Two years after going public, E.l.f. Beauty Inc. isn’t looking so pretty.
On Wednesday, Marathon Partners Equity Management LLC, which owns 8.5 percent of E.l.f., sent an open letter to CEO Tarang Amin detailing its position that the makeup company should either sell itself or cut $25 million in costs, and refocus on core operations. E.l.f has suffered a steady decline in share prices since its 2016 IPO, down 40 percent since the start of the year; and in early August, the brand said in its second-quarter earnings that it expects revenue growth in the “low single digits” instead of its earlier forecast for 6 to 8 percent growth, already down from 18 percent in 2017.
Despite its reputation as a millennial-favorite brand with high-quality products at low prices, the business has faced competition from other prestige beauty brands, while mass retail has struggled.
Across the industry, makeup sales remained flat over the second half of 2017, while prestige skin care grew at a faster pace than makeup, with a 12 percent increase during that period and sales of $1.3 billion, according to NPD Group. This poses an issue for E.l.f., which has positioned itself as a mix of both mass and prestige makeup. Skincare has been forecasted to remain the most profitable product category in beauty with a projected growth of over $20 billion dollars between 2014 and 2019, according to Statista. In response, the brand has begun greater expansion into the category, recently adding a line of oil-control and pore-refining products.
Additionally, an ongoing initiative for the company, dubbed “Project Unicorn,” is also designed to elevate its prestige appearance through new packaging and shelf placement. It involves alterations to the signature black packaging of products in order to better showcase the components and colors, and place more, newer products on existing shelves, Amin said on the earnings call.
“We’re able to fit more products into existing space. So if you think about it, our retailers will be able to take more of our new product into their existing space … [It] allows for better communication on shelves and better navigation, as well,” he said.
But there are specific issues related to E.l.f.’s business operations, too. Most of E.l.f.’s business is conducted through third-party retailers such as Ulta, Walmart and Target, and its brick-and-mortar expansion last year created a lot of unsold inventory, according to multiple analysts. Separately, potential tariffs of Chinese imports could significantly impact E.l.f, which imports 100 percent of its products from China, said Bonnie Herzog, managing director of equity research for Wells Fargo Securities.
In a cost-cutting scenario, Marathon said that cutting operating expenses, including stock-based compensation, in addition to reinvesting some savings into more advertising could help. Marathon also detailed that E.l.f could be a desirable purchase because of its “first-to-mass” innovation and multichannel distribution platform. E.l.f, along with other fast-beauty companies, have found ways to whittle down product development to 13 weeks, Amin said during its the latest earnings call; meanwhile, its legacy peers like Revlon who take several months.
Additionally, in a departure from standard industry practice, E.l.f. does not use celebrity endorsements, instead focusing marketing dollars on micro-influencers, as well as its website and search placement. The company’s website has more than 100,000 product ratings and reviews, and the brand built a community of 50 micro-influencers through its Beautyscape influencer program last year that drove a 25 percent increase in Instagram followers. Overall, E.l.f has grown it social media community to 37 million followers and has increased awareness from less than 3 percent to 17 percent, according to the earnings report. However, E.l.f does not spend on advertising to build this following in the large-scale traditional sense. The company spends 3 percent of its total fiscal 2017 sales on advertising, compared to 20 percent or more for legacy brands, John Bailey, CFO of E.l.f, said on the earnings call.
In a statement from E.l.f. on Marathon’s letter, the company said that E.l.f. “regularly” engages in dialogue with stockholders and will review the idea raised by Marathon in order to increase long-term stockholder value.
“As we do so, and as previously disclosed, we are re-investing in our brand while streamlining operations, actions which we believe will position E.l.f. for long-term, profitable growth,” Amin wrote.
