Description

Thesis Summary

Jamba Juice is an owner/operator and franchisor of juice/smoothie restaurants across 30+ US states with a growing international presence. As of 2Q’17 the company has a store-base of 870 units (798 domestic and 72 international; excludes Express stores). The store base is ~94% franchised currently versus ~60% in 2011 and ~70% in 2013/14.

• Valuation at deep discount to comps and is pricing in no unit growth at all

• Comparable companies that are primarily franchised trade at 14-15x EBITDA vs. JMBA at 7.8x FY’17E.

• The current valuation implies zero unit growth. Even amid challenges of past 2yrs the company was able to achieve low single digit unit growth.

• Under conservative growth assumptions over the next 2yrs and a discounted 12x EBITDA multiple the stock is still ~50% below fair value today (PV at 15% discount rate).  

• High value of core store base suggests limited downside from current levels

• The company is highly successful in its core West Coast market – brand awareness is strong with above average AUVs

• This store base is worth $6-7/share suggesting limited downside from current levels

• Clean balance sheet (net cash) with growing FCF will support a multiple revaluation and also leaves open the potential for small acquisitions that would be highly accretive.  

• New management team in place with a re-aligned organizational structure more appropriate for a franchisor business model. The new management has been in place for over 18-mths now and has had time to assess the issues and execute change – we are no longer in the earliest innings of a turnaround but at an inflection point. Their approach is more data-driven and they are pursuing a more appropriate growth strategy.

• Unit economics are attractive to bring in new franchisees and Jamba has premium brand value

• M&A potential in a longer time horizon: the most viable exit for activist funds Engaged Capital and JCP Investment is via a sale of the entire company

Reasons for cheapness

The stock is down ~50% from ~$17/share in January 2015 and hit a 5-yr low of $6.77 in June of this year. The poor performance has been driven by several factors:

1. Company is not current with its filings

The company has been behind on its filings for several quarters now which has created an overhang on the stock. The last SEC filing was the 3Q’16 10-Q. Per the company the delay is due to transition issues caused by the relocation of its headquarters from California to Texas in 2H’16. As a result of the move the company re-staffed more than 90% of its leadership and support team.

2. Prior management team’s refranchising of 179 stores viewed as value destructive

The company announced plans to franchise 179 company-owned stores in early 2015 and consistently provided overly bullish guidance for proceeds – calling for the high end of a $60-70m range versus actual proceeds of $53m. Based on public filings I estimate stores were sold on average at ~2.5-3.0x EBITDA vs. an expected range of 4.0-4.5x based on comp transactions. It’s likely the refranchising announcement attracted a short-term investor base in early ’15 that was looking for a quick return, and subsequently dumped the stock as the actual economics of the franchising deals were released.

3. Prior management teams aggressive guidance that consistently missed. Elevated store closure levels as prior management team attempted to grow too fast without requisite diligence, particularly when expanding outside of its core West Coast market.

4. Investor skepticism regarding the growth potential and brand value of Jamba

5. Historically elevated SG&A structure that has only recently been right-sized

Investment Thesis

Short interest in the name is massive at 33% of float, yet we don’t see a valid short thesis exists at this point/at this valuation. At this point the negative views and risks are known and priced in the stock. In addition to high short interest, a large % of the float is held by insiders and effectively doesn’t trade. There is the potential for strong technical tailwinds should the company report even modest signs of improvement.

Filings delay should be resolved soon, but remains opaque and is an overhang

We would expect the company to be current on its filings before year-end as they will be strongly incentivized to avoid delisting (deadline to avoid delisting is March 18). That said, there is no transparency around this issue and it remains a risk/overhang. It’s not an issue of fraud or needing to restate prior financials. The company has disclosed comp sales numbers and other figures in the interim.   

The 2015 franchising issue is long gone and the related issues are well understood by the market

The refranchising value was a valid concern at the time and brought to question management’s judgment, however at this point it’s effectively a sunk cost and the focus should be on the new management team and store growth/performance. New management has eliminated non-core concepts such as JambaGo/CPG and is being far more disciplined in assessing the return on capital of growth investments.

Unit economics are attractive to bring in new franchisees and Jamba has premium brand value

There is a prevailing view that smoothie/juice pure play doesn’t have growth potential, particularly outside of its core market. We disagree with this premise and don’t believe the store economics support this view. That said, even under conservative growth assumptions there is significant upside from the trough EBITDA level of ~$10m in 2016.

A traditional store format is 1000-1200 square feet in size, located either in major urban centers or in suburban strip mall centers. Non-traditional locations are locations where the Jamba store is located within another primary business (airports, supermarkets, universities, entertainment venues, etc.)

AUV: Traditional Jamba stores have AUVs of ~$650k. This is 33% higher than JMBA’s next largest competitor Smoothie King (~$490k in 2016).  For context, this compares to Dunkin’ Donuts at ~$950k, Papa John’s at ~$880k, Pizza Hut at $835k, and Baskin Robbins at $238k

Store-level margin: normalized average across all stores around 14-15%

Sales per square foot: JMBA does ~$591 sales/sqft right vs. the QSR median of $582/sqft., Fast Casual median of $574/sqft., and Casual Dining at $541/sqft.  

Franchisee Return: The average initial investment for a franchisee is ~$350k. At the company average $650k AUV this yields a cash-on-cash return of ~24% assuming low-end 13% store margins.

JMBA has a 20% greater unit footprint vs. its next largest competitor while still commanding a much higher AUV per store. Despite challenges of past couple years, JMBA is still the clear market leader in the smoothie/juice category which is expected to grow significantly and remains fragmented. The market is currently valuing JMBA at just $137k EV/Unit and our price target implies ~$275k EV/Unit by 2019. Not a challenging assumption given higher growth franchisors trade at $800k+ and slower growth/mature companies trade at $350k+

Although its AUVs are lower than other QSRs/Fast Casual, sales productivity is on par or better with sales per sq. ft. ~$591 as JMBA needs much less square footage for preparation than other concepts. The company also benefits from lower cost of sales and labor costs per store as it requires fewer employees to run.

Overall these economics underscore some combination of the company’s premium brand value and the favorable economics associated with the smoothie concept in general.

New management has an appropriate growth strategy, with an improved organizational structure in place for site due diligence and monitoring/supporting franchisees.

No restaurant will do well if the store-level operations are not up to standard or a poor location was chosen – both of these are problems that new management has worked to fix. The prior management team attempted to grow the store count without adequately tracking store performance and assumed growth in new markets would follow the same playbook as that of its core regions. The company has revamped its organizational structure to provide better franchisee support. Management has put in place a real estate committee that will now follow a very specific evaluation process to more systematically choose sites.

The new management team recognizes that its brand recognition, while still strong overall, is inevitably lower outside of the west coast region and will be approaching their growth strategy with this in mind. To the extent JMBA is viewed as an undifferentiated brand among smoothie/juice customers – the most important thing the company can do is have a strong presence in a given city or area and scale marketing around it. They don’t think entering a city/town with 1-2 stores is adequate and accordingly they are looking to partner with well-capitalized, experienced franchisees who can take on a more significant store count. Location selection will be even more important as Jamba may not be a “go to” spot in all regions.

Of note, the new disclosure for store growth going forward will provide clearer picture of the earnings impact of openings/closings. The headline unit growth from past earnings reports had masked some important distinctions given Jamba operates a variety of store types which generate a wide range of AUVs. For example, the reported closure rate was very elevated in 2015-16 at 60-80% of openings; however, 19 closings in 1H’16 were low volume kiosk locations with average AUVs of ~300k, much less significant than if 19 traditional stores had closed. In 1Q’16, 13 international closings were co-branding agreements with low volumes. Beginning with its FY’16 preliminary results (released in March 2017) the company now reports store count by type (traditional, non-traditional, drive thru, international) which provides a clearer picture. Additionally the company no longer includes Express in its store counts given their negligible 3k per unit contribution. Prior to this change in reporting a kiosk, express store, and traditional store were reported collectively to arrive at a unit change % despite the massive differences in earnings power.

We expect a return to steady unit growth in 2017/18 with the potential to accelerate to mid-single digit growth in 2019 onward. The market is pricing in no growth potential at all. Importantly, we think low-single digit growth can be achieved from its core markets and similar locations in warm weather regions. Even if you don’t believe JMBA can be a successful mainstream concept, the current valuation is suggesting that it isn’t even a viable niche concept – a view that is unsupported by the data and the company’s long history.  

Areas where JMBA has proven to be a successful concept – the best performing stores are in warm weather locations, typically in a suburb – remain significantly untapped domestically. Having originated in the California/West Coast, this core market enjoys the highest brand recognition and the strongest store level earnings. This region is not fully saturated at this point – existing franchisees had been hesitant to invest incrementally with the prior management team but this has since changed with the new CEO/executives on board ant the company has been pursuing an infill strategy here.  For example, earlier this month the company announced that its largest franchise partner (Vitaligent) would be acquiring another 21 stores from a former franchisee and also signed a 5yr, 12 store development agreement for the greater Seattle market. This brings Vitaligent’s operation to 100 stores across California, Missouri, and now Washington.

Texas and Florida/Southeast region present a huge opportunity in our view. Smoothie King (and to a much lesser extent Planet Smoothie) have a presence in these areas and have been growing – the product demand is there.

Our 2.6% 3yr CAGR for store count (2018-2020) amounts to 70 net openings over 3yrs – the significant opportunity in the above mentioned regions would be more than sufficient to hit this number.

As mentioned earlier, growth outside its core markets likely requires more/different diligence, but we think the new management team is cognizant of this and has shown signs that they will be much more adept at navigating this versus the approach taken by the prior regime. There is plenty of evidence that for many stores the key issue has been poorly run store-level operations, not a lack of interest in the product. The Chicago situation exemplifies this. The company acquired 13 Chicago stores in late 2014, with the intention to renovate and improve profitability and then refranchise at a later date. The company took the stores from double digit negative margins to roughly breakeven at the time of sale earlier this year. In June the company announced a refranchising for these stores as well as a 10-unit development agreement. The buyer is SuSu Hospitality Group – post-acquisition the group will be franchising 25 locations across Illinois/Ohio. There’s no way an experienced franchisee would take these stores on without believing the stores could eventually earn higher margins and a sufficient ROI.  

Corporate SG&A has been right-sized

There is a natural G&A reduction as you refranchise stores as expense for field operations moves to the franchisees and this has only recently been reflected in the numbers (interim reports from company, not K/Q filing). Adjusted SG&A was $34m and $32m in 2014/5 respectively – this is largely before the 173 unit franchising that took place in November 2015. The company was still operating at this same run-rate last year despite the sharp uptick in franchise percentage ($27m through 3Q’16). For 2017 the company is guiding for 20m of SG&A – a significant reduction. The corporate HQ move to Texas from California and the related headcount reduction from 130 to 90 will contribute to this decline. This is a 3.5% margin (% of system sales) versus the company’s stated target in the past of 3%. The average expense ratio for comps with majority % franchise is 2.6% (BWLD, DPZ, DNKN, JACK, QSR, and WING). The typical Jamba franchisee is experienced and operating many stores which requires less corporate oversight vs. a “mom and pop” franchisee distribution. In short, we don’t think this is an unsustainable level of SG&A and the company should be able to grow and scale the business with this spending level.   

Shareholder base adds interesting optionality to the story

Engaged Capital and JCP Investment both have board seats beginning in January 2015. Engaged owns 18.5% of shares out while JCP owns 2.66% of shares out. Given their involvement on the board, the most viable exit for the funds is via a sale of the company. This is not our base case assumption for the near-term but is certainly a possibility in the medium-term and longer once earnings stabilize.  Indus Capital took a 9.3% position this summer – while the fund doesn’t have a board seat they will observe board meetings for a 12-mth time period.

Valuation & Price Target

JMBA is trading at 7.8x FY’17E EBITDA (using management guidance) which is in the low end of its historical range despite being a primarily franchise model at this point (~93% today vs. ~70% in 2014 and prior). On our 1-yr forward estimate of $17m EBITDA the company trades at just 5.7x. The company traded at 15-16x in prior years. Jamba now has a clean balance sheet with net cash position and high EBITDA to free cash flow conversion given its transition to a franchise model

Earnings Estimates

• Assumes 3y CAGR of -3.5% (from $650k average to $585k)

• Store count 3y CAGR of 2.6% (excluding Express stores) – 932 stores by end of 2020

• Store level margins for owned stores normalize to 15% (note: the lower margin Chicago stores have been refranchised so no longer diluting the margin for company owned stores)

• 20m of corporate SG&A (guidance for 2017 exit run-rate) – i.e. assuming no further cost reductions though a further 1-2m of cost rationalization is not out of the question

Price Target

Assuming ~18m of EBITDA in 2019 and a 12-16x EBITDA multiple – price target today of $12-16/share or 50-90% upside from today’s price (PV at 15% discount rate). Down the road as the base case thesis progresses the company could do $25m of EBITDA, which at a low-end 12x multiple gets to $300m TEV vs. current TEV of ~$100m.

Downside

Close to 70% of system-wide stores are located in the West region (CA, ID, NV, OR, and WA) with California having by far the largest store count. This is a region where the Jamba concept is proven and successful, with very high brand awareness. These stores experience better traffic trends and much higher AUV. We estimate the existing store base in the West region (franchised and owned) is worth ~$6-7/share, using a 7-8x EBITDA multiple and assuming AUVs average 750k (+15% higher vs. company average). A 7-8x multiple sufficiently discounts the value for a “no growth” scenario. This is ~15-25% below current price – the market is attributing very little value to the remaining store base.   

Key Risks

• Possible that company does not become current on financials and runs out of extensions with Nasdaq and is subsequently delisted.

• Lack of transparency currently given full financials not released for several quarters

• Significant execution risk

Catalyst

• Company becomes current on its filings

• Return to steady unit growth with potential to accelerate to mid-single digit growth

• Earnings: significant y/y EBITDA growth + growing FCF and net cash position

• M&A: JMBA could be an acquirer in the near-term and in the medium-term would be an attractive takeout candidate