Hydrofarm Holdings Group (HYFM) intends to raise $130 million from the sale of its common stock in an IPO, according to an amended registration statement.

Petaluma, California-based Hydrofarm was founded to design, manufacture, and distribute controlled environment agriculture products, also known as vertical farming, primarily in the United States and Canada.

Management is headed by Chairman and CEO Bill Toler, who has been with the firm since 2019 and was previously CEO of Hostess Brands (TWNK) and has more than 35 years experience in the supply chain management and CPG business.

Below is a brief overview video of a high-tech vertical farming operation:

Source: Bloomberg Quicktake

The company’s primary offerings include:

  • Lighting
  • Equipment
  • Grow Media
  • Nutrients
  • Supplies

The graphic below shows examples of the above categories:

hydroprod

Hydrofarm has received at least $182 million from investors

The company markets its products primarily through its eCommerce marketplace.

Hydrofarm sells more than 80% of its products to specialty hydroponic retailers, with the remaining sales through a smattering of gardening equipment and supply locations such as garden centers, hardware stores, commercial greenhouse builders and commercial resellers

Selling, G&A expenses as a percentage of total revenue have been dropping as revenues have increased.

The Selling, G&A efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Selling, G&A spend, quadrupled to 2.0x in the most recent reporting period.

According to a 2018 market research report by Grand View Research, the global market for vertical farming was an estimated $2.5 billion in 2018 and is expected to reach $9.7 billion by 2025.

This represents a forecast very strong CAGR of 21.3% from 2019 to 2025.

The main drivers for this expected growth are a growing adoption by consumers of fruits and vegetables that are produced in an environmentally friendly manner as well as the strong growth of population in large urban centers.

Also, indoor farming can produce crops throughout the year, protecting crops from extreme weather.

Below is a chart showing the historical and projected future growth rate of various aspects of the vertical farming market in Canada:

canadahydrofarmmkt

Major competitive or other industry participants include:

  • Scotts Miracle-Gro (SMG)
  • National wholesale distributors
  • Small regional competitors

Hydrofarm’s recent financial results can be summarized as follows:

  • Growing topline revenue, at an accelerating rate
  • Increasing gross profit and gross margin
  • A swing to operating profit and net income
  • Uneven cash used in operations

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

hydropl

Source: Company registration statement

As of September 30, 2020, Hydrofarm had $32.9 million in cash and $181.3 million in total liabilities.

Free cash flow during the twelve months ended September 30, 2020, was negative ($10.5 million).

HYFM intends to sell 8.67 million shares of common stock at a proposed midpoint price of $15.00 per share for gross proceeds of approximately $130 million, not including the sale of customary underwriter options.

Investors and company insiders have indicated an intent to purchase up to $30 million of the IPO at the IPO price. This is a significant vote of confidence in the firm and its ultimate valuation at IPO.

Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $582.4 million.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 27.32%.

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

The principal purposes of this offering are to repay existing indebtedness, for acquisitions, for working capital and other general corporate purposes, which may include the hiring of additional personnel and capital expenditures, to establish a public market for our common stock and to facilitate our future access to the public capital markets.

Management’s presentation of the company roadshow is not available.

Listed underwriters of the IPO are J.P. Morgan, Stifel, Deutsche Bank Securities, Truist Securities, and William Blair.

Commentary

HYFM is looking for public capital to pay down its debt and fund its expansion initiatives, which feature targeting the cannabis agriculture industry.

The company is headed by a veteran executive of major CPG and supply chain firms.

Hydrofarm’s financials show impressive topline revenue and gross profit growth, at an accelerating rate of growth and a turn to slightly positive earnings, likely part of a ‘window dressing’ approach to the IPO.

Selling, G&A expenses as a percentage of total revenue have been dropping; its Selling, G&A efficiency rate has quadrupled to 2.0x.

The market opportunity for selling vertical/hydroponic farming products in North America is expected to expand at a substantial rate over the coming years, so presents the company with a positive industry backdrop for its growth trajectory.

J.P. Morgan is the lead left underwriter and IPOs led by the firm over the last 12-month period have generated an average return of 87.7% since their IPO. This is a top-tier performance for all major underwriters during the period.

As to valuation, compared to direct competitor Scotts Miracle-Gro, HYFM is seeking a generally lower valuation multiple while producing a higher growth rate, albeit on a significantly lower topline revenue base.

Given the firm’s accelerating topline revenue and gross profit growth rates, reasonable IPO valuation and positive industry outlook, my opinion on the IPO is a BUY at up to $15.00 per share.

BUY

Expected IPO Pricing Date: December 9, 2020.

Glossary Of Terms

(I have no position in any stocks mentioned as of the article date, no plans to initiate any positions within the next 48 hours, and no business relationship with any company whose stock is mentioned in this article. IPO stocks can be very volatile in the days immediately after an IPO. Information provided is for educational purposes only, may be in error, incomplete or out of date, and does not constitute financial, legal, or investment advice. Past performance is no guarantee of future results.)

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