Globally there are only about 1,000 “unicorns” — private companies valued at $1 billion or more — and only a handful of them are fashion or lifestyle companies. For a privately held fashion company to be valued at more than $100 billion was unheard of—until Shein came along.
Shein, a Chinese fashion startup known for selling cheap and trendy clothes online, broke that barrier in April when private investors valued the company at $100 billion in a fundraising round, making it the third most valuable private company in the world, after TikTok ByteDance and ByteDance. Elon Musk’s SpaceX. For perspective, Shein is now worth more than Zara and H&M, two of the world’s largest publicly traded fast fashion chains, combined.
Retail analysts are baffled as to how an online retailer operating on the saturated fast fashion business model could be worth so much in 2022. And investors, while no strangers to the boom and bust of the ecosystem startups, are increasingly nervous about how long Shein can hold on to the sky-high valuation as capital markets cool and the company’s many internal problems begin to surface as it becomes too big to ignore.
In private market valuations, hype often defies logic
When evaluating an investment in a private company, investors consider two things. The first is the business basics: How much revenue did the company make last year? How fast is it growing? Is there a positive cash flow? Is it profitable?
The second is how many similar companies were recently valued – similar to looking at comparable properties in real estate. In fact, the thought process of buying shares in a startup is not that different from buying a house.
“Your neighbor sold a house for $1 million. You would expect your house, which is similar, to sell for that amount as well,” said Swati Chaturvedi, a partner at Newton Fund, a venture capital firm based in San Francisco.
For startups whose valuation has crossed a certain threshold, typically $500 million, Chaturvedi said, comparables become more important than fundamentals to investors. And after a certain point, it can seem like the basics don’t matter at all. When a company’s stock becomes particularly sought after, investors will buy shares for fear of missing out.
“I don’t think there’s a science to it. It’s just a matter of supply and demand. It often comes down to advertising and what the investor is willing to pay,” said Sucharita Kodali, a retail industry analyst at Forrester, a market research firm.
That’s not to say Shein has no data to back up his monstrous assessment. Shein enjoyed a sudden surge during the pandemic. In 2020, its revenue grew 250 percent from the previous year to $10 billion as consumers stuck at home turned to online shopping.
If these numbers are correct, a $100 billion valuation would give Shein a 10x earnings multiple. Earnings multiple is a metric used by venture capital firms that measures a company’s equity relative to its current sales. A 10x multiple is typically seen in startups that grow at an annual rate of more than 300 percent.
Shein’s growth trajectory is almost enough to justify its market value. However, it is still extremely inflated compared to its publicly traded peers. For example, Spain’s Inditex Group, Zara’s parent company, generated nearly three times as much revenue as Shein in 2020, but was worth just 20 percent more than Shein when its shares peaked in May.
No one knows Shein’s secret formula
Shein was founded in 2008 in China under the name Nanjing Dianwei Technology Information by Chinese entrepreneur Chris Xu, an isolated figure about whom very little is known. The company started as a wholesaler connecting Chinese garment factories with overseas buyers. It officially became Shein in 2015 after acquiring Romwe, a Chinese fast fashion company with warehouses and offices in California.
Quickly, every company is constantly working to strike a balance between small-batch production and economies of scale. The logic goes that the fewer pieces a company makes of a particular style, the faster it can get to the shelf and the lower inventory costs it will have in case the style doesn’t sell. However, to lower unit production costs, it is usually in a manufacturer’s best interest to produce in large quantities.
Shein pioneered the micro-batch production model, producing just 50 to 100 garments in a style and marketing them to hyper-specific audiences, all thanks to its algorithm-powered demand forecasting tools. Meanwhile, Shein seems to have solved the problem of economies of scale by working with thousands of small garment factories in China. According to its website, Shein releases 1,000 new products every day, about twice the amount that Zara releases per week. Most of her clothes cost between $8 and $30.
However, it all sounds too good to be true. “Their whole model is cheap shit. There’s no other way to describe it,” said Forrester’s Kodali. “I think the big question is: How on earth in an already free world did they become even freer?” How did they manage to produce in such small batches while still hitting their price point?”
While its incredibly low prices, along with effective social media marketing, have helped boost Shein’s popularity, the company has also drawn criticism. Environmental groups and fashion activists have accused Shei of exploiting workers, stealing intellectual property and creating excessive environmental waste.
Analysts worry that a damaged reputation could hamper Shein’s future growth. “Fast fashion still caters to many consumer preferences, such as value and convenience. However, a big factor in the fast fashion space going forward is sustainability – consumers are becoming less willing to turn a blind eye to unsustainable business practices,” said Liam Tack, an analyst at CB Insights.
Shein did not respond to a request for comment on its environmental, social and governance practice. In June, a company spokesperson released a soft-spoken statement to Bloomberg, saying its business model “minimizes waste and enables it to be more sustainable.”
As the market turns south, could Shein be the next Klarna?
In April, the buzz around Shein was so high that the company reportedly told investors it hoped to go public in the US as soon as 2024, meeting the hopes of its VC investors. But before long, the US IPO market went dark. Both the number of companies going public and the proceeds raised from initial public offerings fell in 2022. The decline will inevitably trickle down to the private market, said Chaturvedi, of the Newton Fund.
“The rating has dropped significantly,” she said. “I believe the valuation of the private market is completely insane. When the public market equivalent has fallen so much in price, how can you maintain your market cap?”
Chaturvedi said her firm had the opportunity to participate in a fundraising round of Klarna, a Swedish fintech company, in December 2021 at a valuation of nearly $50 billion. Klarna was one of the hottest startups in fintech at the time, but she turned it down because publicly traded companies comparable to Klarna it didn’t look very promising. In the end, it was a wise decision. As of July, Klarna’s valuation had sunk more than 80 percent to just $6.7 billion.
For Shein investors, a bigger concern right now is his track record
In 2021, Shein’s annual sales growth slowed to 60 percent (from 250 percent in the pandemic year). Still impressive, but not enough for venture capitalists who tie valuation to a company’s growth more than anything else.
Those warning signs have prompted some existing Shein shareholders to consider selling their holdings at a discount of up to 30 percent from his $100 billion valuation in April, Bloomberg reported in July. Shein did not respond to an inquiry to comment on the report or whether he has any firm plans to go public.
If it does, it will likely have a tougher audience to convince of its worth. “The IPO market is a more transparent market because there are many smaller investors. You can’t fool as many people as possible in the IPO market,” said Forrester’s Kodali. “There are fewer people to cheat in the private market. Not that investors are stupid, but if you’re a great salesperson, there’s often a stupid person willing to give you money.”
