Description

At $2.80, FLWS has an enterprise value of $215mm, but I believe the two lesser known segments within FLWS are alone worth that valuation, essentially giving an investor the flagship 1800Flowers.com brand for free.  It appears that investors are looking at the top line without recognizing that growth rates and gross margins from each of the different segments tell a different story.

FLWS has three segments: Consumer Floral, Gourmet Food and
Gift Baskets, and BloomNet Wire Service business.  The
flagship brand, 1800Flowers.com, accounts for over 50% of
revenues.  The Gourmet Food and Gift Baskets, which I
believe is where much of the hidden value is, accounts for
over 33% of revenues, but is growing faster and has higher
margins than the Floral segment.  Finally, BloomNet,
accounting for the balance of revenues, is the smallest
segment but fastest growing.

Overall, the argument I'm going to make is that BloomNet and Gourmet F&G Baskets deserve a higher EBITDA multiple than Consumer Floral, and more than the market is giving them credit for.  As I see it, valuation should look similar to this:

Let's take a look at each of the 3 segments more closely. 

First, Consumer Floral.  Over the last 2 years, this segment's revenues have declined from $465mm to $365mm.  I believe much of this is due to the weak economy, but also, it's not a growth business as well.  Personally, while I've purchased flowers online many times in the past, I knew I was paying a premium for convenience.  In an economy where people are much more aware of costs, I think many will choose to drive a bit out of their way on the way home from work to buy flowers.  And there are other alternatives as well.  But that said, I think there will always be a portion of the market that will prefer to buy online (or needs to buy online - if the purchaser lives far away from his recipient).  As of the 1/27/2011 conference call, the company says that its average order size is $53.51.  Assuming that's true, in order to realize $350mm revenues from this segment, they would need 2.2mm customers to order three times a year.   That doesn't seem unreasonable to me, although it implies very little in the way continued weakness in the floral segment which management says it's observing.  On the most recent call, management said revenues were down 3% in this segment, but gross margin improved 30 basis points, which gets me slightly more comfortable that this segment could see the pressure level off.  For this division, I'm going to assign an 7x EBITDA multiple.  (Not coincidentally, this is slightly less than the market gives the entire company which is consistent with my thoughts that the market is not paying attention to the segments within, but instead simply attributing the company's revenues as if they came entirely from Floral.)

The Gourmet Food and Gift Baskets is where I believe much of the overlooked value is to be found.  Because of the brands in this segment, one could argue that FLWS has developed a partial "moat" (Cheryl's Cookies and Fannie May, for example).  I don't think I could persuasively make that argument although I couldn't dispute it either. With such limited data to draw from, I'll mention it for a possible future topic for discussion, and throw in the caveat that if one of these brands really gains traction, more value could be released from this segment.

From the most recent 10k, the EBITDA from Gourmet Food & Gift Baskets is $27.3mm.  Corporate overhead is 43.7mm, and assigning Gourmet Food and Gift Baskets its pro-rata share of Corporate Overhead expenses (based on adjusted EBITDA per division as a percentage of total EBITDA) would lead to a net EDITDA of around 10mm.  I believe this should carry a much higher EBITDA multiple of 12.5x because this segment is still in its infancy.  Over the last few years, despite the poor economy, it has maintained its EBITDA - declining 12% in 2009 but increasing 11% in 2010.  Assuming growth of 2-3% per year for the future with a more "normal" economy, I think the company has years of growth ahead of them for this segment.  In fact, management stated on the Jan27th conference call that the 1800Baskets.com is still in its "very early stages" and that they've "only scratched the surface on its growth potential."  Additionally, FLWS has done a good job of cross-selling through their dual branded website by taking advantage of the eyeballs brought in for their flagship 1800Flowers.com product.  As you can see from the table above, I think this segment could be worth $123mm of enterprise value, using a 12.5x multiple.

The BloomNet segment has shown more consistent growth, albeit off a smaller base.  Over the last two years, it's grown 2.5% per year.  Revenue increased 10% yoy in the most recent quarter, and they have added new products in this area.  Gross margin in BloomNet is over 55%.  This segment appears to be a better-than-average business overall with low asset requirements and decent gross margins, and like Gourmet F&G Baskets, I think it has a lot of growth ahead of it.  Assuming 2-3% growth here as well, I think this segment could be worth 86mm using a 12.5x multiple.

Conclusion:

So putting it together, for the entire company, I see a potential valuation closer to $265mm, or subtracting debt, a share price of approximately $3.60 today, implying around 28% of upside.

Risks:

My three main concerns with this investment are:

• 1) Commodity Costs: FLWS is exposed to commodity costs which have been rising (butter, flour, cocoa). Management dismissed the issue on the last conference call saying that those markets have stabilized somewhat. I think over time, the company would be able to pass on cost increases, but I think in the short term this would be a problem.
• 2) Execution: A large portion of my thesis is based on growth, and as a result, management will have to do the right things in terms of guiding the company, spending advertising dollars, launching new products, etc. Now that FLWS has reduced debt, I think they will begin to focus on potential acquisitions. In general, I think most managers unintentionally destroy value in acquisitions so I think that's a risk here.
• 3) Market Weakness: General market weakness and or a slowdown in the economy. The items that FLWS sells are not essential, and in the case of a slower economy, I think their top and bottom line would suffer disproportionately.

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