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Harry’s Acquisition & the Limits of Direct-to-Consumer Independence

Loose Threads May 9, 2019, 3:24:18 PM
Loose Threads

 

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Edgewell Personal Care, which owns razor brands such as Schick and Wilkinson, just purchased Harry’s for around $1 billion in cash and $370 million in stock. Harry’s co-founders Andy Katz-Mayfield and Jeff Raider will take over Edgewell’s U.S. operations as part of the deal. The sale marks a turning point in a long, winding road for Harry’s and its investors, one that has become emblematic of the promise, then peril, and now recalibrated promise of the digitally-native and direct-to-consumer revolution.

At first glance, the deal looks positive: a billion-plus dollar outcome, the resources of a larger company and continued employment for the founders and the rest of the team. But those high-level wins hide a number of other details that make the picture for Harry’s—and the digitally-native and direct-to-consumer landscape—less rosy.

Financing

Harry’s raised $461 million dollars, second only to Honest Company’s $505 million. While Harry’s exact valuation is unknown, it’s possible to cobble together directional information based on public reporting:

  • In July 2015, Harry’s raised $75 million, which valued the company at $750 million post money, according to TechCrunch and Pitchbook. This $75 million round means that it sold about 10% of the company—unless the round had secondary stock sales in it, which meant existing investors were cashing out without Harry’s needing to sell all of its own equity. Either way, the founders likely sold some of their equity as part of the deal.
  • Since then, the company raised almost $64 million in November 2017 and then $112 million in February 2018. As a company’s valuation rises, the amount of equity a company sells usually goes down. If we assume that Harry’s sold 5% of equity in each of its two most recent fundraises, the first would have put its valuation at close to $1 billion and the second would have raised it even further—potentially above $1.5 billion, depending on how much secondary stock was sold.

With all of this said, it is possible that Harry’s sale to Edgewell represents a down-round at $1.3 billion, although the stock portion of the acquisition could appreciate in value overtime. This sale price is evidence that Harry’s raised too much money and turned it into too little revenue (estimated around $300-400 million) to justify its last valuation—according to the Wall Street Journal, the company is almost profitable. Early investors likely did okay while later-stage investors did worse, but they could have had protections for preferred returns in the event of a sale, so no need to feel bad for them. Even so, the founders are walking away from this deal with tens if not hundreds of millions of dollars (as founders of Warby Parker, they likely already had plenty of money).

Yet it’s still too early to tell if the acquisition will be worth it. Dollar Shave Club, the first and largest exit in the digitally-native, direct-to-consumer space, sold to Unilever in 2016 for $1 billion when it had between $150-200 million in revenue (over six times revenue). But the company has since flatlined given its reliance on viral marketing, which is hard to manufacture, and digital marketing, which is becoming more expensive. Harry’s exit is bigger, but it is no longer a direct-to-consumer brand given its reliance on wholesale at Target and Walmart, among other companies.  

Business model

In the deal announcement, Edgewell and Harry’s executives said they saw the opportunity to form a new consumer product holding company that is well-versed in marketing and selling to modern consumers. This sounds nice, but it raises a number of questions about Harry’s past few years. Harry’s started with the premise of building a direct-to-consumer razor brand, but as it raised more money and encountered rising acquisition costs, it pivoted, first to vertical integration (it bought its factory), then to a holding company for multiple brands (it launched Flamingo for women and moved heavily into wholesale), and finally to a holding company and investment vehicle that would invest and share its infrastructure with other brands (it invested in Hims).

This evolution was not entirely intentional, but rather a forced exercise to continue justifying its expenditures and rising valuation. If the previous positioning of Harry’s was to be a modern CPG holding company, and it was unable to achieve that independently, what does it mean now that Harry’s and Edgewell are saying the same thing again? Edgewell’s chief executive stated in the announcement that “We’ve had an interesting product portfolio, but we’ve lacked a way to communicate with the consumer.” Harry’s now relies heavily on wholesale, so its ability to impact its new owner’s overall business in this way is questionable, whereas Dollar Shave Club has a stronger case to do provide this to an acquirer as a purely direct-to-consumer business. Together, Harry’s and Edgewell have more resources—Harry’s and its wholesale partners also share data, which is unconventional—but the premise of a direct-to-consumer holding company is a lot harder to actualize than it is to say out loud.  

What it means

The razor market perfectly encapsulates the state of the direct-to-consumer and digitally-native landscape. Razors are a small product that can ship easily, are relatively cheap to make and can be sold at a good markup. Their repeat use also means potentially good LTV and makes them viable for a subscription model.

Yet theories about their promise have not played out as expected. Dollar Shave Club was the outlier exit for years, although its timing was impeccable considering its early success was not going to continue. Walker & Company’s underwhelming exit looked like it would become the norm rather than an outlier, given the rising costs of acquisition and the brand’s explicit need to access larger marketing budgets, which P&G can provide. Now Harry’s is added to that list of exits, but its legacy is more complicated and comes with caveats.

As you’ve previously read, legacy CPG holding companies have continued to dominate the razor space, given their superior scale, marketing budget and distribution power. Dollar Shave Club, Walker & Company and Harry’s are now all owned by legacy CPG giants, none of them operating independently. Yes, these brands chipped away at some of the legacy conglomerates, but according to Euromonitor Harry’s commanded only 2.6% of the American market while P&G’s Gillette owned over 47% of it (Nielsen states that Harry’s held 6% of the market in the U.S.). Sure, Gillette has been around for a while, but that is partially the point—this is a game of time and scale, and there are few, if any, shortcuts.  

While people are celebrating Harry’s exit as a win for the direct-to-consumer and digitally-native landscape, the reality is more complex and potentially more chilling. Yes, exits are possible. But raising too much money—which will only happen to more companies as the cost to run and market digital businesses increases—continually limits the number of exit options for startup brands. The lesson for other brands is to navigate the landscape at a slower and more sustainable pace so that they have more of a choice when it comes to mergers or IPOs.

Harry’s founders said in the acquisition announcement that they considered going public, but that the sale made more sense. In reality, Harry’s would have had a very hard time in the public market given its poor capital efficiency and high valuation. While the founders are walking away relatively unscathed, they didn’t really have a choice. In the same way that Harry’s only sells two types of razors, the company only had two options: sell the company or cease selling its products. It chose wisely.

 

Source: Loose Threads

Topics: ecommerce, mergers & acquisitions