Overview

My recommendation for The Beauty Health Company (NASDAQ:SKIN) is a sell rating, as the 3Q23 results were not satisfactory at all, and the outlook has become even more uncertain. I expect near-term demand to remain weak as customers defer their orders until they are sure that Syndeo 3.0 works. Investors are not going to give any credit for recovery until they see solid results, in my opinion. Any positive guidance is unlikely to turn around the sentiment, as I believe investors have basically lost trust in management. Lastly, there is no permanent CEO in place to properly turnaround this ship. Note that I previously had a hold rating for SKIN as I was uncertain about its 2H23 performance, as the implicit acceleration was hard to attain. I expected investors to avoid the stock, as sentiments were very negative back then.

Recent results & updates

3Q23 proved my point that one should wait for 3Q23 results before deciding to invest. SKIN reported 3Q23 sales of $97.4 million, which missed consensus estimate of $116.2 million, a delta of $18.8 million, or 16.1%. The miss was driven by weak performance across all segments, where systems sales came in at $51 million and consumables sales came in at $46.4 million. The same weakness was seen in the adj gross margin line, which declined by 1200bps to 62.5%. As a result, adj EBITDA came in at $9.1 million, or 9.3% margin, which declined by 900bps vs last year.

After the 3Q23 results, I have reinforced my view that the stock is going to continue to be wrapped in negative sentiment. Below, I list out 3 key reasons for my belief.

Firstly, management has revised their guidance. Net sales are now guided at $385 to $400 million, down from the previous range of $460 to $480 million due to lower demand in US Syndeo systems. Management has also suspended their FY25 outlook, which previously was guided for net sales of $600 to $700 million. Honestly, the discontinuation of FY25 targets is unsurprising, as I highlighted before, and the implied acceleration is hard to underwrite. That said, with this, it effectively removed any near-term bull case that some investors might still be holding on to (if SKIN hits FY25, the stock could be worth $X). As such, without any meaningful forward-looking commentary beyond 2023E to replace this prior outlook, I think investors will take on a very conservative approach to their near-term estimates (for myself, I am assuming demand doesn’t recover at all because of the reasons below).

Secondly, it is uncertain whether Syndeo 3.0 will work without issues. There have been a number of issues with the Syndeo series since its inception. Starting with Syndeo 1.0, it faced issues like treatment interruptions, distracting noises, difficult bottle insertion, etc. Because of provider challenges, SKIN was not able to replace the products fast enough. In 2022 and 1H23, SKIN introduced Syndeo 2.0 to address this, which was an upgrade but still has some issues. Once again, to work around this, SKIN released Syndeo 3.0 in order to work around these issues. Hence, with 3.0 out, SKIN wrote off the entire 1.0 and 2.0 inventory, resulting in a $18.8 million impairment charge. Even though Syndeo 3.0 has been doing well so far, I am worried that the same problems that plagued versions 1 and 2 will persist in version 3.0 because it has only been available for less than 6 months. If I were a customer, I would be insanely mad at this development, especially if I bought the 2.0 to realize that it cannot fix all the issues, and now I have to buy 3.0. I believe there are a lot of scarred customers that are not going to upgrade to the 3.0 system until it is proven to work. Which means, near-term demand is going to be weak. I believe this dynamic is already evident in the results as installed base only grew 392 sequentially, a massive drop from the ~2.3k saw in 2Q23.

Thirdly, which I argue is probably one of the biggest reasons for uncertainty, is that SKIN currently has no official CEO at the helm (it has an interim CEO now). The previous CEO, Andrew Stanleick, left the company just under two years ago. In the midst of a massive product and branding challenge, SKIN has no permanent leader to lay out a clear strategy to turn around the entire situation. I am not sure about you, but I am not comfortable riding this ship.

Valuation & risks

One method I used to size the potential downside is what is the trough multiple that SKIN could trade at if the business growth turns negative from here (i.e., Syndeo 3.0 fails again). A good precedent would be Nu Skin Enterprise (NUS), where its valuation took a steep dive to 0.6x forward revenue when growth dropped to the negative region. I believe SKIN could see the same trajectory if growth starts declining. Assuming SKIN trades at 0.6x forward revenue, the stock would see huge downside, especially because of the net debt position.

On the flipside, the upside risk is if Syndeo 3.0 proves to work consistently, solving all the previous issues that surfaced, the stock could work eventually as customers and investors regain confidence in the growth potential of the business.

Summary

In summary, I have downgraded my rating from a hold to sell for SKIN to unsatisfactory 3Q23 results and increasing uncertainty in the outlook. Several factors contribute to my negative outlook. Firstly, revised guidance lowering net sales projections and suspending FY25 outlook removes potential upside scenarios. Secondly, uncertainty persists around the effectiveness of Syndeo 3.0, following issues with previous versions, leading to customer apprehension and potential weak demand. Thirdly, the absence of a permanent CEO amid significant challenges in product and brand development adds to uncertainty.