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Elevator Pitch
Baozun Inc.’s (NASDAQ:BZUN) [9991:HK] stock is rated as a Hold.
I touched on Baozun’s delisting risk and its second quarter financial performance with my prior August 29, 2022 article. In this latest write-up for BZUN, I discuss about the company’s recently proposed M&A transaction, and share repurchases.
I retain a Hold rating for BZUN. On one hand, I recognize Baozun’s inexpensive valuation multiples, and I have a favorable view of the company’s decision to repurchases its shares. On the other hand, I am of the opinion that BZUN’s recently announced M&A deal will hurt its profitability.
Gap Greater China Acquisition
Baozun recently published a press release on November 7, 2022 disclosing that it “signed definitive agreements to acquire Gap Greater China.” In the media release, BZUN describes Gap Greater China as being “wholly owned by Gap Inc., the largest American specialty apparel company.”
In a 6-K filing issued on November 8, 2022, BZUN explained that it chose to do this deal because of “the substantial size and scope of Gap Greater China make the acquisition a significant step in developing BBM (Baozun Brand Management).”
Baozun has only recently ventured into the brand management space in 2021, and it now intends to recognize BBM as a separate business segment in subsequent quarters. In its Q2 2022 financial results presentation slides, Baozun revealed that BBM had achieved an impressive +51% YoY increase in Gross Merchandise Value or GMV for the seven beauty & healthcare and apparel brands within its portfolio for the first half of this year.
As a start, it is necessary to understand that this recently proposed deal is a major transaction for Baozun. BZUN is paying $40 million to buy Gap Greater China, and this is equivalent to 16% of Baozun’s current market capitalization.
The key thing to take note is that the newly acquired business will be a drag on Baozun’s bottom line once the M&A deal is completed. Baozun mentioned in its November 7, 2022 press release that this M&A transaction should be done by the end of the second quarter of next year at the latest, assuming that conditions precedent for the deal are met.
Gap Greater China comprises of two entities, namely, Gap (Shanghai) Commercial Co., Ltd. and Gap Taiwan Limited. Both Gap Shanghai and Gap Taiwan are loss-making. Based on BZUN’s November 8, 2022 6-K filing, Gap Shanghai and Gap Taiwan generated net losses of approximately -RMB256 million and -RMB200 million for their respective recent fiscal years. Furthermore, it is reasonable to assume that Baozun will have to make significant investments in the future to turn around Gap Greater China which isn’t earning a profit now.
According to S&P Capital IQ’s consensus financial forecasts, BZUN is expected (without adjusting for the deal) to report positive non-GAAP adjusted and GAAP net profit of +RMB443 million and +RMB268 million, respectively for fiscal 2023. It is likely that Baozun will register much lower earnings or even be in the red for 2023, if the acquisition is concluded and Gap Greater China’s financials are consolidated as planned.
Separately, BZUN will also likely invest in other brands going forward as part of the company’s plans and ambitions to expand its BBM business. At its Q2 2022 earnings briefing in late-August 2022, Baozun commented that the “investment into the brand management” business will represent a growth “opportunity” for the company.
There is no certainty that the new BBM business will be a success for Baozun in terms of higher revenue and increased profits in the long run, notwithstanding decent initial results (1H 2022 GMV growth for brand portfolio highlighted earlier). But the proposed acquisition of Gap Greater China and the planned investments for BBM are certainly negative for Baozun’s short term profitability outlook.
Share Repurchases And Valuations
Baozun has yet to officially announce the date for its Q3 2022 financial results release, but the company should be reporting its third quarter earnings in late-November using past results announcements as a reference.
BZUN’s share buybacks should be something that investors will watch closely with its upcoming quarterly results disclosure. The company spent $42 million to buy back around 5 million ADS (American Depositary shares) in the second quarter of 2022. Earlier in March this year, BZUN announced a $80 million increase in its share buyback authorization.
The company’s share price dropped by -45% from $11.33 as of July 1, 2022 to $6.28 as of September 30, 2022. BZUN’s shares last traded at an even lower price of $4.11 as of November 8, 2022.
As such, it is important to observe if BZUN continued with its share repurchases in Q3 2022, which should be revealed when it announces its third quarter earnings. Assuming that Baozun still bought back its own shares aggressively in the third quarter, this sends a positive signal about the management’s views regarding its stock’s undervaluation.
Also, Baozun’s management comments at the upcoming Q3 2022 results briefing will also offer an indication of the company’s thoughts about capital allocation and shareholder capital return (i.e. buybacks) in the future.
Based on valuation data sourced from S&P Capital IQ, BZUN currently trades at consensus forward next twelve months’ Enterprise Value-to-Revenue, EV/EBITDA, and normalized P/E multiples of 0.27 times, 4.3 times, and 2.2 times, respectively. Considering its current valuations, share repurchases are arguably a much better capital allocation choice as compared to M&A and other investments.
Closing Thoughts
I still maintain a Hold rating for Baozun. The key issue for the stock is capital allocation. Taking into account where its shares are trading at now, Baozun should be allocating a greater proportion of its excess capital to share buybacks. Instead, BZUN has just announced a significant acquisition which will likely depress the company’s profitability in 2023. Considering all these factors, the risk-reward for Baozun is fairly balanced which points to a Hold rating.
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