Deepak's Musings #127: Why QOR (Quality of Revenue) is critical

💲 The problem with revenue multiples and why QOR (Quality of Revenue) is critical

Everyone in the venture ecosystem is hypnotised by valuations and by valuation multiples. I am going to focus only on consumer startups, which is my area of personal interest. And when it comes to insurgent brands, the multiple they zero in on is revenue multiple. Every founder I meet, most investors I speak to and the numerous bankers in the ecosystem tell me about different brands, how they are doing and why they are valued at [•] revenue multiple. But they forget that what is more important is the Quality Of Revenue (“QOR”).

There are many variables that we look at DSGCP when considering the quality of the revenue. I am going to share the most relevant.

• Unit economics: Simple. Can this business make money for every product it sells or service it delivers

• Margin profile: What are the gross margins (you often live and die by the GMs you start with), EBITDA and PAT of the business today and at a steady state

• Growth rate and its drivers: How quickly is the revenue growing YOY and what is driving that growth? Peeling this back, we look at cohort retentions (customer, retailer and channel) which is indicative of the quality of the growth. Retention is magic. If you cannot retain your existing customers and channels, who will you succeed with new customers and channels?

• Capital efficiency: This is how much capital (equity and debt) has been used by the business to date to get you to your current revenue run rate. Eg if you raised $10m and are at an ARR of $20m, you have a Capital Efficiency Ratio (CER) of 2x. Not relevant when we invest pre-revenue but very relevant when we invest post-revenue.

• Many many many more, both quantitative like above, and also qualitative variables, the most important being whether this is a founder we want to work with and does he/she has it to build a business.

The better the QOR, the higher the multiple you can command for your business. The table below is a snapshot of the market valuation of select listed CPG companies in India and explains the difference in Nestle trading at 12.2x LTM (Last Twelve Months) and Hindustan Unilever at 9.2X.

TLDR: Why use revenue multiples in the first place? In practise once a company is at scale we look at FCF and EBITDA multiples are amongst the best proxy. Because most startups are not cash flow profitable, the proxy becomes revenue multiples. So, until they get to scale, use revenue multiples but do so judiciously. Look at and understand the QOR.

🇮🇳 Consumer sentiment signals a muted festive season in India

The recent Axis My India Consumer Survey is telling us that Indian consumers are spending cautiously. Most respondents said they were planning to spend less than in the previous year, and most were only eyeing small purchases. The ongoing conflict in West Asia and a long period of inflation may have contributed to poor consumer sentiment.

🇮🇳 Building a CPG brand in India is hard

The opportunity has never been better to build an insurgent brand. Consumers have more discretionary spending and this will continue to grow over the next 2 decades as India’s GDP continues to compound. And consumers continue to look for new brands offering a better proposition.

But building an insurgent brand is hard. Takes time. And requires a clear focus.

Worth reading this deep dive into insurgent brand Wingreens and its journey to date.

🧴 Insurgent Brand Mamaearth’s IPO oversubscribed 7.6 times

Fantastic news for Honasa Consumer Limited who will start trading on the Indian stock exchanges on 10 November. Honasa is the holding company for one of India’s most successful insurgent brands Mamaearth. I want to congratulate Ghazal & Varun Alagh for scaling the brand and their venture investors for backing the brand over the last 8 years.

The IPO is the second of an insurgent brand in 12 months after the Sula Vineyards IPO in December 2022. We need more success stories to inspire the next generation of entrepreneurs and give confidence to venture investors that CPG is an attractive investment opportunity.

We have to watch and wait to see how the stock performs post-IPO. Like we say in Sula, investors will be closely watching the performance it will announce in the coming quarters.

🛫 Wanderlust Indians are travelling like never before

This is not surprising given the increasing per capita GDP and Indian desire to see and experience more of India and the rest of the world. There is a huge opportunity to create brands to help Indians with these desires for travel. DSG Consumer Partners portfolio company Stayvista, India’s leading luxury villa business, has seen strong growth over the last few years from Indians looking for domestic experiences. We continue to look for insurgent brands doing more in travel and hospitality.

🌱 Plant-based alternatives: What is the state of the market?

Beyond Meat rushed out a pre-earnings release on 2 Nov 2023 saying that last quarter’s sales were worse than expected, as consumer interest in Beyond Meat continues declining. Is this a company-specific issue or more generic to the category as a hold?

In my view, consumers do want to consume more plant-based but plant-based needs to deliver on two things asap: (1) taste and (2) price-parity.

🌱 Plant-based alternatives: Putting the plant back into plant-based

On the topic of plant based alternatives, Whole Foods forecasted a trend of more companies putting the “plant” back in plant-based products earlier this month in their 2024 predictions report. At home, my wife avoids anything made in lab and prefers plant-based to have veggies, lentils, beans and other protein rich whole foods. One thing I have learnt being married, listen to the boss.

India’s Top 10 CPG Companies

Hindustan Unilever, ITC and Nestle India, are India’s largest CPG companies.

/