Explain in detail the mystery of KK Group's 20 billion valuation: exquisite finance, excellent joining

Author | Liu Yalan

At a time when "new consumption" is popular and controversial, KK Group, a new retail company in the field of trendy goods, submitted a prospectus to the Hong Kong Stock Exchange.

Unlike popular new retail companies such as Pop Mart International, perfect Diary and MINISO Group, the name of KK Group does not often appear in people's eyes. But KKV, the company's fashion store, KK, THE COLORIST, and X11, the mini store for imported goods, are scattered in shopping centers in first-and second-tier cities.

According to the prospectus, as of June 30, 2021, the total number of KK Group stores selling trendy goods in four formats has reached 640, and the company's cumulative sales of GMV in the first half of the year has reached 2.213 billion yuan. According to the annual sales GMV statistics in 2020, the company ranks third among domestic trend retailers, with an annual compound growth rate of 246.2% in the past three years. As the hottest new consumer and new retail track unicorn company in the capital market in the past two years, KK Group has been valued at 20 billion yuan in the latest round of financing before listing in July this year.

But what is amazing is not the company's high valuation, high GMV, high growth, but a sophisticated franchisee mechanism behind them.

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Offline business is not easy to do. Just last week, Haidilao International Holding announced his decision to gradually close 300 stores in the next 56 days. "the more stores you open, the greater the loss" has become the theme sentence of offline retail formats.

However, KK Group continues to narrow its losses at the same time as the revenue side is booming.

In terms of revenue, KK Group achieved revenue of 160 million, 460 million, 1.65 billion and 1.68 billion yuan respectively in 2018, 2019, 2020 and the first half of 2021, with year-on-year growth of 198.6%, 254.9% and 235.1% in 2019, 2020 and the first half of 2021, respectively.

In terms of losses, KK Group's net losses in 2018, 2019, 2020 and the first half of 2021 were 79.485 million, 515 million, 2.017 billion and 4.397 billion respectively, with a cumulative loss of nearly 7 billion in the reporting period. However, this is mainly due to the change in the fair value of financial liabilities during the conversion of preferred shares into common shares in the listing process. Excluding this part of the impact, KK Group showed a continuous improvement in overall profitability during the reporting period. The company's adjusted net loss in 2018, 2019, 2020 and the first half of 2021 was 41.796 million, 76.951 million, 171 million and 38.462 million respectively, with a loss rate of-26.9%,-16.6%,-10.4% and-2.3%, respectively.

The adjusted EBITDA of the company has become profitable in 2020 and the first half of 2021, which is 68 million yuan and 216 million yuan respectively, and the adjusted EBITDA ratio also continues to improve.

In terms of gross margin, KK's overall gross profit margin reached an all-time high of 36.2% in the first half of this year, 5.8 percentage points higher than in 2020.

The biggest problem that has plagued the new retail industry for a long time is that the operating costs at the store level are too high (store rent, labor costs, depreciation of fixed assets, etc.), making it difficult to achieve overall profitability at the store level. However, since 2019, KK Group's three formats, KKV, KK Pavilion and THE COLORIST, have all made overall profits at the store level, and the profit scale has shown a trend of rapid growth. Only the fashion store X11, which began to open in 2020, is still in the investment stage, and the store level is in a state of loss.

Under the background that offline business is generally in trouble, why can KK Group be left alone?

Hide the mystery

The reason why the offline retail industry can perfectly avoid the dilemma of "the more stores you open, the greater the loss", and successfully achieve great progress at the revenue end, while continuing to narrow at the loss end, the core reason probably lies in the franchisee mechanism of KK.

Compared with the franchisee mode of the traditional catering industry and convenience store industry, the brand licensee is more likely to license the brand to the franchisee, providing standardized process and related management services in the process of store management, while the licensee makes a profit by charging the brand authorization fee and service fee. This authorization method is more suitable for fast food and convenience store industries with small overall investment and high degree of standardization.

For stores such as the trend stores under the KK Group, which are often hundreds to thousands of square meters, the overall investment and operational risk are high for franchisees. From the perspective of KK Group, if all stores adopt self-management mode, the early investment is too high and there are also a series of business risks such as location, which is bound to affect the overall expansion speed of the company.

Just before Haidilao International Holding announced the closure of 300 stores nationwide, it was precisely because in the process of rapid expansion, the location and later operation did not meet expectations and other problems, resulting in some stores continued to lose money, so they had to break the arm to stop the loss.

This is a very difficult choice question: on the one hand, it needs a rapid increase in the number of stores in exchange for rapid growth at the revenue end; on the other hand, the company will also fear the rapid growth of offline operations. Store quality is difficult to guarantee huge risks.

Therefore, KK Group has launched a franchisee mechanism with equity investment.

Different from the traditional franchise authorization method, KK Group will establish a joint venture with the franchisee and act as a minority shareholder in the process of cooperation with the franchisee. This means that, in addition to cooperation at the day-to-day business level, the relationship between KK Group and franchisees is also a common advance and retreat.

For such an arrangement, it can play a positive role both at the operational level and at the financial statement level:

In terms of operation, the KK Group, which appears as a shareholder, obviously has a stronger binding relationship with the franchisee, which enables the two sides to carry out more in-depth communication and cooperation.

In the financial aspect, although it appears as a shareholder of the franchisee, because the KK Group only exists as a minority shareholder, the overall profit and loss of the franchisee will not be fully incorporated into the group statement, but will only account for its own profit and loss according to the percentage of profit and loss. This means being able to minimize the impact of franchisees' performance on their own companies.

As of June 30, 2021, the number of the above franchise stores with equity investment arrangements is 277, and the proportion of the total number of stores in the station is 43.3%.

Picture Source: KK Group prospectus

The question is, if franchisees bear most of the store-level risks, why would anyone have the incentive to help KK Group open its own store for growth at their own expense?

This is also the ingenuity of the franchisee model of KK Group-according to the prospectus, KK Group will provide loans and prepayments to franchisees, which means that in the early stage, KK Group will help franchisees cover part of the pre-start-up costs by borrowing, thereby reducing the upfront investment of franchisees.

By the end of June 2021, the total amount of loans and advances provided by KK Group to franchisees is as high as 560 million yuan. According to the calculation of 352 franchisees, the average loan per franchise store is close to 1.6 million.

Picture Source: KK Group prospectus

Through the above loan arrangements, the franchisee can effectively reduce the upfront investment and capital risk, while for KK Group, even if the company borrows money in the franchisee store, it will not be reflected in its own profit statement, which is an absolute "win-win".

In addition, in the equity investment agreement signed with the franchisee, KK Group also retains the relevant interest in acquiring shares from the franchisee during such period of time as it deems appropriate. This means that if the franchise store is profitable in the future, KK Group has the right to incorporate its acquisition into its own statement.

Picture Source: KK Group prospectus

Through the above series of agreements, KK Group can effectively manage financial data on the premise of ensuring that franchisees have sufficient motivation to open stores. For poorly managed franchise stores, they can stop losses in time (maximum loss loans), while KK Group also reserves the right to include well-developed stores that can eventually make a profit. Thus fully realized "advance can be attacked, retreat can be defended".

KK Group's innovative franchisee model, from the company's point of view, is undoubtedly a set of very efficient business model. However, in the process of joining, the arrangement of the agreement is much more complicated than that of ordinary restaurants and convenience stores, and there are more provisions such as equity investment, buyback and so on. therefore, it also poses more challenges for regulators and intermediaries in the daily audit process:

The first is related party transactions. For the third-party franchisee, the intermediary should ensure that it is an independent third-party company in the process of verification to avoid the existence of non-association. In the process of listing in the A-share capital market, the audit of unrelated transactions is the most concerned point for regulators, while in the listing of Hong Kong stocks, it is more as a part of information disclosure rather than the focus of verification.

The second is the quality of franchisees. According to the company's prospectus, KK Group has cancelled its policy of providing loans and prepayments to franchisees since June 30, 2021, and the company will seek more powerful franchisees to cooperate in the future. This also means that KK in the franchisee selection criteria, will be more inclined to quality, rather than simply to be able to open a store-oriented.

Picture Source: KK Group prospectus

Xiao Min, a partner of Matrix Partners China, once said when chasing KK, "Jingwei has always been a firm investor in KK." In the new retail track, KK Group has demonstrated outstanding brand innovation, product selection and supply chain capabilities, store opening and operational capabilities. The evolution from the KK library to KKV, as well as the new species THE COLORIST toner, all attest to the outstanding innovative thinking and excellent execution of the KK team. We also continue to look forward to the surprises of this company. "

Black Ant Capital believes that based on a deep understanding of the nature of retail, KK Group creates a pleasant and efficient shopping scene through personality and diversified products to meet the needs of offline consumers, and has the ability to continuously iterate store types, expand areas, and create new growth points; its "light foreground, heavy background" model can support front-end replication and expansion with efficient background operation ability and high cost-effective performance.

Today, KK, which has excellent performance in the primary market, has come to the secondary market. In addition to the continuous development of business, it seems to be facing another set of tests and challenges of capital logic.