Franchise Group ($FRG) — Initiation (3/14/21)

I bought a small placeholder stake in this business a while back and have followed it from a distance since then. It felt appropriate to dig a bit deeper into this one.

As a starter, I found the situation difficult to analyze based on how quickly management was transforming the business. But as an offset to that, I know and trust B Riley immensely and they were deeply involved in putting this business together. As an extra nugget, B Riley and Vintage Capital had missed out on acquiring Rent-a-Center ($RCII), creating Franchise Group in its current form was a Plan B of sorts to the failed RCII acquisition.

Franchise Group kicked off as a haphazard combination of several brands/businesses:

  • Liberty Tax — retail-based tax prep services
  • Buddy’s Home Furnishing — rent-to-own consumer products
  • American Freight / Sears Outlet — value-priced furniture, appliances, mattresses
  • Vitamin Shoppe — retail-based vitamin stores (not mall-based)

These are all what I’d call “decent” businesses. They all produce gobs of cash and each is heavily exposed to consumer spending which is in excellent shape right now. Some comments on the above businesses:

  • Buddy’s / AF competitors Rent-A-Center and Aaron’s are generating excellent same store sales growth — trends are favorable right now
  • Vitamin Shoppe has been a non-grower ($1.2bn in 2016 sales vs. $1bn in 2020) but EBITDA has been stable — $70m in 2017 vs. $77m in 2020

The play is to take these formerly company-owned locations and franchise them — this provides a one-time boost to cash and then a relatively stable stream of cash into the future in franchise fees.

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And there’s still plenty of runway left in the franchising opportunity…

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FRG just sold 47 Buddy’s stores for $35m which would rake in another ~$35m or so on the remaining 45 locations. Then there’s the 719 unfranchised Vitamin Shoppe locations and 343 American Freight locations. Hypothetically, if each of these 1000+ locations were sold for $500k to a franchisee, that would bring in $500m.

If they can keep company performance on the uptrend, this strategy should give them plenty of cash to recycle into paying down debt and more acquisitions.

Guidance and valuation…

2020 results will give you a sense for the relative size of the 4 divisions.

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…and 2021 guidance calls (called?) for:

  • $3-3.1bn in revenue
  • $310m in EBITDA
  • $3.25 in adjusted EPS

To put a wrinkle in things… FRG announced a major acquisition ($700m purchase of Pet Supplies Plus) and a major divestiture (Liberty Tax being sold for $243m in cash and stock).

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FRG has 40m shares outstanding and a $40 stock price = $1.6bn market cap. Net debt is $940m (3x leverage on 2021 guidance). This nets a ~$2.54bn enterprise value and a 8.2x EV/EBITDA multiple.

It’s not an expensive stock and there seems to be plenty of runway left in the franchising effort (i.e. early innings). The challenge with this one is the fast and furious pace at which they’ve built the current company — makes it challenging to adequately predict what it currently looks like and what it may look like in the (near) future.

For my portfolio, this is a bet on a reasonably decent business at a decent price and a management team / ownership group that I trust.