Description

Long Betterware de Mexico Common and Warrants

Investment Thesis

• Make 6.5x+ over <5 years or 100%+ in a day on warrants: 6x+ return potential on warrants in <5 years if they don’t tender for warrants or make 100%+ in a day if they do tender. The market seems to have missed that the warrants have an anti-dilution provision, which lowers the strike price by the amount of dividends over $0.50 on a 12 month basis. As a result, the warrants are incredibly valuable to companies that pay dividends (Betterware just implemented a dividend that annualizes to $1.68). Even without this provision, the warrants are absurdly cheap

• Growth is accelerating / EBITDA guidance increased 39%: Sales growth accelerated from +28% YoY in 1Q20 to a stunning +82% YoY in 2Q20. The company increased their 2020 EBITDA guidance by +39%, sales guidance by +31%, and EBITDA margin guidance by +160bps. The company stated they “would like to remain conservative” in their EBITDA guidance, so they’re setup to beat their guidance should the environment remain status quo 

• New 14% dividend yield provides support / pristine balance sheet: The company just implemented a 9.58/sh peso dividend ($0.42 in USD) and this is quarterly, meaning the stock currently trades at a 13.1% dividend yield. The company is in a net cash position with net debt/ebitda at -0.1x. The company is going to be in a large net cash position if they don’t raise their dividend further, tender for the warrants, or engage in M&A

• Niche, under the radar, direct-to-consumer business in Mexico: The company is a leading direct-to-consumer (read: multi-level marketer) in Mexico. This is a region that the business model seems to thrive in. The company merged with a SPAC in March of this year and hasn’t had any coverage on the street. The float is only 2mm so this isn’t suited for funds of any size and the warrants are even less liquid 

• Valuation too cheap to ignore: The stock trades 6.2x NTM EBITDA vs peers at 9.0x (31% discount). Peers have seen revenue decline 5% LTM and EBITDA decline 23% vs Betterware with +54% LTM EBITDA growth, which currently accelerating. One can argue Betterware is worth well north of peer valuations as long as organic revenue growth is 10%, let alone the 65% sales growth and 71% EBITDA growth expected for 2020

Side note: We own both the common and the warrants. I was reluctant to write up the warrants because the common stock is more actionable and presents an attractive opportunity. Further, I believe the warrant write-up sounds a bit over the top whereas the underlying business is the reason we became involved in this in the first place. The warrants were not an option on VIC so we used the common.

 Enter the Warrant Opportunity: A 9x or a double? (I know this is a bit hyperbolic but hey it’s 2020 and the year of the SPAC)

The warrant agreements have an anti-dilution provision that doesn’t get much attention because most sponsors don’t merge with businesses that are throwing off tons of cash (e.g., NKLA, SPCE) and paying dividends. The provision basically says that the warrant strike price is to be adjusted downwards by the cumulative dividends over $0.50 during a 12 month period. This has caused certain companies to tender for their warrants immediately when they buy a business that pays out its cash flows in dividend. See our Trinity Merger warrant write-up (https://www.valueinvestorsclub.com/idea/TRINITY_MERGER_CORP/6762258456), which did better than expected and conveniently highlights this dynamic.

Trinity paid an effective warrant exchange ratio of 0.20 ($1.60 in cash and gave us ¼ of a warrant for us to remove the anti-dilution provision). If Betteware were to do this, it would imply a price of $2.63 (+55% upside). The Betterware warrants are worth significantly more than Trinity’s warrants because 1) the deal has already closed, 2) Betterware’s common stock is trading more than $2 higher than where Trinity was, 3) Trinity needed the warrant amendment just to close the deal. 

The most likely outcome if the company is to continue paying out such high dividends is for the company to tender for the warrants. There’s a whole list of precedents warrant exchange rates as highlighted below. If they do tender for the warrants, they need to pay us a fair amount for the warrants to take into account the anti-dilution provision. It’s not just a straight Black-scholes analysis like what might happen for other warrant exchanges. 

https://docs.google.com/spreadsheets/d/10S78ZVlNrCl4OF2yePhy8874V6civBbeqIIAGeaw_Xs/edit?usp=sharing

To illustrate how valuable the anti-dilution provision is over the life of the warrants, here are a few different cases:

Base case: If the stock price stays flat at $12.00 over the next 5 years, the dividend remains the same, and the warrants expire, we will generate a +50% IRR and 6.5x MOIC with the warrants.  The warrants will be worth $12.79 in year 5, discounted back at 25% per year brings us to a current warrant value of $4.19 (+147% above the current stock price). 

Upside case: Now lets say this company continues to execute, the stock appreciates at 12% per annum, and the dividend rises at 12% per year for the next 5 years. The warrants would generate an +77% IRR and 16.3x MOIC. Yes this is crazy and is not going to happen as the company will tender for the warrants before it does.

Downside case: Now lets say this company runs into some issues, the stock declines 10% per year, and the dividend declines to $0.20 per quarter after a year. The warrants would end up being worthless at the end of the day, although will trade with some time value on its way to zero. 

Betterware Warrant Agreement: https://www.sec.gov/Archives/edgar/data/1748252/000114420418051570/tv503154_ex4-4.htm 

TPG PACE’s (the spac that bought Accel Entertainment public) spelled out in their filings what the warrants are worth in an exchange offer (below). If we assume the warrants are tendered for at the 51 month market (4 months from now), use the average of the $12 and $13 stock price conversion ratios, the warrants are worth $3.81 (+124% above the last price)

Company Description

Betterware de Mexico originated from Betterware, an English company established more than eighty years ago. Since then, it has been a successful and internationally recognized brand due to its wide variety of home solutions. The company was founded in 1995 and is headquartered in Zapopan, Mexico. 

Betterware de Mexico is a leading direct-to-consumer company in Mexico with a clearly differentiated model. Betterware specializes in the home organization segment, with a wide product portfolio for daily solutions including organization, kitchen preparation, food containers, smart furniture, among others. 

Betterware has a distribution network of 740k active distributors (+108% YoY in 2Q20) and 42k associates (+94% YoY in 2Q20) and serves approximately 3 million households in more than 800 communities throughout Mexico.  Betterware’s mission is to be the go-to company for home organization solutions in Mexico and Latin America.  They offer reliable top quality products, consistent on time deliveries and commitment with the sales force.

Betterware offers a unique product portfolio. It is focused on providing everyday solutions for modern spaces. Betterware has an unparalleled logistics platform with zero last mile cost. It has a long haul distribution through exclusive third parties and 98.5% on time deliveries to anywhere in the country within 24-48 hours. 

Financials

Betterware has achieved extraordinary results in the middle of challenging times from the COVID-19 pandemic. 2Q20 results were superb but more importantly the underlying fundamentals of the businesses accelerated with associates up 56% QoQ and distributors up 68% QoQ. The result of 2Q20 was affected due to the Mexican Peso devaluation against the US dollar which impacted betterware's gross margin for the quarter. EBITDA increased by 94% YoY as a result of an increase in sales and the operating leverage of fixed expense which led to an EBITDA margin of 27.2%, 1.7pp higher than 2Q19. 

As of June 2020, the Net debt to EBITDA ratio decreased substantially to stand at -0.1x, while a strong generation of cash led to a 59.7% increase in the adjusted levered free cash flow, thus boosting their liquidity. 

Sales growth accelerated from +28% YoY in 1Q20 to a stunning +82% YoY in 2Q20. The company increased their 2020 EBITDA guidance by +39%, sales guidance by +31%, and EBITDA margin guidance by +160bps. The company stated they “would like to remain conservative” in their EBITDA guidance, so they’re setup to beat their guidance should the environment remain status quo 

COVID-19 Impact

Betterware is an essential business selling products of sanitation, cleaning solutions and organization products, the Company was able to continue normal operations throughout 2Q. 

Valuation

Comps

Management

• Andres Campos – CEO & Board Member: Prior to becoming CEO of Betterware, Andrés Campos served as: Commercial Director of Betterware (2014-2018); Strategy and New Businesses Director of Betterware (2012-2014); Banamex Corporate Banking (2005-2010); KPMG Auditor (2004-2005)
• Jose del Monte – CFO: Prior to Betterware, José del Monte served as: Regional Director of Banco Regional de Monterrey (2007-2019); Founding Partner of  Geltung Asesores (2001-2007); Corporate Banking Regional Director of Banca Serfín (1996-2001)
• Fabian Rivera – COO: Prior to becoming COO of Betterware, Fabián Rivera served as: IT Director at Finamex (2012-2016); Consultant at Deloitte (2009-2012); Software Products Coordinator at IBM(2006-2007)
• Luis Campos - Chairman: Prior to Betterware, Luis Campos served as: Chairman of Tupperware Americas (1994-1999); Chairman of Sara Lee – House of Fuller Mexico (1991-1993); Chairman of Hasbro Mexico (1984-1990) 
• Martin Werner – CEO & Chairman of DD3 Acquisition Corp / Board Member: Martin co-founded DD3 Capital Partners and is its Managing Partner. Prior to DD3, Martin Werner served as: Partner at Goldman Sachs (2006-2016); Co-Head of Investment Banking for LatAm; Managing Director at Goldman Sachs (2000-2006); Head of Mexico Office; Director of Public Credit and Deputy Finance Minister of Mexico (1995-1999) 

Risks

• If Betterware is unable to retain its existing independent distributors and recruit additional distributors, its revenue increase could potentially slow down

• The regulatory environment in which Betterware operates is evolving, and its operations may be modified or otherwise harmed by regulatory changes, subjective interpretations of laws or an inability to work effectively with national and local government agencies.

• Currency exchange rate fluctuations, particularly with respect to the US dollar/Mexican peso exchange rate, could lower margins 

• Mexico is an emerging market economy

• Laws and regulations may prohibit or severely restrict Betterware’s direct sales efforts and harm its revenue and profitability

• Failure of Betterware’s internet and its other technology initiatives to create sustained consultant enthusiasm and incremental cost savings could negatively impact its business. Failure of new products to gain distributors and market acceptance could harm Betterware’s business

• The loss of key high-level distributors could negatively impact Betterware’s consultant growth and its revenue

• If Betterware’s industry, business or its products are subject to adverse publicity, its business may suffer

• Largest shareholders may do something that doesn’t benefit us

Catalyst

• Tender offer for warrants
• Dividend yield showing up on screens
• Executing on business plan