effect being built through professional training opportunities. Six months later, pre Q3 2023 earnings, we revisited the company and discussed in further detail the reasons for the downtrend in stock price over the period. The main reasons being a carousel rotation within the C-Suite and some egregious mismanagement by former executives, and a botched roll out of the 3rd generation Syndeo Machines, many of which had required replacing at the detriment of gross profit margins.
Then came the now infamous Q3 2023 earnings report, where the company fell nearly two thirds in a single day. The CEO hadn't turned up, the company refused to answer analyst questions and the full extent of the botched Syndeo 3 roll out showed just how poor the build quality was on some of these machines. This huge drop was where we initiated a position in the company into the Moats and Monopolies Portfolio at a cost basis of $1.45. And the stock price has slowly made its way back, including this week's pop, to prices seen before that disastrous one day collapse.
On Monday, there was a point at which the stock was up nearly 35% before giving some of that back. Whilst these sharp, short term fluctuations offer great opportunities for traders, we are long only and are really only interested in what we learned in the earnings call that helps us understand the future opportunity for The Beauty Health Company better. Here are a few things that stood out and may be responsible for the increased and/or returning excitement in the company.
As discussed in our most recent article, Beck has a decent track record in the industry, having founded and led Bluemercury, an omnichannel cosmetics retail chain, up to and beyond a sale to Macy's (M) where the company had over 200 retail outlets as well as an ecommerce division. She had held the temporary CEO role at Beauty Health and we see it as a great step in the right direction to have her take the top job on a permanent basis. From our perspective, she said all of the right things, including a 3 pronged focus on driving sales, improving operations and being more fiscally responsible. Further, she was explicit about how important the one-use consumables required for each treatment (the blade in the model) are moving forward: "we see an attractive opportunity around consumables to drive further penetration... we are in the early innings of addressing the opportunity".
One issue that we pointed out in both of our previous articles is how scatter gun the approach to the company's direction had been under previous leadership. Rather than working on making really good machines that deliver high end facials to clients and then scaling up and profiting from these consumable items, previous leaders had seemed to think that the company could become L'Oréal (OTCPK:LRLCF) overnight and go direct to consumer and into various other verticals. Beck made it clear that as part of her transformation of the company, it would focus on the razor/blade Syndeo Machine/consumable business. This was great news for us after advocating for this streamlined focus and clearly Wall Street appreciated it to with the bump in the price. Further, the company's new CFO Michael Monahan for the first time that we can remember actually stated this explicitly: "It is important to remember that our business is a razor-razor-blade model...Our consumables segment represents a growing predictable and high-margin recurring revenue stream". We hope that this more clearly stated alignment between new CFO and CEO is the start of a more sensibly run Beauty Health Company in the future.
One of the main reasons why the company has struggled over the past 12 months is its horrible rollout of its 3rd generation, connected, Syndeo machine. A recall and replacement was required for faulty machines in order to maintain relationships with vendors. Whilst the kinks were being ironed out, the company was simultaneously selling refurbished older devices alongside the new machines. In this earnings report, the corner seems to be turning, with Monahan stating that the company will no longer be taking in and reselling old devices and will be further pushing vendors to upgrade to Syndeo 3, with around 3,000 machines to be upgraded by the end of the year. The way that we read this, is the company are increasingly confident that the quality of these new devices is finally up to snuff and that it will only serve both beauticians and shareholders better to see the newest iteration of the facial machines working as promised.
This might sound like a trivial one, but in terms of slowly regaining and rebuilding trust, this is actually very important. The infamous 60% one day drop had a cluster of terrible things that shareholders didn't want to see in one neat package. Alongside the disappearing CEO and the poorly handled roll out of a new product, being told that there will be no questions answered after the prepared statement is a definite red flag.
On Monday, management answered questions clearly and thoughtfully, and for the first time in a while we felt that there was some actual leadership here. Gone seem to be the days of flashy presentations with dodgy puns ("Skintuition" - anyone?) and relatively pointless slides on Net Promoter Scores, Google Trends and flashy selfies with influencers. We hope that an actual focus on operations and improving the financial fundamentals follow. If so, we've got ourselves a really interesting company here.
On the earnings call, management stated that FY 2024 revenue was likely to be flat to up single digit % year on year, but with operational efficiencies, churning out a small (and adjusted) EBITDA of around $40 million. The first half of the year would see a decline in gross margins year on year, as the company invests in improvements to its supply chain, which should balance back out again towards the end of the year. This wasn't very exciting near term guidance, which means that we are looking beyond that for actual accretive fundamental improvements moving forward. Management provided nothing beyond the upcoming year, which makes sense as the company has over promised before and Beck and Monahan are both relatively new to their roles.
Our thesis is pretty simple. As the number of active machines increases internationally, and there is traction in partnerships such as that with LVMH (OTCPK:LVMHF) owned Sephora, there will be more, higher margin and recurring revenue sales of consumable items, including the potentially lucrative customisable 'boosters'. High end beauty treatments will always be relatively niche, but there is a market for them. Spas, salons, retreats, clinics and luxury hotels are not going away, and even during highly recessive periods, the rich generally don't struggle too much. These middle class and aspirational treatments are big business, and Beauty Health have a big opportunity should they ever get near to taking advantage of it. We feel for the first time that the company finally has a leadership team that could align potential opportunity with actual operational success and are excited to hold this company for the long term to see how this plays out.
The Beauty Health Company has done very well to get its high end facial machines and consumable products internationally scaled, in high end retail outlets, embedded in professional industry training and to within touching distance to profitability (again). It has been terribly mismanaged since IPO and a roller coaster ride for those holding the stock long term. From here, we consider it a strong buy assuming that current leadership stays in place and keeps their word; however, note that it is a stock that has the potential to go down another 60% in a single day or double in a month. Future investors need to understand this before getting involved.
Over the next few years, if Marla Beck a) stays in place and b) keeps her word and focuses on the company's core product and improving operations and profitability, then there is certainly the potential for a large return from here and strong Alpha. If you do choose to become a co-owner of this company, allocate your holding according to your risk level. It is very much to the right side of the risk/reward spectrum.
As always, we appreciate constructive and polite feedback.