Description

FTD spun out of United Online (UNTD) in November 2013 and will soon report their first quarter as a public company since 2004.  FTD was founded in 1910, owned by Perry Capital from 1994-1999, was briefly public from 1999-2004, but then LBOd by Leonard Green, who sold it four years later to UNTD.  There’s a good background piece on UNTD from August of 2013 which gives a history of the spin and the former parent company.  FTD hasn’t attracted any sellside coverage yet, and has met with a few investors in private meetings and at the ICR Conference in January, but I would say it is still fairly unknown.

FTD participates in an oligopoly in the business of selling flowers on the internet in the US and the UK (where it is known as Interflora).  It is the largest and most well-known of the four players in the US, and Interflora has the highest unaided awareness scores in the flower business in the UK.  FTD operates a consumer internet retailer at FTD.com, and also sells by phone, which still accounts for about 10% of retail sales.  They enable consumers to order floral arrangements online (or by phone) for delivery anywhere in the country.  The orders are then fulfilled by local florists who pay to be part of the FTD network.  FTD makes money by taking a commission on the sale, charging some service fees to the florist (primarily interchange fees), and by charging membership fees to the florists to be a part of the network.  The membership fees are a recurring revenue stream, whereas the commissions and fees from retail transactions obviously depend on the number of retail orders they get in a given period.  Commissions and fees from retail sales are 78% of revenues and carry a low 20s margin.  The remaining 22% of sales are membership fees, which carry an 85% margin.  The company EBITDA margin has been quite stable in the 13.5%-14.0% range.  Two of their competitors, 1-800-Flowers (FLWS) and Telefora (private), have a similar business model – basically serving as an agent, standing between retail customers and local small businesses, while the third competitor, ProFlowers (currently part of LINTA, formerly the old Provide Commerce – PRVD), is a direct shipper of boxed flowers (a traditional etailer model).  FTD, FLWS, and Telefora have a model like eBay’s, whereas ProFlowers is more like Amazon.

One of the attractive things about this business is that there are huge barriers to entry for someone to enter the national floral network business.  In order to get a florist to join your network, you need to have retail order flow, but in order to get retail order flow, you need a network in place to fulfill it.  It is highly unlikely that a fourth entrant comes in to challenge FTD, FLWS, or Teleflora in the network business.  Also attractive is the fact that FTD holds no floral inventory and very little inventory in general.  They do direct ship some non-floral gifting items (chocolates, cookies, teddy bears, etc.) – although for a lot of the product they ship they may not actually own the inventory but instead only serve as a fulfillment agent.  Given the perishable nature of floral inventory, holding a lot of it would obviously increase the risk of this business.  And by having little inventory in general, one of the biggest sources of risk in a retail business has been eliminated, and makes the deleveraging that they experience in recessions much lower than you see at traditional retailers.  They also benefit from a negative working capital cycle because they charge retail customers at the time of the order, and pay the network florists a few days later, after the order has been fulfilled.

While the business is low growth (low to mid single digit grower), FTD is the largest player and has been outgrowing and taking share from FLWS, and I believe Teleflora as well.  While the flower gifting market is unlikely to accelerate in terms of growth, it is also increasingly going online, so the online players should continue to grow faster than the overall market.  Currently online flower sales are around $4 billion, and the total floral market is $28 billion.  FTD has done a number of things to try to increase average order size as well as order frequency.  In terms of order size, they have been pushing a good/better/best strategy in terms of the arrangements.  They display an arrangement on their site and label it as “starting at$ xx.99”.  When you click to see the arrangement, you will be shown a base arrangement at the starting price, and an option $10ish more for an extra half dozen or so flowers, and then another option for $20 more with perhaps an extra dozen flowers.  The company doesn’t disclose how many customers opt to upgrade, but I can say from personal experience, I am shamed into the “better” option 100% of the time.  They also use the standard CRM techniques used by most internet companies to try to increase frequency – holiday/birthday event gifting reminders, seasonal promotions, etc.  There are various merchandising initiatives in place to increase order value (such as a brand collaboration with Vera Wang) as well as frequency (such as the College Rose program, which offers floral arrangements in popular college colors for celebrating Game Day).

In terms of risks, FTD is clearly subject to the general macroeconomic risks surrounding consumer spending, and also the highly seasonal nature of their business (big peaks around Valentine’s Day and Mother’s Day) can lead to heightened earnings volatility if a holiday doesn’t go well.  The biggest non-macro risk to the business is the fear that Amazon gets into the flower business in a big way.  Amazon currently delivers fresh flowers as part of Amazon Fresh, the grocery delivery service that operates only in Seattle and LA as of now.  While no business wants to compete against Amazon, I view their eventual entry as more of a threat to the pre-packaged flower business at grocery stores, gas stations, and other non-floral shops, as opposed to the more stylized, arrangement-oriented flower gifting business that currently goes through FTD, FLWS, and local florists.   And if Amazon were to start shipping boxed flowers directly from its DCs, that would probably be a more direct threat to ProFlowers, who pursues a similar strategy.

This business has fantastic cash flow characteristics.  Without bricks and mortar stores, or much in the way of inventory and warehouses, capital needs are low.  My free cash flow estimate for 2014 is around $3.25, so at the current quote of $30.92, it’s trading at over a 10% free cash flow yield.  Usually you only see yields over 10% if the company is in secular decline or highly leveraged – neither is the case here.  I’m not sure why it is that high – FLWS, which has operationally underperformed FTD for many years and has a smaller market cap, trades around a 5.7% free cash flow yield.  I think the valuation disparity may be related to FTD not trading as a public entity for more than a few months and being relatively undiscovered.  Since the company is unlikely to grow its topline higher than low-mid single digits and its free cash flow more than mid single digits, I wouldn’t get that aggressive in my target free cash flow multiple, but I think an 8% yield wouldn’t be that aggressive as relatively stable results somewhat offset the low growth.  At an 8% free cash flow yield, the stock would trade around $40.50, up 31% from here.  I’m hoping once they start reporting some quarters (the first one as a public company should be in the next few weeks), it should start hitting some value screens and/or attract some sellside coverage – either could be a catalyst for closing the valuation gap between it and FLWS, or it and other high free cash flow yield retailers like GME and BBY – both of which have businesses that are far more secularly challenged, yet trade at much lower free cash flow yields. 

It should be noted that the company looks a lot more expensive on PE than EBITDA or FCF because the company has about 4% of sales in D&A (there’s a bunch of amortization of intangibles that is related to UNTD’s purchase of the company) but only spends about 1% of sales in capex.  Free cash flow per share exceeds earnings per share by around $1.75, because D&A exceeds capex by so much, and there is also some stock comp running through the income statement.  A lot of the amortization goes away after either 2014 or 2015, so once that happens, the company will look optically cheaper to someone who looks at PE only.

While the company has not instituted a dividend nor articulated a dividend strategy, I think it is possible they could initiate a dividend sometime in this first year as a public company, as they have ample capacity to do one.  Their former parent, United Online, was a big dividend payer (dividend was often as high as 8-9% as they paid out almost 100% of free cash flow).  I get the sense FTD management wants to respectfully distance themselves a bit from their former parent and is unlikely to adopt as aggressive a cash return policy as paying out 100%, but a 15-30c quarterly dividend, for a yield of 2-3.5% off the current price, wouldn’t be shocking and could help the stock pick up some attention as well. 

The impending spin of LINTA into two publicly traded tracking stocks – one for QVC, and the other for the non-QVC internet businesses later in the first half of 2014 could turn the spotlight a bit to the flower industry.  The non-QVC tracker, LDC, will be about 30-40% made up of the flower business, so once LDC is trading, the number of “comp companies” in the flower business will have expanded from 1 to 3 , which also might attract better coverage from the sellside and the financial media. 

I should mention that I have some concerns about how the terrible weather over the last few days affected their business over the extremely important Valentine’s Day holiday.  On the one hand, terrible weather should have encouraged people to shop on the internet for gifts.  On the other hand, large amounts of snow probably made delivery of flowers to florists as well as to customers more difficult and possibly delayed.  While FTD doesn’t bear any of the expense related to deliveries being slower and thus more costly on a per unit basis, it is possible that a significant number of floral deliveries were late or didn’t arrive at all or were fulfilled with substitute floral product this Valentine’s Day.  This is more of a reputational risk and a risk to future orders than a Q1 revenue issue, and any problems on this front suffered by FTD will be shared by their competition as well, as this was an industry issue.

Risks:

1. Weak Valentine’s Day either because of macro (retail and even internet retail have been putting up weak numbers almost universally across the board for months) or weather
2. Management issues really conservative guidance their first quarter out of the gate (why not?)
3. Headline noise about Amazon increasing their presence in flowers could crop up at anytime
4. The number of florists in the US is in secular decline, so the number of florists that they collect high margin membership fees from is in secular decline too.  This has been going on for years so it’s something they have learned how to manage.

Catalyst

1. Reports first few public quarters, data starts to be included in financial databases, and company appears in screens for cheap high free cash flow companies
2. Initiation of sellside coverage
3. Initiation of a dividend
4. Spin off of LDC draws more attention to the floral industry