Will Douglas IPO be a dog or a darling?

In Jean-Paul Sartre’s 1944 play No Exit, hell occupies a drawing-room with other people who can’t leave even when the door opens. True misery, the play suggests, arises from an inability to use freedom of choice to take ownership of one’s fate.

In 2024. hell for private equity firms is a clogged IPO market and a backdrop of dormant M&A interest. They have been trapped with a “towering backlog” of an estimated $3tn of assets to sell. But unlike Sartre’s feckless characters, buyout firms are determined to seize control of their destiny and will seek to exit if the door opens a crack.

On Monday evening, German beauty products retailer Douglas announced a price range for its up-to €907mn IPO. For buyout giant CVC, this offering marks an investment milestone. It had bought its stake from Advent back in 2015, and it’s understandable that CVC is looking for an exit path. Nine years is a very long holding period for private equity.

The strong recovery of the equity markets has provided a window to take the company public, but the shareholders — CVC and the Kreke family — aren’t taking anything for granted. They and the lead banks are pulling out all the stops to make the IPO a success. Will it be one though?

Well, this IPO does have some things going for it — not least buoyant equity markets.

For one thing, the company is well-established and had been listed in Frankfurt until 2013. This is a substantial business of real substance, operating in 22 countries and employing 18,000 people. It is also performing well, with management saying Douglas is on track to achieve a midterm target sales growth of around 7 per cent and an EBITDA margin of around 18.5 per cent.

The offering also isn’t a case of private equity doing a runner: CVC and the Kreke family are in fact injecting an additional €300mn — for no consideration — to reduce debt on the balance sheet. And the valuation looks fairly priced at around six times 2024 EV/EBITDA compared to 14 times for its nearest peer, the American firm Ulta.

Moreover, the deal architects have thought creatively about how to enable underwriters to stabilise the price without changing the size of the offering. The IPO features a “brownshoe”, which means that if the deal trades off and the underwriters have to buy shares to support the price, they can “put” up to 13 per cent of the offered shares back to CVC and the Kreke family. (Alphaville explained how the far more typical “greenshoe” works in this post on Birkenstock’s IPO.)

The five IPO global coordinators are also putting their money where their mouth is. They are providing margin loan financing to CVC and the Kreke family for the capital contribution and (if necessary) the shares purchased upon exercise of the brownshoe. Presumably — as with Softbank’s IPO of Arm — the margin loan support was a condition for a senior syndicate role, but nevertheless it demonstrates a tangible commitment from the banks.

Within hours of the price range announcement, the underwriters informed the market that the deal was oversubscribed. This bodes well for the offering, whose success would create an ideal backdrop for CVC’s own IPO in Amsterdam expected later this year.

But this is no time to be complacent, because if you wash off the foundation*, you can find a few wrinkles. This beauty will definitely be in the eye of the beholder.

For one thing, investors take these “the-book-is-covered” messages with a pinch of salt. Often at the outset of bookbuilding, hedge funds put in large indications as a placeholder, as they wait to see if fundamental investors come in later. Right now, there are about 80 hedge funds with dedicated European new issue strategies. They’re easy to get into the book, but hard to make stick.

The most salient issue is that the company carries a lot more leverage than public investors will tolerate; different agencies calculate the leverage differently, but roughly speaking, the net debt is around 4.7 times adjusted EBITDA.

This means the IPO will have to raise a lot of new equity. Indeed the IPO involves an €850mn issue of new shares, as well as a small (€57mn) selldown by management to cover tax liabilities. It’s the need to deleverage that explains why CVC and the Kreke family aren’t selling and indeed are putting in even more money.

Another challenge is the deal size for what is a small-to-mid cap company. The underwriters will need to allocate €907mn of stock. Ideally, you would allocate, say, about €600mn to fundamental or “long-only” investors, which in turns requires gross demand of €1bn or more from them. After all, you need them to buy more once the stock starts trading. In addition, you don’t want to allocate a really high percentage to a long-only order (unless the investor specifically says it wants to be “filled”), because it signals weak demand and makes investors skittish about the after-market.

The IPO global coordinators are presumably focused on generating that long-only demand, and it will require some elbow grease. They will need substantial orders — tickets of €10-20mn won’t make much of a dent.

German institutions are typically cautious, and not many have the heft to put in the big orders that this deal needs. The key question is therefore whether the global mutual fund complexes have the appetite to put in for a large size for a €3bn market cap retail firm with moderate growth. The prospectus also has no indications from named cornerstone investors, as is sometimes seen on IPOs.

Then there’s the company. The offering is coming at a steep discount to Ulta, but the dynamics of the US market are very different. And with a $27bn market cap, Ulta is a much larger company. Moreover, while Douglas has performed well, it comes to market after a prolonged period of challenges (detailed at length here in MainFT).

For investors with a choice of stocks to buy, is this kind of business a must-own? The European IPO pipeline includes other very attractive companies with differentiated business models. The danger is that investors think the company is “fine” and “solid” but fall for the pretty face and batted eyelashes of other names.

Finally, there’s the overhang. As we mentioned, CVC purchased its stake from Advent nine long years ago. By any reckoning, it has held on to this asset for much longer than the normal 3-5 year holding period. A stock exchange listing would enable CVC to sell shares via a series of block trades, thus making an eventual exit much more achievable. So any investor in the IPO will expect more supply of stock to come as lockups expire.

In short, the shareholders and underwriters are doing everything to ensure the IPO’s success. From a capital markets standpoint, they are doing the right things. The valuation doesn’t seem like a stretch, the shareholders are putting in more money to bring down leverage, and the banks are offering balance sheet and have the firepower to stabilise.

At the same time, the markets are as favourable as they have been in a long time, investors have pent-up demand for IPOs, and the flotation is coming before the spring rush of new listings.

It will be interesting to see if this is enough for Douglas to float successfully and trade well.

*changed from mascara, which didn’t make a lot of sense. Clearly Craig and the editor of the post aren’t on top of their beauty products.