Loha (LOHA) intends to raise $25.7 million from the sale of its Class A shares in a U.S. IPO.

The company sells premium and healthy-oriented grocery and retail products for discerning customers in China.

LOHA is growing quickly in a promising market segment but the IPO is expensive. My opinion is NEUTRAL based on high valuation.

NEUTRAL

Shenzhen, China-based Loha has developed a distribution and retail network in China that sells premium healthy and fresh products to Chinese consumers.

Chairman and CEO Yanyue Zhang has been with the firm since founding and was previously founder of Lohas Agricultural and Lohas Mobile IoT Trading Platform.

Loha has developed relationships with more than 100 suppliers from 16 countries and the firm is 'now actively pursuing the smart retail development of fresh products through our smart micro marts, which are intelligent vending machines that provide a unique shopping experience.' The marts are located in large cities with high urban density.

The company’s primary products include:

  • Imported fruit
  • Wild-harvested seafood
  • Green vegetables and eggs
  • Healthy dry goods

Loha has raised $9.5 million from various investors including Lohas World (controlled by Chairman/CEO Zhang) and JW Investment Management, so the firm is relatively lightly capitalized.

The company manages its entire vertical distribution channel, via its 'Farm to Business to Consumer' business model, thereby eliminating the need for middlemen. It seeks to keep minimal inventory and requires pre-payments for orders.

Loha sells through three channels:

  • Wholesale
  • Smart micro marts
  • Online group purchasing

Group purchasing is from social media-organized buying groups that receive discounts via bulk purchases.

On the marketing side of the business, selling expenses as a percentage of revenue have dropped as revenues have increased, a good sign that economies of scale are favorable.

The selling efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of selling spend, fell to a still impressive 8.4x in the most recent six-month period.

According to a 2019 report by Think China, the market for health food in China is expected to reach RMB300 billion by 2021.

This growth would represent a 26.2% increase from 2017's result of RMB237.6 billion.

The main drivers for this expected growth are growing demand for healthy products among older consumers in China and new e-commerce selling platforms aimed at younger demographics.

Management says its approach results in lower overall costs, tighter inventory control and greater visibility into the supply chain than other approaches.

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

  • Growing topline revenue, at nearly 24% year-over-year
  • Increasing gross profit (12.5%) but decreased gross margin
  • Lowered operating profit and margin
  • A swing to negative cash used in operations

The firm’s recent operating statements are below:

lohapl

As of September 30, 2019, Loha had $2.3 million in cash and $10.1 million in total liabilities.

Free cash flow during the twelve months ended September 30, 2019, worsened to a negative ($7.9 million).

LOHA intends to sell 4.3 million shares of Class A stock at a midpoint price of $6.00 per share for gross proceeds of approximately $25.7 million, not including the sale of customary underwriter options.

Class B shareholders will be entitled to five votes per share versus one vote 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 $358 million.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 7.26%.

Per the firm’s most recent regulatory filing, the firm plans to use the net proceeds for expanding its business through additional marketing and branding efforts and for general corporate purposes and working capital.

Commentary

LOHA is a growing specialty retailer in China that seeks U.S. public investment for its expansion plans.

The company’s financials show a firm growing revenue and gross profit with enviable operating margins and net profits.

Sales and marketing expenses have dropped as revenues have increased, a positive signal on the firm’s marketing efficiency as it has grown its revenue base.

However, Loha is using increasing cash flow in operations and margins are dropping.

The market opportunity for speciality retail and health food in China is forecast to grow strongly in the coming years, as discerning consumers seeks healthier alternatives to existing food and product options.

On the legal side, 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 have an interest 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 the legality of such arrangements. Prospective investors in the IPO would need to factor in this important structural uncertainty.

As a comparable-based valuation, the firm is asking IPO investors to pay a roughly 3x valuation compared to a basket of U.S. publicly held speciality retail company valuations as compiled by the NYU Stern School.

While I’m impressed by the market potential in healthy foods and products within China, paying a 3x premium for that growth potential is too much.

So, my opinion on the IPO is NEUTRAL at its current price of $6.00. Should the firm trade in the public market at or below $4.00 per share, I might be interested.

NEUTRAL

Expected IPO Pricing Date: To be announced.

(I have no positions in any stocks mentioned, no plans to initiate any positions within the next 72 hours, and no business relationship with any company whose stock is mentioned in this article. Information provided is for educational purposes only, may be incomplete or out of date, and does not constitute financial, legal, or investment advice.)