Summary

The cosmetics market is expected to expand in the future.

The technological products offered by SKIN are what set the company apart from traditional facials.

SKIN has a business strategy geared toward estheticians

Investment thesis

The Beauty Health Company (NASDAQ:SKIN) stock, in my opinion, is fairly valued. Having said that, the company has good growth prospects, and I would reconsider going long at a lower valuation. The company hopes to capitalize on the growing trend of consumers seeking healthy skin through treatments rather than concealing flaws with makeup. HydraFacial’s technology is appropriate for both young and mature skin, and its multi-channel strategy allows it to effectively reach customers. It is also a better alternative to manual facials, as its painless and reasonably priced treatment produces visible results.

Business overview

The Beauty Health Company, also known as HydraFacial, is in the business of beauty and health. The company’s mission is to “democratize and personalize skin care solutions” by catering to estheticians, consumers, and partners by bridging the gap between the medical and consumer retail sectors.

Beauty industry has long-term growth prospects

The future of the beauty and health industry will be heavily influenced by a few emerging trends, in my opinion. Firstly, as millennials age, they become more concerned with skin care and are more willing to spend money on upscale options. Similarly, they value experiences over material possessions when making purchases. As the millennial population continues to rise, so too must the methods used to effectively advertise to this demographic. In the selfie era, skin care has risen to prominence, and as a result, influencers and social media have a disproportionate amount of sway over consumer decisions.

Even more importantly, market research conducted by HydraFacial indicates a growing trend away from covering up imperfect skin with products like makeup and toward treating the skin from the inside out in order to make it healthy and reveal its natural beauty (according to the prospectus).

Consumers are also looking for brands and products that appeal to their emotions as well as their rational needs. The way SKIN has structured its company, combining health and beauty and making skin health accessible to people of all ages, races, and genders in a way that is both convenient and easy to access, gives me confidence that it can deliver on all of these fronts.

The global skin care and hair care markets, as per the S-1, are currently valued at more than $200 billion, with a 3% CAGR expected from 2019 to 2024. Also, the S-1 also indicates that skin care will drive approximately 75% of all incremental beauty sales during that time period. As a category creator (discussed more below), I think HydraFacial has a solid footing in the market, and its brand, scale, intellectual property, community, and partnerships are all excellent tools for expanding the company’s reach in new markets.

In addition, HydraFacial’s patented technology works well for both young and mature skin (according to S-1). More importantly, I believe multi-channel strategy (as discussed below) allows it to reach customers conveniently and effectively no matter where they may be.

SKIN has a strong technology product offering that sets it apart from manual facial

At the intersection of the rapidly growing skin care market, the spa industry, and the medical aesthetics field is where you’ll find HydraFacial. I think HydraFacial stands out from the crowd thanks to these unique characteristics. There were traditionally three routes to acquiring skin care products for the general public.

1. One option is to invest in visiting professional clinics that provide services such as lasers, fillers, and toxins, etc.). These procedures are uncommon but highly effective.
2. Traditional manual facials are one example of the second strategy, which has spread mainly through lifestyle channels such as facial clinics.
3. The third strategy involves making use of over-the-counter skin care items. Some of the many channels that help bring products from factories to shoppers’ hands are online marketplaces, niche retailers, megastores, and discount chains.

In my opinion, HydraFacial has successfully connected the professional skin care, lifestyle, and retail channels, thereby expanding the total addressable market. Being a regular customer at facial clinics that employ the second method, I can attest to the discomfort associated with manual facials (and the resulting red scars that can last for days).

This is one of the many reasons why I believe HydraFacial offers a superior, painless, and reasonably priced option for skin care. In just 30 minutes, the signature HydraFacial treatment cleanses, extracts, and hydrates the skin using a revolutionary system that provides visible results and a satisfying glow. Aestheticians can be quickly trained on the systems, and they are easy to use. Clients also report no redness, after treatment, in contrast to those who receive manual facials.

Business model optimized for estheticians

HydraFacial has created the HydraFacial Nation, a group of devoted estheticians and consumers. This, I believe, is made possible by HydraFacial’s cutting-edge skin care solutions, in-depth training, marketing initiatives, and powerful social media campaigns.

HydraFacial’s market research, in the prospectus, shows that 20% of users receive more than six other treatments in a given year, which means additional spend on other products for the esthetician. I believe this is the single most important reason why estheticians love to use HydraFacial as it provides favorable economics for them. With such high incremental margins that go straight to the bottom line, this represents a substantial increase in profits for estheticians.

Estheticians will likely be able to make a profit off of upselling additional HydraFacial products thanks to the high number of returning customers.

HydraFacial, on the other hand, has built a strong community of estheticians who are the biggest advocates of the products by focusing their efforts on educating them regardless of channel. The result is apparent, for instance, the prospectus claims that most HydraFacial-related content on social media is generated by HydraFacial practitioners and their patients posting about their experiences on their own volition. This is a noteworthy achievement to highlight because the opinion of a customer carries more weight than that of the service provider or HydraFacial.

Large installed base provides revenue stability and lends credence to product quality

Today, more than 15,000 HydraFacial delivery systems are in use. Delivery systems grew as a result of rising interest from estheticians, strong domestic sales, and rapid international expansion. Also to date, HydraFacial has established distribution networks in 80 countries. Having a large installed base has two main advantages:

1. Stable revenue stream: A more stable revenue stream from consumables delivered will reduce the reliance on one-time sales and boost the company’s ability to reinvest and maintain liquidity.
2. Enhanced brand reputation: In my opinion, a high rate of adoption from satisfied customers (both patients and aestheticians) is a strong indicator of a high-quality product and, thus, the importance of a positive brand reputation.

Effective marketing strategy

I believe that HydraFacial’s ability to market itself successfully is essential to the company’s overall success. Their advertising spending plan revolves around a “push and pull” marketing strategy that actively involves service providers and end users.

Investment in push-side initiatives, such as educating estheticians, creating a reward programs, and bolstering other ongoing engagements, is something HydraFacial plans to keep doing. The recommendations of estheticians are often relied upon by patients who visit clinics, so it is important for HydraFacial to cultivate a loyal base of advocates.

Conversely, HydraFacial its focus on digital and location-based engagement in its marketing to consumers. This is also important because consumers represent the source of revenue. They need to be constantly marketed to so that when people think of facial treatments, HydraFacial is the first thing that comes to mind.

Valuation

According to my model, SKIN is currently roughly 6% undervalued. The model is based on management’s FY22 forecast (both revenue and EBITDA).

SKIN should continue to grow and ride on this wave of beauty trend through its marketing strategy and loyal base of estheticians. Estimates wise, my revenue and EBITDA forecasts in FY23 and FY24 are similar to consensus. The latest quarter was strong as well, which indicates good level of growth momentum.

SKIN is currently trading at 3.1x forward revenue, and I assumed it would trade in the same multiple in FY23. However, SKIN used to trade at a much higher multiple, so there is potential for a re-rating upward.

Based on these assumptions, I estimate SKIN’s stock to be worth $11.03 in fiscal year 23.

Risks

Competition from larger peers that could pressure pricing

HydraFacial can’t compete with the likes of many major consumer goods conglomerates in terms of size and fame. When there is little to differentiate one company’s offerings from another, competitors may try to steal market share by offering products at prices that are on par with or lower than the typical prices of the first company. These market forces could force HydraFacial to lower its prices, hurting profits and possibly costing the company some sales.

Past success in innovation is not representative of those in the future

The cosmetics and skincare market is highly responsive to shifting consumer preferences. The success of HydraFacial is dependent on its ability to accurately predict consumer tastes and adapt accordingly. If HydraFacial misses an opportunity, it might have to work harder in the short term to “catch up” to competitors who are already ahead.

Conclusion

The Beauty Health Company’s mission is to “democratize and personalize skin care solutions” by providing services to estheticians, consumers, and partners by bridging the gap between the medical and consumer retail sectors. HydraFacial has a strong technology product offering that sets it apart from manual facials, and its multi-channel strategy allows it to reach customers conveniently and effectively. HydraFacial’s patented technology works well for both young and mature skin, and its brand, scale, intellectual property, community, and partnerships are all excellent tools for expanding the company’s reach in new markets.