APRN - IPO Update: DDC Enterprise Readies U.S. IPO Plan

2023-11-09 15:43:44 ET

Summary

• DDC Enterprise Limited plans to raise $44.6 million in an IPO by selling Class A common stock.
• The company provides ready-to-cook meals and related food products to consumers in China.
• DDC Enterprise' flatlining revenue, high valuation expectations, and regulatory risks in China make it a risky investment.
• My opinion on the DDC Enterprise Limited IPO is to Sell [Avoid].

A Quick Take On DDC Enterprise Limited

DDC Enterprise Limited ( DDC ) has filed proposed terms to raise $44.6 million in gross proceeds from the sale of its Class A common stock in an IPO, according to an amended SEC registration statement .

The company provides ready-to-cook meals and related food products to consumers in China.

I previously wrote about the firm's initial IPO filing here .

Given DDC’s flatlining revenue, excessive valuation expectations and regulatory risks operating in China, my outlook for the IPO is to Sell [Avoid].

DDC Enterprise Overview

Hong Kong, PRC-based DDC Enterprise Limited was founded to develop a variety of ready-to-cook type meal offerings for younger demographic customers in the PRC.

The firm is led by founder, CEO and Chairwoman Norma Ka Yin Chu, who has been with the firm since its inception in 2012 and was previously Head of Research at HSBC Private Bank in Hong Kong.

The company’s primary offerings include the following:

• Ready-to-cook meals

• Ready-to-heat

• Ready-to-eat

• Plant-based foods.

As of June 30, 2023, DDC Enterprise has booked fair market value investment of $204.3 million in equity from investors including K11 Investment Company, Voodoo Enterprise, Tontec International, Ironfire Angel Partners, Shanghai Heyi Kewen Investment and Virtual King Investments Limited.

DDC Enterprise - Customer Acquisition

The company markets its services primarily online through major Chinese e-commerce platforms such as Tmall, JD, Pinduoduo, content marketing platforms and group-buy platforms.

DDC says it has access to a number of offline point-of-sales locations at convenience stores, retail stores and boutique supermarket chains.

Sales and Marketing expenses as a percentage of total revenue have declined as revenues have returned to growth, as the figures below indicate:

(Source - SEC.)

The Sales and Marketing efficiency multiple, defined as how many dollars of additional new revenue are generated by each dollar of Sales and Marketing expense, rose to 3.0x in the most recent reporting period:

(Source - SEC.)

DDC Enterprise’s Market & Competition

According to a 2022 market research report by Deloitte China, the Chinese market for pre-created dishes was an estimated $81.34 billion in 2021 and is forecast to reach $150 billion by 2026.

This represents a forecast CAGR (Compound Annual Growth Rate) of 13% from 2022 to 2026.

The main drivers for this expected growth are younger demographics, increasing demand due to changing preferences for cooking less and the availability of delivery services.

Also, the ease of online ordering reduces friction in the market, as did the COVID-19 pandemic, which pulled forward new habits by consumers.

Major competitive or other industry participants include traditional ready-to-eat firms, plant-based food companies, major food-centric content providers and Internet companies that choose to enter the food business.

DDC Enterprise Limited Financial Performance

The company’s recent financial results can be summarized as follows:

• Flat topline revenue (at an annual run rate)

• Growing gross profit and gross margin

• Reduced operating loss

• Variable cash used in operations.

Below are relevant financial results derived from the firm’s registration statement:

As of June 30, 2023, DDC Enterprise had $3.1 million in cash and $56.9 million in total liabilities.

Free cash flow during the twelve months ending June 30, 2023, was negative ($5.9 million).

DDC Enterprise’s IPO Details

DDC intends to sell 4.25 million shares of Class A common stock at a proposed midpoint price of $10.50 per share for gross proceeds of approximately $44.625 million, not including the sale of customary underwriter options.

Class A ordinary shareholders will be entitled to receive one vote per share, while Class B shareholders will receive ten (10) votes per share.

The S&P 500 Index (SP500) no longer admits firms with multiple classes of stock into its index.

No existing shareholders have indicated an interest in purchasing shares at the IPO price.

As a "foreign private issuer," the company can choose to take advantage of reduced, delayed or exempted financial and senior officer disclosure requirements versus those that domestic U.S. firms are required to follow.

The firm is also an "emerging growth company" as defined by the 2012 JOBS Act and may elect to take advantage of reduced public company reporting requirements; prospective shareholders would receive less information for the IPO and in the future as a publicly-held company within the requirements of the Act.

Many such companies have performed poorly post-IPO.

The firm’s enterprise value at IPO (excluding underwriter options) will approximate $174 million.

The float to outstanding shares ratio (excluding underwriter options) will be approximately 21.1%.

Per the firm’s most recent regulatory filing, it plans to use the net proceeds as follows:

Management’s presentation of the company roadshow is available here until the IPO is completed.

Regarding outstanding legal proceedings, management says the firm is not subject to any legal proceedings that would have a material adverse effect on its financial condition or operations.

The listed bookrunners of the IPO are CMB International, The Benchmark Company, Maxim Group, Freedom Capital Markets, Guotai Junan International, Eddid Financial and Tiger Brokers.

Valuation Metrics For DDC Enterprise

Below is a table of the firm’s relevant capitalization and valuation metrics at IPO:

(Source - SEC.)

Commentary About DDC Enterprise

DDC is seeking U.S. public capital market investment to fund its working capital and acquisition needs.

The firm’s financials have produced flat topline revenue on an annual run rate basis, growing gross profit and gross margin, lowered operating loss and reduced cash used in operations.

Free cash flow for the twelve months ending December 31, 2022, was negative ($5.4 million).

Sales and Marketing expenses as a percentage of total revenue have dropped as revenue has declined; its Sales and Marketing efficiency multiple was negative (0.9x) in the most recent reporting period.

The firm currently plans to pay no dividends and retain any future earnings for reinvestment back into the firm's growth and working capital requirements.

DDC’s recent capital spending history indicates it has spent lightly on capital expenditures despite its operating cash use.

The market opportunity for ready-to-eat/heat/prepare dishes in China is large and expected to grow at a robust rate of growth in the coming years, so the firm has positive industry dynamics in its favor.

Like other Chinese firms seeking to tap U.S. markets, the firm operates within a VIE structure or Variable Interest Entity. U.S. investors would only have an interest in an offshore firm with contractual rights to the firm’s operational results but would not own the underlying assets.

This is a legal gray area that brings the risk of management changing the terms of the contractual agreement or the Chinese government altering the legality of such arrangements. Prospective investors in the IPO would need to factor in this important structural uncertainty.

Additionally, the Chinese government’s crackdown on IPO company candidates combined with added reporting requirements from the U.S. side has put a serious damper on Chinese IPOs and their post-IPO performance.

A significant risk to the company’s outlook is the uncertain future status of Chinese company stocks in relation to the U.S. HFCA act, which requires delisting if the firm’s auditors do not make their working papers available for audit for three years by the PCAOB.

Additionally, post-IPO communications from the management of smaller Chinese companies that have become public in the U.S. have largely been spotty and perfunctory, indicating a lack of interest in shareholder communication, only providing the bare minimum required by the SEC and representing a very different approach to keeping shareholders up-to-date about management’s priorities.

Management is seeking an Enterprise Value / Revenue multiple of 6.26x . The closest publicly held comparable would be Blue Apron Holdings ( APRN ), which, at its current buyout valuation, has an EV/Revenue multiple of around 0.23x .

Given DDC’s flatlining revenue, excessive valuation expectations and regulatory risks operating in China, my outlook for the IPO is to Sell [Avoid].

Expected IPO Pricing Date: Week ending November 17, 2023.

For further details see: