Fairway Group Holdings Corp. Jared Ziment, Max Lipscomb January 11, 2015

Transcription

1 Fairway Group Holdings Corp. Jared Ziment, Max Lipscomb January 11, 2015

2 Table of Contents I. Sourcing & Investment Thesis II. Company Overview III. Valuation IV. Conclusion V. Appendix 2

3 I. Sourcing & Investment Thesis

4 Early History of Fairway Market HISTORICAL OVERVIEW 1933 Nathan Glickberg opens a small market in Manhattan s Upper West Side neighborhood. For much of it s history, Fairway operates as a single, family-owned market Nathan s grandson Howie expands the original location and builds a new store in Harlem Westport, CT based private equity firm Sterling Investment Partners purchased a majority stake in the business, valuing it at $150mm. Fairway had opened 3 stores Fairway IPO s at $13 per share, raising $177mm at a total valuation of around $400mm. Fairway had opened 12 stores. Source: Company Presentation and Filings 4

5 Headlines Galore Sources: New York Times, Dealbook, Wall Street Journal, Bloomberg 5

6 All Was Going Well IMMEDIATE PRICE PERFORMANCE FOLLOWING IPO $30 High: $28.31 $25 $25.46 $20 $15 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Source: Bloomberg 6

7 Until PRICE DECLINE SINCE OCT. 13 $30 Earnings Miss $20 Earnings Miss $10 Earnings Miss Jan. 9 $3.47 $0 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Source: Bloomberg 7

8 So What Happened? 1 Private equity-fueled management became increasingly aggressive with growth plans. At the time of the IPO in April, 2013, fairway told investors it expected to expand at a rate of 3 to 4 stores per year. 2 To meet growth expectations, management invested in an industrial scale distribution center and focused on store openings. Costs began to spiral out of control and bottom line suffered despite strong top-line growth. 3 With a cost structure designed for a 30 store operation and only 14 stores opened, consistent earnings misses and downward guidance revisions destroyed positive investor sentiment. 4 The stock currently trades in the $2-4 range (~0.2x sales), indicating that investors are seriously concerned about the possibility of bankruptcy and/or further dilution. We believe overly negative investor sentiment has exaggerated the possibility of bankruptcy and ignored FWM s $50MM in liquidity along with the possibility of a secondary equity raise. This presents us with an investment opportunity at below the security s intrinsic value. 8

9 Fairway Group Holdings Corp. (NASDAQ:FWM) As of January 9, 2015 Fairway Market has proven its ability to successfully deliver a unique product met by strong consumer demand. Mismanagement and overly ambitious expansion plans have nearly derailed the company, but a newly installed veteran management team create an undervalued turnaround opportunity. Recommendation: Buy Current Price: $ Yr. Price Target: $6.67 CATALYSTS Newly appointed CEO Jack Murphy has experience building two nearly identical businesses Fairway s product is proven to be differentiated and desirable; fixing cost structure and store management issues will lead to bottom-line increases and multiple expansion Immediate price catalyst Jack Murphy is presenting at the ICR Xchange Conference on Jan. 13 th ; presentation is likely to cover new plans for growth and expansion RISKS High probability of a secondary equity raise in the next year Bankruptcy is a legitimate possibility for this company in the event of a liquidity crunch; FCF has been negative for 7 of the past 8 quarters Fairway s market and industry are both highly competitive 9

10 II. Company Overview

11 Unique Position within the Evolving Grocer Industry Fairway Market is a grocer based in New York City, NY which provides a highly differentiated one-stop shopping experience Like No Other Market. Specialty / Fresh / Convenience Conventional Grocery Natural / Organic Source: S-1 Filing 11

12 Differentiated Product Offering in a Growing Market Segment FOOD INDUSTRY SALES (1) $1,000 $800 $695 $716 $738 $760 $783 $806 $830 $855 $881 $600 $400 $200 $0 $51 $54 $59 $64 $69 $76 $83 $91 $ E 2015E 2016E 2017E 2018E 2019E 2020E Total Food at Home Natural / Organic Y/Y GROWTH IN ORGANIC PACKAGED FOOD SALES (2) 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 11.8% 12.2% 10.5% 8.4% 8.7% E 1. Nutrition Business Journal, USDA 2. IRI, Morgan Stanley Research 12

13 Stable Top-line Growth Follows Leading Capacity Utilization 40.00% Top Line Performance Summary (FY 09 FY 14) 900, Operating Metrics Summary (FY 09 FY 14) 1, % 800, , % 700, , % 20.00% 15.00% 10.00% 5.00% 0.00% 600, , , , , , % 100, % Revenue Gross Margin SSS Store Count Sales Per Square Foot Peer Sales Per Square Foot Source: Company Filings, I-Club Research, Morgan Stanley Research 13

14 Cost Structure Issues Arise From Inexperienced Management Team 30% Margin Analysis Summary (FY 11 1H 15) Quartely Free Cash Flow ($ Millions, CFO - Capex) 25% 25.07% $10,000 $5,000 20% 22.62% 0 ($5,000) 15% 13.80% ($10,000) 10% 8.24% 9.14% ($15,000) ($20,000) ($12,352.9) 5% 6.03% 3.43% ($25,000) ($30,000) 0% ($35,000) Direct Store Expenses Adj. EBITDA Margin G&A Expenses Average Peer EBITDA Margin Free Cash Flow Average FCF Burn Source: Company Filings, I-Club Research, Morgan Stanley Research 14

15 Newly Installed Veteran Management Team Jack Murphy Chief Executive Officer (CEO) 30+ years of experience in retail businesses Started Fresh Fields, a grocer in the DC area; grew from 0 to 25 stores before selling to Whole Foods Managing partner tasked with investment in 24 Hour Fitness; helped grow company from 30 to 400+ locations Most recently CEO of Earth Fare, a North Carolina grocer; grew from 10 to 30 stores and sold business to Oak Hill Capital We are very pleased by the growth and financial performance of Earth Fare, which has more than quadrupled run-rate EBITDA since we acquired the company in This has translated into a very successful investment for our firm. Charlie Yoon, Partner at Monitor Clipper (1) Dorothy Carlow Chief Merchandising Officer (CMO) Media and Community Relations manager at The Fresh Market ( ) Worked at Earth Fare under Murphy ( ) Was promoted four times, eventually becoming the Chief Merchandising Officer Responsible for Earth Fare s same store sales growth, new store openings, profitability, cost controls, shrink management, and rebranding for 32 locations across 9 states Source: Company Website, Earnings Transcripts, LinkedIn 15

16 III. Valuation

17 Comparable Universe EV/LTM EBITDA EV/ LTM Sales EV/LTM FCF Stores SSS Growth (%) Sales per Square Foot (FY '14) Sprouts Farmers Market (SFM) 19.46x 1.66x 78.16x The Fresh Market (TFM) 12.23x 0.98x 42.29x Whole Foods (WFM) 9.84x 0.91x 34.11x Mean 13.84x 1.18x 51.52x Fairway Markets (FWM) 3.73x 0.20x -7.11x EV / LTM EBITDA x 15.2x 5 0 CQ CQ CQ CQ CQ CQ x FWM Peer Group Average Russell Source: Bloomberg, Company Filings, Morgan Stanley Research

18 Notes on Valuation When looking into Fairway Market s valuation, we made the following observations: 1. This is an extremely risk-laden investment with high leverage, implying that we should seek LBO-like returns to compensate 2. The investment is characterized by several years of expected negative free cash flows 3. There is a high possibility for a secondary equity issuance to raise additional capital and ensure maintenance of loan covenants Leading us to conclude The Venture Capital Method of valuation is an appropriate measure for this stock s intrinsic value. It allows us to account for the necessity of high returns, short-term unprofitability, and likely equity dilution. Basic concept is to assume future sale of the company, discount the expected proceeds, and assume a certain amount of dilution. 18

19 Venture Capital Valuation Method VALUATION Terminal Year Discounting Required Rate of Return: 20% Years to Sale of Investment: EBITDA 48,797 Terminal Estimated EBITDA 195,188 EBITDA Multiple 8.5x Terminal Firm Value 1,659,098 Discount Factor 32.0% Present Firm Value 530,871 Required Ownership Percentage Current Shares Outstanding (MM) 29.3 IPO Shares 13.6 New Shares Issued 6.8 Price Per Share $3.00 Amt. Raised 20.4 Total Shares 36.1 Retained Ownership % 81.2% Dilution Factor: 18.8% Required Ownership Percentage: 84.1% Intrinsic Firm Present Value 446,724 Net Debt 216,614 Intrinsic Mkt Cap - With Dilution 230,110 ASSUMPTIONS 1. Assume required 20%+ required IRR 2. Sale of company in 6.25 yrs 3. Jack Murphy is able to replicate his success at Earth Fare, quadrupling run-rate EBITDA in 6 years (not unreasonable given inefficient cost structure and previous poor management) 4. Company is sold at 8.5x EBITDA, the low-end of the peer range 5. Equity is raised to address near-term liquidity issues 6.8mm shares issued at $3.00 per share; current shareholders retain ~80% ownership RESULTS We are easily able to hit our 20% IRR breakeven point with these relatively conservative assumptions. Even with significant equity dilution, the investment is a homerun in the event of a successful turnaround. Intrinsic Mkt Cap - No Dilution 314,257 Mkt Cap as of 1/7/ ,400 Source: Venture Capital & Private Equity: A Casebook, by Josh Lerner, Felda Hardymon, and Ann Leamon 19

20 Terminal EBITDA ($ 000's) Terminal EBITDA ($ 000's) Price Target and Sensitivity Analysis As of January 9, 2015 Compared against 1/9/2015 $153mm MCAP for breakeven With Dilution No Dilution SENSITIVITY ANALYSIS EBITDA Multiple 230, ,000 ($1,208) $25,717 $52,643 $79,569 $106, ,000 $52,643 $86,300 $119,957 $153,614 $187, ,000 $106,494 $146,883 $187,272 $227,660 $268, ,000 $160,346 $207,466 $254,586 $301,706 $348, ,000 $214,197 $268,049 $321,900 $375,752 $429,603 EBITDA Multiple 314, ,000 $39,367 $71,364 $103,362 $135,359 $167, ,000 $103,362 $143,359 $183,356 $223,353 $263, ,000 $167,357 $215,353 $263,350 $311,346 $359, ,000 $231,352 $287,348 $343,344 $399,340 $455, ,000 $295,347 $359,343 $423,338 $487,333 $551,328 PRICE TARGET 80% Venture Capital Method (20% IRR over 2 years) = $ % Comparables + (8.0x EBITDA Multiple) = = $13.37 Price Target: $6.67 / share 20

21 IV. Conclusion

22 Closing Thoughts POST-DILIGENCE OPINION After significant research into Fairway Group Holdings Corp (NASDAQ:FWM), we believe that Fairway is currently plagued by a series of very fixable problems The firm s stable top-line revenue, differentiated product, and incoming senior management present an overall investment picture better than the apparent market consensus Given a willingness to maintain a long-term investment horizon, we believe this investment provides a favorable riskadjusted return Primary Risks: Risk of bankruptcy, while exaggerated, is a legitimate possibility for Fairway At current burn rate, management has roughly 1 year of runway remaining ($50mm in liquidity, average of $12mm burned per quarter) If current short-term funding is exhausted we find a secondary issuance to be likely in the $20-30mm range We believe Murphy will be able to reduce the burn rate substantially given current operational inefficiencies Taken together, these facts imply a high likelihood of refinancing capability for FWM s 2018 loan maturity of $250mm Fairway operates in a highly competitive industry To further this concern, New York s metropolitan area is one of the most saturated in the world for highend/luxury grocers That said, Fairway has proven its ability to compete for customer dollars in NYC and the surrounding area 22

23 V. Appendix

24 Financial Model Fiscal Year ($ in thousands) FY FY FY FY FY FY FY FY FY FY FY FY FY Net Sales $343,106.0 $401,167.0 $485,712.0 $554,858.0 $661,244.0 $775,986.0 $873,837.7 $1,033,360.9 $1,219,365.9 $1,438,851.7 $1,697,845.1 $2,003,457.2 $2,364,079.5 COGS $230,912.0 $271,599.0 $326,207.0 $368,728.0 $445, ,659.0 $591, , , , ,120, ,322, ,560,292.4 Gross profit 112, , , , , , , , , , , , ,787.0 Operating Expenses 102, , , , , , , , , , , , ,032.0 Operating Income (EBIT) 9, ,103.0 (406.0) (3,335.0) (18,095.0) (34,010.0) (901.2) 42, , , , , ,755.0 D&A 7, , , , , , , , , , , , ,281.6 Non Reoccurring Items 4, , , , , ,751.0 Adjusted EBITDA 21, , , , , , , , , , , , ,036.6 Source: I-Club Estimates, Company Filings 24

25 Financial Model Key Assumptions Fiscal Year y/y sales growth NA 16.92% 21.07% 14.24% 19.17% 17.35% 12.61% 18.26% 18.00% 18.00% 18.00% 18.00% 18.00% y/y Adj. EBITDA growth NA 9.59% 22.77% 22.06% 32.39% 3.03% 0.79% 64.82% 9.05% 22.07% 21.93% 19.52% 24.01% Gross Margin 32.70% 32.30% 32.84% 33.55% 32.65% 32.39% 34.00% 34.00% 34.00% 34.00% 34.00% 34.00% 34.00% Operating Margin 2.84% 1.27% -0.08% -0.60% -2.74% -4.38% -0.10% 4.14% 5.25% 5.50% 5.75% 5.85% 6.25% Adjusted EBITDA Margin 6.35% 5.95% 6.03% 6.45% 7.16% 6.29% 5.63% 7.84% 7.25% 7.50% 7.75% 7.85% 8.25% D&A / Sales 2.09% 2.55% 3.00% 3.46% 3.34% 3.49% 3.57% 3.70% 2.00% 2.00% 2.00% 2.00% 2.00% COGS/ Sales 67.30% 67.70% 67.16% 66.45% 67.35% 67.61% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00% Operating Expenses / Sales 29.86% 31.03% 32.92% 34.15% 35.38% 36.77% 32.38% 29.00% 28.75% 28.50% 28.25% 28.15% 27.75% Source: I-Club Estimates, Company Filings 25