THG courted by 'numerous parties' – the ultimate cheap date?

Despite its recent slump, THG (THG) isn’t among the most heavily shorted UK stocks; it’s around 80th in the pecking order. And some of the concerns over accounting treatment (rather than corporate governance) may well come with the territory where proprietary tech platforms are concerned, or, rather, companies with a higher proportion of enterprise value derived from intangible assets. The shift towards a digitalised economy, in which software, data, patents and customer franchises make up the lion’s share of enterprise value, has rendered income statements and balance sheets less relevant in a sense.

It’s around 25 years since more capital was given over to intangible rather than tangible assets in the US economy and the gap has widened appreciably in the intervening period. The accelerated move away from the bricks ‘n’ mortar economy has provided an ongoing challenge for regulators and the audit industry alike. There are plenty of examples of how accounting standards have struggled to keep pace with commercial change, but an oft-cited concern centres on the way in which some intangibles were expensed immediately, and therefore didn’t always show up as assets on balance sheets. How does one attempt to value an idea, I wonder? Unfortunately, the speed of accounting reform is glacial in nature, but at least the various anomalies have provided fertile ground for activist investors.

But it’s doubtful whether THG’s accounting practices were uppermost in the mind of founder and chief executive Matt Moulding as the ecommerce group revealed a mixed set of figures for 2021. Shares in the retailer, formerly known as The Hut Group, have absolutely cratered since October 2021, when investors were spooked at its inaugural capital markets day when speculation mounted that the group’s main backer, Japan’s SoftBank (JP:9984), was suffering buyer’s remorse.

They may have been prescient in that regard. The Financial Times recently reported that SoftBank had liquidated many of its main positions in its abortive internal hedge fund SB Northstar, although it may not be overly keen to crystallise its paper losses on THG given that the shares have lost 84 per cent of their value since September. In June 2021, SoftBank’s interest was confirmed at 80.6mn shares, a holding then worth in the region of £495mn. At the time of writing, the investor’s involvement equated to a 6.6 per cent holding, together with board representation. The preliminary statement makes just one free-text reference to SoftBank, highlighting a “meaningful financial and trading partnership”. Well, the Japanese backer certainly couldn’t argue with the first part of that statement.

In 2021, the group recorded a 7 per cent increase in adjusted cash profits to £161mn, with the Beauty and Ingenuity segments the standout performers. It also incurred an operating loss of £137mn “impacted by certain non-recurring costs”. We have previously raised concerns over the classification of some of these costs, specifically those relating to Covid-19. There can be no doubt that recurring revenues are heading in the right direction and sales momentum has been maintained in the first quarter of 2022 against a tough comparator. However, cash margin guidance has been cut to c6 per cent from c8 per cent due to inflationary pressures. The group does not anticipate passing on all the increased input costs to customers, and it may well be more prudent to continue building its catchment during a periodin which discretionary incomes are shrinking. 

Intriguingly, Moulding told shareholders that the board had received indicative proposals from multiple parties in the past few weeks, none of which were felt to have reflected the underlying worth of the business. It wouldn’t be surprising if the group was attracting prospective suitors given the severity of the sell-off since the final quarter of 2021, and there is even the outside possibility that it may be taken private again.

The idea that the shares are in play, perhaps with private equity in the frame, should support the valuation, at least over the near term. The market responded positively to the release, sending the shares up by nearly a fifth, albeit from a low base. Analysts at Jefferies believe that the “valuation compares unfavourably to peers with lower margins/growth and with more elevated cash burn”. We have always been wary given corporate governance issues, the golden share arrangement, the relationship with SoftBank, and historical accounting questions.

Last IC view: Hold, 608p, 16 Sept 2021