Description

Thesis Overview

Olaplex is a hyper-growth and viral protective haircare brand in the growing bond-building category benefiting from haircare premiumization, which is still low (but rising) compared to premiumization penetration in skincare, cosmetics or fragrance. It is the fastest haircare brand to breach $500mm+ revenue threshold that is still estimated to grow at a strong ~40% pace this year. On top of the solid existing product foundation, the brand has meaningful category / product extension opportunity after having acquired so much positive consumer goodwill.

Unlike many money-burning DTC consumer businesses, Olaplex commands ~80% gross margin and 60%++ EBITDA margin due to its unique marketing model heavily reliant on “earned media” vs. paid media, and lean corporate structure (“remote-work” was the default starting 2014).

You are paying low-20x NTM after-tax earning for a beauty business with best-in-class profitability while it’s still in the hyper-growth mode, compared to Estee Lauder / L’Oreal trading at north of ~30x NTM P/E with HSD % organic growth and low-teen EPS growth algo.

The company IPO’ed in Fall 2021 and the stock has fallen more than 50% from the highs. If growth proves to be durable (so far so good), the stock will prove out to be a double to triple over the next 2-3 years. This opportunity exists because it’s in the “hot 2021 vintage IPO basket” that has been going through a violent wave of liquidation YTD, but the unit economics of this business along with current valuation is substantially different from a lot of the garbage in that basket.

Business Description: Olaplex is the fastest company to reach $500mm+ revenues in prestige haircare category with high virality

What does Olaplex do? It creates and markets patent-protected and proven haircare products that restore all hair types to the healthiest state possible. You may be surprised to that despite the almost ~$10bn enterprise value (last price), this is a very lean company in both product complexity and organizational structure: there are a total of ~12 SKUs today with ~110 employees

Yet, it has achieved phenomenal financial scale: ~$600mm 2021 revenues (+112% vs. 2020) growing to an estimated ~$800mm+ in 2022 (+34% YoY), while having generated an impressive ~68% Adj. EBITDA margin in 2021

Olaplex carries a lot of #1’s within the haircare space across brand affinity, social media presence and NPS

(source: OLPX Investor Deck)

From a business mix perspective, it’s relatively diversified across channels and geography. The international business is predominantly Europe (5-6 countries including UK make up for the bulk of it), there is very little APAC / China presence today

What makes the brand special? Well, the secret sauce is its proprietary active ingredient “Bis-Aminopropyl Diglycol Dimaleate” (Bis-Amino), which rebuilds and repairs “hair bonds”. Bis-Aminos works on a molecular level to improve hair by 1) protecting, 2) strengthening, and 3) repairing disulfide bonds in hair that break when damaged. Olaplex puts Bis-Aminos is in each of the 11 SKUs

Olaplex created the Bond Building category. At first, this product was used to rebuild hair bonds before / during / after salon treatments (coloring or other heat-intensive services) – but then the company introduced maintenance products / more consumable SKUs.

After Olaplex treatment, your hair gets stronger, more hydrated, has more shine, bounce and smoothness

(source: OLPX Investor Deck)

The company encourages a multi-step regimen. As of today, OLPX has 12 products (including the recent nourishing hair serum launch) targeted for 1) treating, 2) maintaining, and 3) protecting hair; 3 of these products are only sold to salons (Pro Rx)

Treatment products (~53% of revenue): Includes the intensive in-salon treatment, and at-home hair repair treatment for use 1-2 times weekly (Bond-Building Pre-Treatment, Hair Perfector, Moisture Mask)

Maintenance products (~30% of revenue): Shampoo and conditioner for everyday use

Protection products (~17% of revenue): products like Bond smoother strengthens/protects hair from everyday damage / chemical services, promotes faster blow dries. Also Bonding oil that increases shine, softness and color vibrancy

 (source: OLPX filings) 

IP Portfolio and Competitive Advantage

Bis-Amino is the game-changer ingredient and OLPX has ~13 years remaining on its average patent portfolio. OLPX owns a portfolio of 150+ issued patents worldwide. Approx. 95 patents are a part of patent family with claims that cover OLPX’s commercial formulation containing the Bis-Amino ingredient. The patents cover uses + claims that cover other haircare / skin care products

Remaining patents address maleic acid, an alternative formulation to Bis-Amino that holds further IP opportunity + Keratin Bio-markers (used for straightening and perms)

A few years ago, L’Oreal (after having learned about Olaplex’s formula during a potential acquisition diligence) tried to launch a copycat bonding product based on bis-amino under Redken brand. Olaplex sued and they ultimately won, as L’Oreal was forced to pull those products off shelf

https://www.thefashionlaw.com/court-orders-loreal-usa-to-permanently-pull-infringing-haircare-products-in-olaplex-case/]

(source: OLPX filings)

OLPX believes it has a unique growth flywheel that starts with Professional Channel (salons) acting as “consultants” to get consumers into the door. OLPX took time to build a large stylist community to provide consumer education as “an unpaid network of advertisers” who can build credibility for the brand. OLPX correctly realized recommendation from stylist was the leading factor in consumer hair care purchasing decision given the personal tie between consumer and stylist

OLPX also has a highly engaged digital community further deepens the word of mouth advertising affect, “Olaplex Users” Facebook group is the largest social media community for hairstylists, with 145k+ members and 12% of all US stylists as members / 25% of users engaging daily

Each of the 3 distribution channels serves a distinct purpose providing a true omni-channel experience. As an example, ~50% of customers that purchase products via DTC has purchased OLPX products in retail locations and 40% have also purchased in a salon

Usually salon stylists hate it when a product gets launched in retail/DTC channel (because then the consumers don’t have to buy those products from the salons anymore), but in OLPX’s case salon stylists continue to endorse OLPX quite hard because the products really allow the stylists to do creative coloring services for consumers (where the $$$ is in a salon), and the fact that maintenance products (like shampoo/conditioner) are available at retail distribution means consumers can protect their hair and won’t be afraid of taking on more coloring / heat-treatment services

Former Category Manager at SalonCentric (distributor)

Differentiation: “…OLPX products created a huge difference because it was the only product in that range that it could really allow haircare professionals to do crazy things with color, like going from black to completely blond without breaking the hair”

Benefits everyone in ecosystem:  “it was a good deal for everybody because it was a good deal for the people who were selling it. They would make more commissions. They would be able to sell more hair color, which is really where the money is. They were able to offer their customers things that nobody had been able to offer before…hair color brands were piggybacking from that because now they started offering all these different colors, and it created a whole trend, being able to now make those drastic hair color changes that made a huge difference in the whole industry”

Here is how I would sum up OLPX’s competitive advantages:

·         It has a unique formula that works to address a large consumer pain point (hair damage), demonstrated high repeat purchase rate / loyalty

·         It has a hard-to-replicate distribution strategy led by Salon stylists and followed by well-managed omni-channels

·         Robust social media “marketing” via engaged users posting contents that OLPX doesn’t have to pay much for

·         Since it has earned consumers’ trust to-date, it has “platform optionality” as it works on additional innovation products to cross-sell

Quick look at historical growth / KPIs: “looks like the unicorn among the unicorns”

Yes, it’s absolutely crazy that revenues grew by ~$500mm over 3 years on sub-$50mm of incremental marketing / R&D investments, I admit it feels “too good to be true” (which is partly why this stock is valued at the current multiple)

Thesis Point #1: We are at the cusp of acceleration of premiumization trend within hair care category, and OLPX’s ability to show consumers instant benefit will help accelerate hair care premiumization (where there has been a lack of innovation historically)

Global hair care is a ~$82bn market but premium product penetration (by value) is materially lower than skincare, makeup and fragrances

However, the US hair care market is now undergoing significant premiumization w/ the premium segment growing at ~7% in the US as women are willing to pay more for better products

There could be a “longer duration” to premium hair care category growth from here if premiumization penetration has a lower starting point

Here is some scanner data (published by Evercore ISI) showing avg price for Shampoo / Conditioner in US Mass Channel is up 30% in the last 3 years (HSD % CAGR), pointing to premiumization accelerating

OLPX’s product suite plays into ~70% of the hair care market by application (shampoo, conditioner / treatments, and salon professional hair care), the only area where it doesn’t participate in is styling agents / colorants space. Unlike skin care, there is potential to show instant benefit for premium hair care products so consumers can assess immediately if the product work or not

Historically, hair care premiumization is low due to lack of notable innovation / differentiation in this space, but OLPX wants to change that

Below graphs highlight the size of the market (massive), and that unlike prestige skin care, prestige hair care is more reliant on Western Europe + US growth and less reliant on China growth.  There is likely more durable growth in hair care and less Chinese macro risk (which is always a worry in prestige skin care)

Ulta Beauty and L’Oreal got very bullish recenetly on Prestige Hair Care category

Ulta Beauty at Investor Day

         “We expect the hair care segment will accelerate as consumers focus on hair health, and subsegments such as textured hair will add incrementality to the category, and we anticipate continued growth in fragrance and bath with the rise of self-care and wellness

         Hair care as self-care, reflecting new rituals adopted during the pandemic with hair masks, scalp massages and more and building confidence to bridge the skill gap to care for and style their hair. And high engagement with product innovation disruptors such as Dyson and OLAPLEX have fundamentally changed the engagement consumers have with the hair category and have migrated many to trade up. Hair care is our most profitable category, and there is opportunity to increase our share.

         And now to hair category trends. Skinification of hair as consumers see their scalp as an extension of their skin and treating it as such. Bond-building products and damage repair have seen explosive growth, thanks to true innovation. Inclusivity and diversity is more important than ever for the hair category and vegan, clean, cruelty-free. Google searches were up nearly 50% for vegan hair products. And today, clean, vegan and cruelty-free are table stakes for new brands launching”

L’Oreal

         “We see premium haircare growing faster than the basic products, both because, I mean, it's the retailers’ interest, but also because e-commerce, which has taken a bigger share of the market, e-commerce algorithms push up higher value items, and our innovations also are a source of [their] innovation”

Thesis Point #1(a): While OLPX pricing is high, we’ve seen evidence in consumers’ willingness to “trade-up” for more value-add

OLPX’s shampoo/conditioner are quite expensive at $28 per bottle (8.5oz), or a $3.3 per Oz. That is the typical push-back from consumers who liked the product trial results

EVR ISI Survey Results point to ~40% of early adopters of OLPX’s products upgraded from Mass, and these consumers aren’t shying away from the high price when they see a real difference the product makes

In addition, if you look at competitive sets’ pricing, they are mostly in-line with OLPX besides K18 at the ultra-premium end and Revolution Hair at the low/value end. There is very little pricing irrationality in this space

Thesis Point #2: large demand exists for this product, and it’s relatively easy to demonstrate that the product works

Per an interesting Evercore ISI’s survey, 50%+ of women believe their hair has been damaged due to hairstyling so OLPX address a relevant consumer need, and that 90%+ of women who tried it believe the product works

This is corroborated by OLPX’s internal survey who suggest NPS is very high, and future purchase intention / repeat purchase is high

Actual data from Numerator also corroborates OLPX’s the data points above on consumer loyalty and repeat purchase behavior. Numerator’s Omnichannel purchase panel consists of 100k US households (tracks both DTC and Specialty Retail channels for OLPX)

(source: Barclays retail team)

With such good trial response, OLPX clearly needs to expand the brand awareness / widen top of the funnel.  What’s interesting is that US awareness remains low per Evercore ISI survey – showing ~70% of women not having heard of the product (this sounds really high to me, but I believe that number is definitely smaller now given the survey was done around Fall 2021)

In a deck, OLPX officially cited a statistic that says it has current aided awareness of only ~11% amongst Sephora consumers, maybe that was from a few months ago, but that certainly points to a lot of upside opportunity

Thesis Point #3: meaningful category / product extension opportunity after acquiring so much consumer goodwill

There is plenty of white space in the existing TAM (Prestige hair care) where it can fill by launching new products with a “test and learn” approach; it plans to launch 3-4 products per year. So where are the white spaces?

By product

OLPX doesn’t have anything in dry shampoo, hair styling (spray / gel), or textured hair area

By Solution

OLPX doesn’t have anything in anti-frizz, color protection, scalp care, and straightening area

Its IP in keratin bio-marker may help in the straightening and perm area

Largely absent in the hair coloring business (high SKU complexity though)

In general, OLPX can rely on its deep social network of stylists to gain continuous insights into what hair concerns are top of mind such that it can inform its R&D agenda

 How OLPX’s offerings look on a typical salon distributor grid (Sally Beauty in the example below)

(source: Barclays retail team)

The real humongous oppy is adjacent TAM expansion into mass hair care and then into skin care one day. I hate talking about fluffy BS-esque TAM expansion, but it’s sheer incredible that vast majority of OLPX consumers want to see skin care lines + half of them said they want to switch to OLPX skin care products without it even existing yet (per company survey).  Is this exaggerated? Most likely, but it shows the strong (almost irrational) brand affinity

Since this is value investor club, we aren’t going to underwrite any of that optionality

Thesis Point #4: differentiated marketing strategy with tremendous focus on Earned Media Value vs. Paid Media Value

Gate keepers and influencers for consumer products are different now vs. before. While brands used to pay celebrities and use the sales associates in Beauty counters on 1st floor of department stores to influence consumer decision, that’s shifted today to loose influencers creating “unauthorized” content on Social Media, consumers are gravitating towards brands with authentic DNA

OLPX is the No.1 “EMV” hair care company according to Tribe Dynamics, an influencer marketing analytics co. EMV / Earned Media Value is proprietary metric for measuring the performance of digital earned media – by assigning EMV to each social media post created about a brand based on the engagement associated with the post

Demonstration of OLPX’s impressive community-based marketing prowess (#s are higher by now):

Massive content library built over the years (latest TikTok view is “well over 750 million”):

Per Tribe Dynamic, OPLX “earns” marketing dollars in social media platforms equivalent to ~20% of net sales, and this EMV as % of sales (illustrated below) is much higher for OLPX than its peers given base revenue size difference

Thesis Point #5: unique financial profile (“Rule of 100” instead of “Rule of 40”) could warrant scarcity value

It’s really difficult to find a profitable company with a higher “combined revenue growth % + EBITDA margin %”. People think Rule of 40 is good (revenue growth % plus FCF margin %, I use EBITDA here as a proxy), but Olaplex has been putting up 100%+

OPLX has guided to a lower “medium term EBITDA margin” to ~55% to 60% by middle of the decade but it creates 2 polarizing debate

On one side, you can argue medium margin could be higher than that given what’s been achieved to-date and high GM % (~80%) with incredible marketing efficiency

On the other hand, there is a more existential worry about how much incremental investment needs there might be to keep scaling this company and building out a durable global beauty franchise

I can see both sides of the argument, one drives operating upside and one downside

OLPX is already guiding 2022E EBITDA margin to be ~400bps lower YoY given inflation + incremental investments. It plans to double down on Sales and Marketing model and increase R&D investment behind science-backed innovation ahead of revenue growth, it wants to bulk up organization with new hires to build up more capability / is expecting more public company costs. There will be a slight degradation in Adj. Gross Margin given some ingredient / manufacturing cost inflation that can’t be offset by mitigation efforts

The bear case is “is OLPX just massively over-earning on margin”? Here is the defense argument and I think there is quite some truth to it (only time will tell):

Selling and Marketing: Products that work / can demonstrate immediate results require less of a push than prestige products marketed on “imagery”, OLPX’s online stylist community and ability to “earn digital media” could be a structural competitive advantage, these are assets not captured by traditional accounting

R&D: This DOES need to step-up, as OLPX needs to think more creatively about other active ingredients interacting with “dead” proteins like keratin in hair / nails. However, even Estee only spends ~1.5% of revenues on R&D so it’s not going to derail margin

G&A: OLPX embraces a “Future of Work” model with regard to low real estate footprint and reliance on 3rd-party co-manufacturing. OLPX is the “OG” of remote working (they’ve been doing this “WFH” thing since 2014, way before the pandemic) and to this date doesn’t have an HQ office (only some sites for R&D work). You can argue that instead of OLPX spending too little, legacy peers are too inefficient on G&A spend (30%+ of revenue)

Potential financial trajectory

Revenue near-term drivers

·         Continued box roll out at Specialty Retail -- OLPX has discussed potential to expand brick & mortar presence by 3.5x

·         It is already in all Sephora US stores but can further improve penetration – OLPX basket penetration improved from 9% in 2021 to 12% currently

·         Sephora at Kohl’s in US: currently 200 ish stores ramping up to 650 in 2022 and 850+ stores by 2023

·         Sephora in Europe: only in ~50% of Sephora’s in Europe, 450+ incremental doors to go in Europe + SE Asia

·         ULTA: Olaplex No. 1 and No. 2 are now offered at ULTA salons (started Q4 2021), but it’s simply a first step before full product line-up launch at front of store

·         Europe: Expanding to more doors with Douglas, also eyeing at 60k pharmacy and perfumery door oppy in key EU markets

·         Plan to launch In prestige department stores

·         No former plan to enter China in scale yet, but OLPX was #1 hair care brand across all classes of trade on Tmall Global for Singles’ Day 2021 (China is likely LSD % of revenues)

Cost drivers

You should reasonably bake in some moderate GM % headwind, and operating deleverage from S&M and R&D

Here is an illustrative financial summary

Valuation and Return Expectation

Comps suggest 2x PEG is the minimum unless there is real fad risk (YETI, SKIN). Estee Lauder and L’Oreal are growing at HSD % organically and trade at low 30x NTM P/E (PEG is closer to 3x). You can argue Monster and LULU are much more established brands so they also deserve more of a PEG premium given durability in growth

The play here is OLPX is trading at “closer to GARP multiple” despite still in the ultra-fast part of the growth curve, so the valuation adjusted for growth is more than reasonable. I can easily see the shares double or more from here, but I admit it’s hard to identify catalyst for multiple expansion – the company has beaten and raised revenues / EBITDA twice since IPO in Fall 2021 and stock traded down on both days

Concern is on growth durability / the unknown unknown that derails growth – I don’t see it happening anytime soon but it’s that “skeptical narrative” that has been haunting this stock

Reward: If you believe this is a 20% EPS grower beyond 2024 and get north of 1x on PEG, you can pencil out a total return potential of between ~55% and ~140%, or a 2-year IRR between~ 25% and ~60%

Downside: unless biz is blowing up, OLPX should be on-track to earn ~60c EPS In 2022, and let’s just say growth runway is “over” and this is a 5% organic growth consumer staples from here for argument’s sake (super bearish assumption), put 20x on that and you get $12, down 17% from here. At that price, it’d be an $8bn implied market cap and could be acquired by a large global CPG company to achieve “organic growth accretion” and EPS accretion at the same time (with their IG-rated cheap debt)

Blow-up Downside: if you believe this is a pure TikTok-driven fad brand with no staying power, you can pencil out more aggressive downside, but I won’t entertain that scenario yet as long as the co is executing

Risks

1)    Competition: if a major competitor launches a hair care product focused on bonding that starts to steal the narrative away from OLPX. So far L’Oreal has launched Redken Acidic Bonding but that hasn’t made an impact, but K18 is the latest viral brand to watch out for

a.    K18 is the latest hot brand (with single product) that is trying to market itself like OLPX – “Science-based”

b.    This brand didn’t emerge / break out until 2021 but has been very viral on TikTok as of late

c.     Markets a patented leave-in treatment with active “biotechnology” that works on a molecular level to repair hair damage

d.    Secret ingredient is “K18 Peptide” – also contains some “amino acids’

e.    Only 1 product (3 SKUs/sizes) offered to consumers at retail

f.      Entered more than 500 Sephora doors in US in December 2021

g.    Brand projecting $100-150mm sales in 2022

“…the brand’s K18 Peptide carries amino acids inside the hair cortex to reconnect broken bonds and keratin chains – for hair like new in 4 minutes, said the company. It can be used immediately after chemical services to repair damage done during the service, and at home to keep hair in its healthiest, strongest state…”

K18 Founder on strategy diff vs. OLPX:

“I have a huge respect for Olaplex and what they built in the last five years,” he says, “At the same time, our mission is driven by less is more. Everything has been about more, more routines, and that resulted in more needy hair. Your hair is needy for products, for your attention, and what we believe is that less actually works better for hair. So, to us, it’s not about how do we launch multiple products. It’s about being thoughtful, more intentional. The less you do with the hair, the more you liberate your hair, your hair routine and your hair expression

2)    Supply chain vulnerability and risk of ingredient / package shortage: Third-party contractor Cosway manufactures products accounting for 75%+ of net sales in 2021. Company should be in the middle of supply chain diversification, the reliance on Cosway is too much IMO but there is nothing unique about Cosway / takes 6 months to form 1-2 more contract manufacturing relationships

3)    Recently OLPX faced some negative PR due to lilial (a fragrance) classified as “reprotoxic” that is in Olaplex No. 3. Olaplex has removed lilial from the product globally and says the small portion of lilial has no scientific impact on fertility

4)    Secondary risk by PE owner, Advent still owns bulk of the stock and has a very low cost basis, giving this stock a high degree of overhang, but hey that’s why the “opportunity exists”

5)    Recession that is severe enough to make consumers pause on premiumization trend in haircare

Catalyst

Consistent growth execution