So-Young's CEO-led Buyout Dissolves After Stock Plunge

Key Takeaways:

• So-Young said a group led by its co-founder and CEO has withdrawn its earlier buyout offer made nearly a year ago
• The withdrawal came as the company faces challenges from a regulatory crackdown on the medical aesthetics industry and a slowing Chinese economy

By Warren Yang

For So-Young International Inc. SY investors, a management-led buyout offer floated nearly a year ago must feel like a distant dream by now. Completion of the deal at the proposed price looked increasingly unlikely with each passing month, as shares of the popular cosmetic surgery app plunged in an increasingly tough landscape for its products and services.

So it wasn’t a huge surprise when the company said last Friday a preliminary buyout offer made by a group led by co-founder and CEO Jin Xing last November was officially off the table. Back then, the group offered to purchase all of the company’s outstanding shares they didn’t already own for $5.30 per American depository share (ADS), in a deal that would take the company private. The offer price represented a premium of about 23% to So-Young’s last share price at the time.

Market reaction back then suggested investors were skeptical the deal would go through. So-Young’s stock did pop on the day the buyout plan was announced, but closed well below the offer price at $4.82. And rather than close the gap in the months that followed, So-Young shares have actually been in a free fall, similar to ones seen for many of their U.S.-listed Chinese peers.

At their Tuesday close of $0.535, the stock now officially trades in penny territory – not very pretty at about one-tenth of the original buyout price, and technically putting the company at risk of delisting for trading below the $1 mark.

Jin’s buyout offer meant he believed So-Young would grow faster as a privately held company under his ownership, and could perhaps fetch a higher valuation if it tried to later go public again. Similar thinking often underpins such buyouts led by company management, who typically know their operations well and believe they are undervalued by less-informed stock market investors.

But in reality, times are rough for So-Young. Most importantly, Chinese regulators have been cracking down on the country’s medical beauty market, which is one of the largest globally, to eradicate malpractice as illegal establishments mushroomed. The clean-up crusade started just months before Jin’s buyout offer and are creating huge uncertainties for So-Young’s business.

In late August last year, regulators issued draft guidelines requiring beauty companies to obtain a special license to advertise publicly. Making life difficult for such companies will almost certainly hurt So-Young, which derives the bulk of its revenue via fees from such companies for sharing information about them on its social media-like platform.

Whether authorities will treat such information as advertisements has become the big question for So-Young. In its latest annual report, the company said that scenario is “improbable” but it also warned the content on its platform can be considered advertisements, which are defined vaguely. If regulators took that position, the impact on the company would be huge, potentially forcing it to scale back or alter how information is distributed on its platform. In other words, So-Young might have to overhaul its entire business model.

Gloomy Outlook

Even without the big regulatory headache – one of many for China’s tech companies over the last two years – a sharp slowdown in China’s economy was already making life hard for businesses providing non-essential services. So-Young is no exception.

As consumers with shaky income cut back their spending on items like cosmetic treatments, aesthetic clinics earn less and rein in their marketing spending. China’s strict Covid-control policies, which are partly behind the country’s recent economic slump, can also force providers of medical aesthetic services to shut at any time. And even when they’re open, people tend to stay away from such facilities for fear of infection. That reality is further undermining the medical aesthetic industry, and translating to less demand for So-Young’s platform.

At the same time, So-Young is facing increasing competition from other similar app operators, such as unlisted Gengmei, which counts beauty software maker Meitu (1357.HK) as an investor, as well as search engines and e-commerce sites.

So-Young’s revenue fell 32% to 309.1 million yuan ($42.3 million) year-on-year in the second quarter, according to its latest results, even though the number of medical service providers that pay to use its platform actually increased. This suggests that the company generated far less revenue from each customer than it did in the year-earlier period despite the expansion of its clientele as they reduced their spending. As a result, So-Young recorded a net loss of 32 million yuan in the quarter, reversing a profit of 58 million a year earlier.

The company has introduced a product called “So-Young Select,” which is aimed at enabling medical service providers to improve their operational efficiency by lowering customer acquisition costs. Such services can be attractive as it becomes harder for medical service providers to increase revenue, but only if they are convinced such tools can generate more business than their cost.

For now, at least, it doesn’t seem like So-Young will fare much better in the third quarter than it did in the second. At the time of its second-quarter results announcement in August, management said it expects third-quarter revenue to fall year-on-year as much as 28%.

Given So-Young’s less-than-pretty outlook, it’s not hard to see why Jin pulled the plug on his buyout offer that would have cost 10 times the company’s latest market value. The deal was going to be a leveraged buyout using debt, meaning it would only work if the company could increase revenue substantially for the next few years and generate sufficient funds to both pay down debt and provide extra profits for the deal’s backers.

So-Young shares dropped about 14% in the two days after it announced the withdrawal of the buyout offer. At their current price they are now worth a fraction of the $13.80 they fetched in their 2019 IPO. And the company’s market value, which exceeded $1 billion when it went public, is now just about $60 million, giving it a meager price-to-sales (P/S) ratio of less than 0.3 times, based on its revenue for last year.

By comparison, shares in food delivery giant Meituan (3690.HK), which also has a service similar to So-Young’s app, are trading at a much healthier P/S ratio of about 4. Even beauty app Meitu, which is also losing money and similarly specialized like So-Young, trades at a much higher P/S ratio of 1.6.

China’s economic downturn is creating challenges for everyone, from giants like Meituan down the food chain to smaller specialists like So-Young. But the big names have a much wider range of products to rely on than the latter, and also more financial resources, making it easier to survive negative developments like the ones So-Young is facing. Without such a safety net, So-Young’s future looks precarious.