IPO engines are about to start whirring again, with a listing of cosmetics retailer Douglas to be the first true test of sentiment. But the company’s high leverage is fuelling some investor pushback.

Europe’s IPO market has had a strong start to 2024. German defence contractor Renk [ETR:R3NK], up a staggering 74.4% from its IPO price, and Athens International Airport [ATH:AIA] raised the spirits of the market.

“Renk was an early green shoot, if that initial crop had failed it would have set the market off on the wrong foot,” said an ECM investor. “Some of what is coming, though, is very different where there is going to be a lot of primary to help fix the capital structure. In these cases, issuers are going to have to be more flexible on things like valuation.”

Chart note: IPOs pricing on European exchanges excluding Turkey

The IPO of Douglas is certainly in that camp. The CVC-backed German retailer is expected to be a substantial listing of over EUR 1bn, according to sources speaking to ECM Pulse. As a sponsor-backed deal, it is also highly leveraged which is often a point of contention for many ECM investors.

In its last full-year results, ending 30 September, Douglas had net debt of around EUR 3.4bn, giving it leverage of 5x EBITDA and 4.7x adjusted EBITDA.

“It is difficult to see this performing well after another US PE-backed candidate, KKR’s Brightspring [NASDAQ:BTSG], came with a lot of debt, and very much underperformed,” noted a second investor.

The first investor, though, was more positive, adding that the company had committed to reduced leverage to 2x EBITDA in the near term.

“It’ll be a big deal, probably over EUR 1bn and most of it will have to be primary to pay of the leverage; that won’t leave much for CVC on secondary so there will be an overhang on the stock as everyone knows there will likely be sell downs,” the investor said.

“That’s another driver though to try and ensure the deal performs well in the aftermarket,” they added.

EUR 7bn valuation tall order

CVC is reportedly hoping for a valuation of EUR 7bn for the German beauty and perfume retailer.

Swiss-based duty-free retailer Avolta (formerly Dufry and Autogrill) [SWX:AVOL], US-based Ulta Beauty [NASDAQ:ULTA], and British retailer NEXT Plc [LON:NXT] are possible peers, according to the investors.

Based on this peer group, Douglas could command an enterprise value of around EUR 7bn on a fair-value basis, but any IPO discount would bring that number down.

Douglas reported annual sales of EUR 4bn, EBITDA of EUR 683m, Adjusted EBITDA of EUR 725.9m and net debt of EUR 3.4bn, for the 12 months ending 30 September 2023.

This news service has calculated peer averages based on FY23 actual numbers or estimates using data provided by Fidessa and compiled by Factset.

Avolta has estimated FY23 sales of CHF 13.4bn with an EV/EBITDA ratio of 7.4x, Ulta has estimated 2023 sales of USD 11.1bn with an EV/EBITDA ratio 13.5x, and NEXT has sales of GBP 5.4bn with an EV/EBITDA of ratio of 9.8x. The average 2023 EV/EBITDA ratio for the peer set is 10.2x.

If compared just to Ulta, Douglas could have a pre-money enterprise value of EUR 9.2bn on 2023 EV/EBITDA, before any primary proceeds to pay off debt are factored in.

Douglas’ margins of around 16.7%, according to Fidessa data, put it far closer to the US company than its European peers. However, Ulta’s sales are 2.5x that of Douglas and the US firm is debt free.

Investors have also frequently told ECM Pulse that they are sceptical of European IPO candidates being marketed against higher-valued US peers, which have different costs of capital and equity market exposure. The tactic was criticised in the listing of German software company IONOS [ETR:IOS] in 1Q23 and given as a reason for its poor aftermarket trading.

The first investor noted that a pre-money enterprise value of between EUR 5.5bn and EUR 6.5bn would be fairer for Douglas, which would reflect a discount of around 30% to 40% to Ulta’s EV/EBITDA multiple.

Luxury of choice

The upcoming IPO window is likely the first “sensible one” for retail in the past few years, given companies can show two years of financial growth unaffected by the COVID-19 pandemic, said a source close to the deal.

Douglas has the advantage of both a product range that people want to buy in person, perfume and beauty products, and an omni-channel model that has shown resilience to being “disembowelled by Amazon”, he added.

The first investor recognised that Douglas has impressive margins but noted that given its leverage and the expected overhang, CVC should be flexible on discount given there is plenty of listed exposure to the consumer and beauty sectors; if an IPO candidate is not unique, it has to be compelling on price.

There are also other big consumer opportunities coming to the IPO market this year, according to Dealogic’s predictive IPO pipeline, notably Spain’s Puig and EQT-backed Swiss skincare company Galderma.

With the market still in a delicate recovery state, any buyers’ remorse will quickly sour investor moods for the candidates ahead.

CVC and Douglas declined to comment on this story.