Description

Jamba Juice (JMBA) is a growing consumer franchise that is being overlooked by the market as high corporate G&A expense masks the successful turnaround of the underlying fundamentals. Under the leadership of CEO James White, JMBA has successfully refranchised locations, added licensing revenue streams, and dramatically improved unit-level profitability. Now that White’s initial plan is executed, continued focus on reducing overhead will allow the improved franchisor economics to pull through. I believe JMBA is currently 40% undervalued to a private buyer using very simple and conservative assumptions. As an analyst for a private equity fund specializing in restaurant/retail investing, I believe I can add some unique insights on the private market which support my valuation.

Business Overview:

Jamba Juice is a franchisor and operator of 849 quick-serve smoothie/healthy lifestyle restaurants and also licenses their brand through various consumer packaged brands (CPG) channels. JMBA went public through a SPAC in 2006, followed by a miserable stretch of unprofitable years and near collapse in 2008. Despite deteriorating margins and weak same store sales, prior JMBA management continually pressed for growth, opening 99 company-owned locations in 2007 alone. In December 2008 JMBA hired CEO James White, an executive with a clear turnaround plan and experience in executive roles at Gillette, Nestle Purina, and Coca Cola.

Today the Jamba system has 804 domestic locations (517 franchised / 287 corporate) and 45 international locations (all franchised) across 30 states and in 3 foreign countries. In the last few years Jamba broadened their menu by adding healthy food options, lower calorie smoothies, and a new focus on fresh squeezed juices. These moves, along with marketing efforts and partnerships with pro athletes, emphasize Jamba as a healthy lifestyle brand rather than simply a smoothie retailer.

JMBA management believes there is potential for a total 1,300 domestic stores and 1,500 international stores, giving the brand plenty of room to grow. While Jamba CPG products are available in all 50 states, the store base is mostly concentrated on the west coast and California in particular. Today there are 390 JMBA locations in California alone while there are only 62 locations on the entire east coast, highlighting the room the Jamba brand has to grow over the next few years.

Unit Economics:

A restaurant/retail business is only as good as the economics of one location, or “The Box”. Try to grow aggressively without a good formula for The Box, and you get Krispy Kreme in 2004-2005. The same fate was playing out for Jamba in 2008, however White prioritized the economics of The Box over growth and executed on the plan. After lowering labor costs by 700+ bps and cost of goods sold by 250+ bps, building and operating a Jamba Juice is once again a prudent investment for the company or a franchisee.    

Jamba Juice’s are typically 1,200 – 1,400 square feet in-line retail locations that cost $300,000 - $400,000 to build. Jamba’s average unit volumes (AUVs) are ~$715,000 which is double that of rival Smoothie King and compares favorably to Subway at ~$450,000 and Domino’s at ~$715,000. Management guidance is for Jamba to produce a 16% - 17% unit-level margin in 2013 and 18% - 19% in 2014, both dramatic improvements over the 10.7% unit-level margin White inherited in 2008. Add it all up, and the typical Jamba location throws off $115,000 - $135,000 of cash flow producing a high 20% - low 40% cash-on-cash return.

Refranchising:

Through refranchising efforts since White took the helm, JMBA is now ~66% franchised compared to their prior mix of ~70% company-owned locations. Jamba’s improved unit economics should help drive the refranchising trend, as franchisees see the potential for a strong return on investment. Over the next few years, new unit growth and selective refranchising should drive the mix towards 70%+ franchised locations. For reference, many restaurant peers such Domino’s, Burger King, and Dunkin Donuts are 90% - 100% franchised.

The benefits of an asset-light franchisor model compared to a lower margin, capital intensive restaurant business are well documented. Buffett went as far as to say “the best business is a royalty on the growth of others, requiring little capital itself”. JMBA is still transitioning to the franchisor model, but results are beginning to show through. In 2012 JMBA produced positive free cash flow for the first time as a public company, compared to the cumulative $61mm of negative FCF in the 2 fiscal years prior to White’s arrival.

Jamba CPG/JambaGO!:

Part of White’s plan is to expand JMBA beyond solely a smoothie operator and into a healthy, active lifestyle brand. Drawing on his experience in consumer packaged goods, White is licensing the Jamba brand through CPG partners and JambaGo! locations in retailers nationwide. These initiatives offer high margin revenue streams and increased brand awareness with little capex required by JMBA to achieve the growth.

Jamba CPG products consist of at-home smoothie kits, healthy snacks, and all natural energy drinks. CPG revenue, expected to be $3mm - $4mm in 2014, is typically a 3% - 7% royalty fee from the sale of Jamba branded goods produced by outside manufacturers. JambaGo! locations are typically found in convenience stores, retailers, or schools and serve fruit smoothies through self-serve dispenser. JMBA makes ~$2,000 of annual royalty revenue per location, with no capex and limited overhead to support the initiative. JMBA recently announced that 1,000 Target locations will feature JambaGo! stations, and a total of 1,800 will be open by the end of 2013. Guidance is for an additional 1,000 locations opened in 2014, resulting in ~$5mm of run-rate cash flows from this segment alone.

The Brand:

A common concern amongst investors is the very low barriers to entry in the smoothie industry. It’s true, a guy with a blender and $100,000 could set up a viable smoothie operation. However, this same point could be applied to McDonald’s, Starbucks, or many other leading restaurant/retail brands. That’s why restaurants are such a tough business; it’s a fiercely competitive micro game where anyone can copy your format.

But the brand, and the share of mind that accompanies it, now that is something that I can get interested in investing behind. Case in point is the Jamba’s Facebook page which has 1.7 million likes, over three times as many as their two primary smoothie competitors combined (Smoothie King and Robek’s). Chipotle has only 25% more Facebook fans than Jamba, despite having almost 7x the system sales. Noodles & Co. has only 1/5^th of the Twitter followers of Jamba, despite having over 8x the enterprise value.

True I can’t pay my bills with Facebook “likes” the same way free cash flow can, but these stats show Jamba owns an intangible asset that really connects with their customers. For whatever reason, a disproportionate amount of consumers want Jamba Juice to be a part of their online persona. As JambaGo, Jamba’s CPG channel, and franchise locations continue to grow, the brand awareness will only strengthen and reinforce each division. My bet is James White, with a background as an executive at Gillette, Nestle Purina, and Coca Cola, will figure out how to squeeze the cash flows out of this valuable brand.

Management:

Within one month of taking over JMBA, CEO/Chairman James White laid out a detailed strategic plan accompanied with the line “Promises Made Will Be Kept”. The plan, which stressed refranchising, licensing the brand, and closing unprofitable stores, made it clear that White was focused more on margin and cash flows than aggressively growing revenues. Executive compensation remains tied to Adjusted Operating Profit (store-level EBITDA), comparable store sales growth, and G&A expense targets to avoid JMBA’s previous downfall of revenue growth at any cost.

White’s background is mostly with consumer packaged goods and brands, with prior roles as SVP of Consumer Brands at Safeway and SVP of North American Business Development at Gillette. This skill set better matches the direction JMBA is heading, with a greater focus on growth through licensing and franchising the Jamba healthy lifestyle brand. For a more detailed review of White’s background and the Jamba story in his own words, check out this excellent video: http://vimeo.com/16430521.

White owns ~2% of the company, and management has demonstrated a willingness to purchase JMBA stock opportunistically with their own capital. In November 2012, JMBA’s stock dipped down to split-adjusted prices of <$8. White and CFO Karen Luey purchased just under $40,000 worth of stock in the open market, an investment that almost doubled in under a year before the recent pullback in JMBA’s shares.

A blue-chip resume, a clear strategy, and open-market purchases are great, but what about results?

- The refranchising initiative is largely completed, with a shift from 70% company owned to 66%+ franchised locations

- The unit-level economics are dramatically improved, from low teens margins to high teens margins

- JMBA is growing again, but this time with limited capital expenditures through franchise agreements and licensing

- JMBA is profitable on a GAAP basis for the first time

- JMBA is generating positive cash flows in excess of net income

Through White’s first five years, promises made have actually been kept.

Many of White’s current leadership principles are inspired by his time working under Jim Kilts, who received widespread acclaim for his success running Gillette, Nabisco, and Kraft. Buffett, Welch, and others have praised Kilt’s no-nonsense leadership of these successful consumer brands, and I believe JMBA presents an opportunity to invest behind one of his understudies in an emerging brand with years of growth ahead of it. At age 52, White has plenty of years ahead of him and remains intensely focused on executing “the Plan”.

Recent Open Market Purchases:

In the last few months multiple highly informed investors made meaningful purchases of JMBA stock. Independent director Andrew Heyer, CEO of investment firm Mistral Equity Partners, purchased $138,000 worth of stock in the open market on August 8^th, 2013 at levels ~25% above the current trading price. Heyer followed up this purchase with another $64,000 worth of open market buying on September 4^th at prices ~15% above the current trading level. Mistral provided $20mm of convertible preferred financing to JMBA in June of 2009, and Heyer has served on the board since, making his recent open market purchases particularly interesting.

Additionally, on October 21^st, 2013 hedge fund Coliseum Capital Management filed a 13G disclosing a 6.1% ownership stake. Coliseum has partners with deep experience in the QSR restaurant industry, and the fund prides itself on private equity level due diligence with their public holdings. While this filing is only a 13G, Coliseum has been an activist at P.F. Chang’s in the past where they successfully pushed for the take-private by Centerbridge Partners.

Valuation:

So what is this growing consumer franchise with an exceptional management team worth, and what is it selling for in the public markets today? Other pitches on JMBA, such as Lloyd Khaner’s at the 2012 Value Investing Congress, do a great job of highlighting the turnaround success and qualitative strengths of the business and White as a leader. What is less widely discussed is the valuation of JMBA, which I believe compares very well to their current $163mm enterprise value and $192mm market cap. In order to better understand the intrinsic value, I’ve broken out the various segments within the company:

Company Owned Stores:

Jamba owns and operates 287 locations, with average unit volumes of ~$715,000 and unit-level margins of 16% - 17%. To a potential private acquirer, this is ~$34mm of unit-level EBITDA in a growing chain with margins expected to increase to 18% - 19% next year. In private transactions, G&A or corporate overhead is typically adjusted or “run-rated” to reflect the economics of the business following a transaction. 5% - 6% of sales is a typical G&A expense applied to mature systems, while 8% - 10% is more common for rapidly growing chains. Applying an 8% G&A expense to JMBA’s company owned stores results in pro-forma corporate EBITDA of ~$17.5mm.

Caribou Coffee was taken private last December at ~12.5x EBITDA and Peet’s Coffee and Tea was taken private for ~20x EBITDA in July 2012 by the same group. From everything we see as a PE fund in the space, multiples have done nothing but continue to push higher in 2013, with growing restaurant chains routinely selling for 10x – 15x EBITDA in private transactions. Applying a 10x multiple, which would be a very fair price in today’s market, to JMBA’s pro-forma EBITDA yields a value of ~$175mm for the company-owned stores to a private buyer.

Franchisor Royalty Stream:

Today there are 562 franchised Jamba locations, and management believes there is room for almost 1,500 more franchised locations internationally. While JMBA does not explicitly break out franchisee revenues, $10mm of annual royalties is a conservative estimate for today and will likely look very conservative given the anticipated growth through franchisees over the next five years. Assuming a 50% EBITDA margin (a margin typically applied to pure franchisors) on these annual royalties, the JMBA brand is capable of producing $5mm of EBITDA to a private acquirer. Franchisor’s typically receive higher EBITDA multiples than chains, and publicly-traded franchisors such as Dunkin Donuts and Domino’s are trading at 15x – 20x EBITDA currently.  Using a very reasonable 12x multiple, the JMBA franchisor segment could be worth ~$60mm to private buyer.

JambaGo!:

While each JambaGo! only provides a small royalty of $2,000, collectively the growing division will begin to deliver a high-margin income stream that materially impacts JMBA’s earnings power and valuation. With 1,800 locations open up by the end of the year, and limited overhead, JambaGo! is on track to deliver ~$3mm of pre-tax cash flows going forward. Considering the projected growth in JambaGo! over the next few years, the intrinsic value of this royalty stream could conservatively be pegged at $25mm.

Add up the 3 segments described above and JMBA’s value to a private acquirer can be ~$260mm using simple math and conservative assumptions. This valuation does not even factor in the potential upside to JMBA’s expanding licensing revenue through the CPG channel. Taken together, JMBA’s stock provides the opportunity to own a growing operator and franchisor of healthy lifestyle restaurants at a 40% discount to today’s private market value, while also holding the free option that White delivers on his CPG promises.

Additional optionality to the upside exists because of JMBA’s current balance sheet, which is overly conservative relative to QSR or franchisor peers. Today JMBA carries ~$29mm in cash and no debt, a possible overcorrection following their liquidity crunch in 2008/2009. The ability to add leverage to the balance sheet or commence a large share buyback program adds another lever for realizing JMBA’s intrinsic value.

Why Is It Cheap?

I believe JMBA is trading at such a large discount to intrinsic value for three reasons: its size, the current elevated G&A levels, and the recent negative headlines.

- Size: JMBA is a micro-cap stock that is below the radar of most institutional investors. I believe very few <$200mm market cap companies offer a national, growing brand or the quality of leader that JMBA does.

- G&A overhang: The above sum-of-the-parts valuation fails to take into account that JMBA has materially higher corporate G&A expenses than industry standards. With current G&A at ~$40mm, almost 18% of JMBA’s revenues go towards overhead, a figure that is more than double the industry averages. This 18% figure is actually a dramatic improvement from the 30% G&A levels White inherited in FY 2008, and G&A reduction continues to be a major focus for JMBA management. The elevated G&A obscures the underlying improvement in JMBA’s company-owned stores and makes the company screen poorly on most P/E or EV/EBITDA metrics.

- Recent negative headlines: On October 7^th JMBA had a call to “Provide Updates on Key Business Initiatives”. The unscheduled call included a pre-release of lackluster Q3 2013 results and updates to 2013 guidance, some of which were positive but most of which were negative. The tone of the call was uninspiring, and a few days later COO Bruce Schroder announced his resignation, which combined to send the stock down almost 20%. I believe White addressed the issues much more clearly on the subsequent Q3 earnings call, and the quarter will ultimately amount to a minor setback in the long-term progression of the plan. With the stock down 35%+ from its high in June, while the Russell 2000 has risen 14%, I believe the current pessimism provides an ideal window for accumulating shares.

Summary:

As a growing consumer franchise, with improving economics and an exceptional leader, I believe JMBA has the potential to compound intrinsic value at high rates for many years to come. Through buying at a significant discount to private market value today, there are a lot of ways for investors to win over the next 3-5 years as White continues to execute the plan and transition JMBA into a growing franchisor.

Disclaimer: I currently own shares in JMBA, the fund I work for does not have a position but may buy, sell, cover, or otherwise change the form of investment for any or no reason. 

Catalyst

- Continued refranchising and growth of high margin royalty businesses

- Earnings leverage on G&A through continued overhead cost-cutting

- Optimizing balance sheet in line with QSR peers

- Initiating a share repurchase program

- Sale to a strategic or private equity firm