MICHAELS COS INC MIK
July 31, 2014 - 7:19pm EST by
can869
2014 2015
Price: 15.08 EPS $1.46 $1.67
Shares Out. (in M): 203 P/E 10.3x 9.0x
Market Cap (in $M): 3,063 P/FCF 10.8x 9.9x
Net Debt (in $M): 3,201 EBIT 551 596
TEV ($): 6,264 TEV/EBIT 11.4x 10.5x

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  • Recent IPO
  • LBO
  • Retail
  • Private Equity (PE)

Description

MIK is a broken IPO that is down 11% from $17 pricing a month ago, with no news out other than the CEO & CFO both bought $170k worth of stock at $17.  The sponsor, Bain, did not sell any stock on the IPO (100% primary to go to reducing debt).  The stock trades at 9.2% 2014 FCF yield and 10.3x 2014 P/E. 
 
MIK is a high quality industry leader that has shown stable and consistent growth and cash flow generation/deleveraging in a sub-sector of retail that has proven to be recession resistant and much less exposed to internet disintermediation.
 
Over the next year, MIK will generate ~$300mm of FCF, allowing it to pay down all of its remaining 7.5% holdco notes, which will allow it to save ~$16mm a year in interest expense on an after-tax basis, and drive double digit EPS growth in 2015.
 
As a very near-term catalyst, analysts will be able to publish on the name starting Tuesday, 8/5.

Company is recession resistant and has a long history of positive results

  • Since the 2006 LBO, the company has grown EBITDA from $575mm to $772mm LTM and generated ~$1.8bn of FCF – net debt has declined from $3.9bn to $2.7bn
  • Peak to trough EBITDA in the recession was ~20% (-5% comps in 2008), and the company recovered its EBITDA by 2010
  • Comps have been positive in every year since 2008, including +2.9% in 2013 and +3.8% in the most recent Q114, which was very challenged for retailers
  • Gross margins have been stable – between 38.5% - 40.3% in every year other than 2008, indicating that competition/promotional environment is stable

Industry leader in a sub-segment that is growing and relatively less exposed to internet disintermediation

  • Michael’s is the largest player in a fragmented arts & crafts market, with ~10% share (other large competitors are Jo-Anns Stores & Hobby Lobby, but primarily mom & pop)
  • MIK's e-commerce effort just launched and this industry has been very slow to go on-line for several reasons:
    • Lack of national brands (MIK is ~50% private MIK brands, and the remainder are not well known)
    • Low priced items, so customers less likely to price compare or research price extensively
    • Need to look/feel/see selection – products are primarily mix and match inputs rather than finished goods
    • Focus on in-store experience through classes and assistance by salespeople

Management is conservative – proceeds from IPO and subsequent FCF will go to deleveraging, driving EPS growth

  • IPO is 100% primary shares that will generate a net ~$450mm, that will go to retire 7.75% holdco bonds and take leverage down from 5x -> 4x
  • Very conservative growth plan of 1-3% square footage per year – not spending capital on a new concept, rapid acceleration of store growth, or international adventures
  • Once leverage reaches an acceptable level (~3x?), FCF can then be deployed for a dividend or share repurchases

Considerations

  • Tough comps in back half of the year due to introduction of Rainbow Loom in Q314 – comps likely to be negative in Q314 and possibly Q414 facing a +8% comp in Q314 (we think this is understood by the market)
  • Retail environment remains promotional – risk that Amazon shows more focus on this category driving lower gross margins – less likely for reasons explained above
  • Lack of big growth story means harder to get equity guys interested/premium multiple
  • Bain & Blackstone lockup expires in 180 days
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Analysts will be able to publish starting 8/5
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    Description

    MIK is a broken IPO that is down 11% from $17 pricing a month ago, with no news out other than the CEO & CFO both bought $170k worth of stock at $17.  The sponsor, Bain, did not sell any stock on the IPO (100% primary to go to reducing debt).  The stock trades at 9.2% 2014 FCF yield and 10.3x 2014 P/E. 
     
    MIK is a high quality industry leader that has shown stable and consistent growth and cash flow generation/deleveraging in a sub-sector of retail that has proven to be recession resistant and much less exposed to internet disintermediation.
     
    Over the next year, MIK will generate ~$300mm of FCF, allowing it to pay down all of its remaining 7.5% holdco notes, which will allow it to save ~$16mm a year in interest expense on an after-tax basis, and drive double digit EPS growth in 2015.
     
    As a very near-term catalyst, analysts will be able to publish on the name starting Tuesday, 8/5.

    Company is recession resistant and has a long history of positive results

    • Since the 2006 LBO, the company has grown EBITDA from $575mm to $772mm LTM and generated ~$1.8bn of FCF – net debt has declined from $3.9bn to $2.7bn
    • Peak to trough EBITDA in the recession was ~20% (-5% comps in 2008), and the company recovered its EBITDA by 2010
    • Comps have been positive in every year since 2008, including +2.9% in 2013 and +3.8% in the most recent Q114, which was very challenged for retailers
    • Gross margins have been stable – between 38.5% - 40.3% in every year other than 2008, indicating that competition/promotional environment is stable

    Industry leader in a sub-segment that is growing and relatively less exposed to internet disintermediation

    • Michael’s is the largest player in a fragmented arts & crafts market, with ~10% share (other large competitors are Jo-Anns Stores & Hobby Lobby, but primarily mom & pop)
    • MIK's e-commerce effort just launched and this industry has been very slow to go on-line for several reasons:
      • Lack of national brands (MIK is ~50% private MIK brands, and the remainder are not well known)
      • Low priced items, so customers less likely to price compare or research price extensively
      • Need to look/feel/see selection – products are primarily mix and match inputs rather than finished goods
      • Focus on in-store experience through classes and assistance by salespeople

    Management is conservative – proceeds from IPO and subsequent FCF will go to deleveraging, driving EPS growth

    • IPO is 100% primary shares that will generate a net ~$450mm, that will go to retire 7.75% holdco bonds and take leverage down from 5x -> 4x
    • Very conservative growth plan of 1-3% square footage per year – not spending capital on a new concept, rapid acceleration of store growth, or international adventures
    • Once leverage reaches an acceptable level (~3x?), FCF can then be deployed for a dividend or share repurchases

    Considerations

    • Tough comps in back half of the year due to introduction of Rainbow Loom in Q314 – comps likely to be negative in Q314 and possibly Q414 facing a +8% comp in Q314 (we think this is understood by the market)
    • Retail environment remains promotional – risk that Amazon shows more focus on this category driving lower gross margins – less likely for reasons explained above
    • Lack of big growth story means harder to get equity guys interested/premium multiple
    • Bain & Blackstone lockup expires in 180 days
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Analysts will be able to publish starting 8/5
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