- RLX Technology has filed proposed terms for its $1 billion U.S. IPO.
- The firm develops and sells e-cigarettes and related products in China.
- RLX has grown impressively and is a leading company in the world’s largest market, so the IPO is worth close consideration.
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RLX Technology (RLX) has filed to raise $1.05 billion from the sale of ADSs representing underlying Class A stock in an IPO, according to an amended registration statement.
The company is a large provider of e-cigarette devices and related products to Chinese consumers.
RLX faces future regulatory risks, and the IPO isn’t cheap, but the firm’s growth potential, breakeven financial result and strong free cash flow generation mean the IPO is worth consideration.
Company & Technology
Beijing, China-based RLX, was founded to develop closed system e-vapor smoking products. According to management, it is the number one seller in China, achieving a market share of 62.6% in retail sales for the nine months ended September 30, 2020.
Management is headed by co-founder, Chairperson, and CEO Ms. Ying [Kate] Wang, who was previously head of Didi Youxiang and head of Uber China at Didi Chuxing.
RLX has received at least $139 million from investors, including Relx Holdings, BJ BJ Limited, Deep Technology Linkage Fund, and Sequoia Capital China.
The firm has developed an offline distribution and ‘branded store plus’ retail model that uses over 100 authorized distributors covering more than 250 cities in China.
The firm leverages its RELX Branded Partner Stores to provide further reach into a variety of retail stores such as electronics, convenience, and e-vapor specialty stores.
The firm counts more than 100,000 retail store locations as carrying at least one of its products, helping the firm to attain a number one ranking in brand awareness, according to a study by CIC, which was commissioned and paid for by RLX.
Selling expenses as a percentage of total revenue have been dropping sharply as revenues have increased, as the figures below indicate:
|Selling||Expenses vs. Revenue|
|Nine Mos. Ended Sept. 30, 2020||11.2%|
Source: Company registration statement
The Selling efficiency rate, defined as how each dollar of Selling spend generates many dollars of additional new revenue, rose to 4.3x in the most recent reporting period, as shown in the table below:
|Nine Mos. Ended Sept. 30, 2020||4.3|
Source: Company registration statement
RLX’s recent financial results can be summarized as follows:
- Strong topline revenue growth
- Increased gross profit but lower trending gross margin
- Growing operating profit and net income
- Sharply increased cash flow from operations
Below are relevant financial results derived from the firm’s registration statement:
|Period||Total Revenue||% Variance vs. Prior|
|Nine Mos. Ended Sept. 30, 2020||$ 324,211,000||93.6%|
|Gross Profit (Loss)|
|Period||Gross Profit (Loss)||% Variance vs. Prior|
|Nine Mos. Ended Sept. 30, 2020||$ 122,750,000||81.6%|
|Nine Mos. Ended Sept. 30, 2020||37.86%|
|Operating Profit (Loss)|
|Period||Operating Profit (Loss)||Operating Margin|
|Nine Mos. Ended Sept. 30, 2020||$ 25,279,000||7.8%|
|Net Income (Loss)|
|Period||Net Income (Loss)|
|Nine Mos. Ended Sept. 30, 2020||$ 16,026,000|
|Cash Flow From Operations|
|Period||Cash Flow From Operations|
|Nine Mos. Ended Sept. 30, 2020||$ 191,360,000|
|(Glossary Of Terms)|
Source: Company registration statement
As of September 30, 2020, RLX had $40.2 million in cash and $514.3 million in total liabilities.
Free cash flow during the twelve months ended September 30, 2020, was $181.5 million.
Market & Competition
According to a 2018 market research report by ResearchAndMarkets, the Chinese market for e-cigarettes grew from an estimated RMB1 billion to RMB4 billion from 2013 to 2017.
According to the report, ‘if 10% of 30 million to 35 million Chinese smokers (out of up to an estimated 350 million total smokers in China) turn to electronic cigarettes, the potential market size will be above $15 billion.’
The main drivers for this expected growth are government initiatives to reduce smoking and younger demographic smokers who wish to transition to potentially less unhealthy forms of smoking and prefer diversified tastes.
Also, the Chinese government has a complicated relationship with smoking, as it is selling traditional tobacco products to the population.
It prohibits the importation and online sale of heat-not-burn electronic cigarettes.
The company competes against traditional cigarette sellers, including the Chinese government and other e-cigarette firms, in a fragmented industry.
In 2019, the government banned the online advertising and sale of e-cigarettes, so the firm is subject to regulatory changes that may adversely impact its ability to operate.
RLX intends to sell 116.5 million ADSs representing Class A shares at a proposed midpoint price of $9.00 per ADS for gross proceeds of approximately $1.05 billion, not including the sale of customary underwriter options.
Class A shareholders will be entitled to one vote per share and Class B shareholders will have ten votes per share.
The S&P 500 Index no longer admits firms with multiple classes of stock into its index.
Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $13.9 billion.
Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 7.5%.
Per the firm’s most recent regulatory filing, the firm plans to use the net proceeds as follows:
Approximately 30% for development of products and technologies and scientific research;
Approximately 25% for enhancement of distribution and retail network;
Approximately 25% for improvement of supply chain capabilities; and
The balance for general corporate purposes and working capital.
Management’s presentation of the company roadshow is available here.
Listed underwriters of the IPO are Citigroup and China Renaissance.
RLX is seeking U.S. public capital market investment for its expansion plans within China.
The company’s financials show strong topline revenue growth, slight earnings, and significant cash flow from operations and free cash flow.
Selling expenses as a percentage of total revenue have dropped as revenues have increased, and its Selling efficiency ratio has improved. Both signals are positive as to the firm’s capital efficiency in this important area.
The market opportunity for selling e-cigarettes in China is approximately 290 million smokers, and management says this is the largest single such market in the world.
Citigroup is the lead left underwriter, and IPOs led by the firm over the last 12-month period have generated an average return of 31.7% since their IPO. This is a middle-tier performance for all major underwriters during the period.
As to valuation, RLX seeks a significant valuation premium over U.S. comparable Turning Point Brands (TPB).
However, in its favor is RLX’s strong topline revenue growth rate and leading position in a huge market.
The company business’s main risk is the potential for negative government regulation since the Chinese government is itself in a competitive position, selling legacy cigarettes to consumers.
However, I view this threat as only moderate, as the government also seeks to reduce the health care costs associated with legacy cigarette consumption.
Like many Chinese firms seeking to tap U.S. markets, the firm operates within a VIE structure or Variable Interest Entity. U.S. investors would only be interested 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 such arrangements’ legality. Prospective investors in the IPO would need to factor in this important structural uncertainty.
While there are regulatory risks the company faces and the IPO isn’t cheap, its growth potential, breakeven financial result, and strong free cash flow generation mean the IPO is worth a close look.
Expected IPO Pricing Date: January 20, 2021.
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