Value Investors Club / PARTY CITY HOLDCO INC (PRTY)

Description

Background

Party City is a retailer based in the United States that is a vertically integrated producer and seller of

party supplies. The company currently has 749 corporate owned stores and approximately 100

franchised locations. The company has had multiple private equity owners having been owned by

Berkshire Partners in 2003 and Thomas H. Lee partners in 2011. The company IPO’d in 2015 and has

always been levered to the max.

Pre-COVID, PRTY was faring poorly as helium shortages, poor Halloween execution, and stale inventory

combined to take EBITDA from $400 million in 2017 and 2018, to $267mm in 2019. As such, the stock

re-rated from the mid-teen’s in 2018 to below $3 before covid as the company had over $1.8 billion in

debt during those periods. With the onslaught of COVID, business trends deteriorated, and by June of

2020, the company and its creditors agreed to a debt exchange that eliminated $500mm of debt. The

company currently has $1.24 billion in net debt as a result.

In addition to the debt exchange, PRTY sold its Canadian operations to Canada Tire and offloaded its

European wholesale operations at favorable and accretive multiples. It has a long-term agreement with

Canada Tire to continue supplying party supplies from AMSCAN, its wholesale operation.

At the core of its operations, PRTY is an inflated balloon provider to the masses. Balloon sales are

approximately 20-25% of revenues at retail. It is one of the only locations where consumers can buy

inflated balloons with many unique options conveniently. There are other independent party supply

stores that offer these services (who are often supplied balloons by PRTY’s wholesale operations) and

grocery stores also offer the products albeit with limited staff and customer service dedicated to the

effort. As such, I believe that PRTY has a durable retail franchise around its balloon offerings as balloons

don’t really sell well on the internet.

According to PRTY’s presentation materials at the time of the debt exchange, the balloon market has

seen consistent growth. Please review the presentation titled Exhibit 99.2 in the May 28, 2020 8-K filed

by the company.

The company has seen improving results as COVID comes and goes. In the company’s most recent quarter,

the same store sales comp was +19.1% vs. 2019’s Q2. The company guided for mid-teens comparable

sales growth for Q3 2021 vs. 2019’s Q3. Prior to COVID, the company managed to keep comps in the -

2%-+2% range. Those sales trends did not indicate a long-term hobbled retailer by any means and given

the high leverage on the business, several private equity investors believed the business had some level

of a moat – balloons.

On August 5, 2021, the company reported Q2. In the week prior to the call, the stock was trading

around $9. In the week or two following the call, the stock fell to $6. Why? First, their Q3 guidance

showed YOY declines in revenue and second, showed a YOY decline in EBITDA even though the company

guided to mid-teens comparable growth over 2019. From a modelling perspective, the company sold its

European operations at the beginning 2020 so approximately $80 million in revenue and $6 million in

EBITDA were removed from this year’s Q3.

Second, the company indicated that they were experiencing $7-$12 million in headwinds in Q3 21

related to inflationary pressures, mostly container ships (up to a $50 million headwind per year with

container ship pricing at $20,000). This thesis has clearly become very well covered in the last month as

retailers have warned of the container ship issues impacting their businesses.

Third, people perceive anyone who is associated with the word “Party” will be impacted from the Delta

Covid wave.

On the Q2 call, the company indicated that it was raising prices at wholesale and retail and would offset

these higher prices beginning in Q4 for its important Halloween season (Halloween sales are

approximately 20% of the company’s consolidated revenues). Perhaps proof is required for investors to

get comfortable that they have the pricing power to achieve what at first glance seems unachievable.

However, my due diligence has uncovered the following things:

1) The company has completely stopped issuing 20% off coupons that were common prior to July

for every Thursday-Saturday. I estimate that saves $12-$15 million per year.

2) The company’s wholesale division, AMSCAN, has announced an across-the-board price increase

of approximately 6%. I estimate that with wholesale revenues of approximately $325 million

that the price increases in this strong demand environment will help to offset approximately

$19.5 million of these inflationary pressures.

3) The company has been studying demand elasticity across its product lines at retail in the last 12-

24 and has detailed analytics relating to each SKU (they didn’t before). The have raised prices

on inelastic demand items in their stores. Spot checks and detailed modeling of pricing has

shown price increases in many product lines such as paper plates, forks, napkins, boys’ and girls’

birthday, etc. From my analysis, at least half of the SKU’s in the store have been raised

representing approximately 35% of sales. Retail is approximately a $1.8 billion revenue

business, so this similar 6% price increase on those SKU’s represents a further inflationary offset

of approximately $37.8 million per year.

In total, my analysis suggests that the company by the end of Q3 will have in place mitigation strategies

totaling approximately $72.3 million. That figure gives them some room for demand destruction should

it occur with higher prices. However, with the demand trends that have emerged in a COVID world

(19.2% SSS comp), they can raise price (review comments from WMT CEO following last quarter’s

earning release on party supplies).

Halloween is an important season for the company. They have not had a solid financial Halloween in 2

years. In 2018, Q4 EBITDA was $180 million. It fell to $119 million in 2019 and $77 million in 2020. Part

of this was related to a spike in helium prices from 2018-2020 (to be discussed later). Most of the

weakness was related to stale inventory for the season as costumes can be stored for the next season.

Those write-downs of stale seasonal product are behind the company as they took meaningful write offs

in Q4 2019 and finished the job in Q4 2020 after refinancing their debt into a senior bond with no

covenants ($80 million write-down). As it stands, the retail stores are now carrying 1/3rd less inventory

per store in Q2 21 as compared to Q2 18.

The company indicated on the Q2 call that the boats carrying Halloween merchandise are either in port

in the US or on the water for this important season (November and December are less meaningful for

them). The market will be well supplied for the season and the company will be in a position to take

share if some of the competitors stumble with supply chain. Home Depot indicated recently that some

of its early arrivals of Halloween decorations “Sold Out Immediately”.

Investment Thesis

1) Strong sales will continue in this COVID on COVID off world. People are celebrating differently,

celebration demand is built up, and Party City is perfectly positioned to take advantage of these

market dynamics. The company should continue to comp for the foreseeable future.

2) The company locked in helium contracts at above market rates. Checks with independent party

stores suggest that party city is paying at least $30 million per year more than the current

market for its helium to lock in it supply. Several of those contracts expire in early 2021.

3) The company regularly used to earn $400 million in EBITDA. Helium was a $30 million

headwind. The sale of Canada was a $12 million headwind. The sale of the European

operations is approximately an $8 million headwind. Theoretically, as this business normalizes,

the business should return to EBITDA of approximately $350 million excluding any benefit from

restructuring the out of the money helium contracts.

4) On August 31, 2021, the company posted a presentation to its IR site under Presentations

detailing their Next Gen store opportunity. They did this without an 8-K and without a press

release. Here is the link:

PowerPoint Presentation (q4cdn.com)

In the presentation, the company highlights that new store remodels are comping at least mid-

single digits above the rest of the fleet. I have visited the remodeled locations in Las Vegas, and

they are visually stunning. It is like going from a Ford dealership to a Porsche dealership, they

are beautiful. The remodels cost net $150,000 and the payback is less than 24 months, or

$75,000 per location. With 680 locations remaining to be remodeled, this creates an after-tax

opportunity of $51 million per year which equates to a structural EBITDA increase of

approximately $65 million. Party City intends to remodel 100-125 locations next year and can

likely knock out the remaining 530 the stores in the following 3 years.

Having visited the remodeled locations and interviewing staff, the key to the remodels is a new

balloon kiosk in the middle of the store with balloons merchandised surrounding the kiosk like

greeting cards. When balloons are sold in neat and deflated little packages, the customer buys

more and balloons are the highest margin business for the company. The remodels offer better

visuals across the store as the shelves are cut down to 6 feet. A customer can see the entire store from anywhere in the store which increases baskets of non-ballon items. As a sresult, the remodels enable the company to remove

approximately $100,000 in inventory per store of slow-turning SKU’s (aided in part from their new demand analytics).

5) The company has cleaned out legacy staff including the ex-CEO’s son who was running supply

chain and is modernizing the entire operation. It is my belief that there will be synergies and

profit opportunities from these efforts although they are unquantifiable at this time.

Target/Valuation/Event Path

The street estimates EBITDA of $302 million for 2022. However, I estimate the company will do $350

million as the Halloween season is normalized at the company this year and the years that follow given

the fresh Halloween supply. At 7.5x that EBITDA with 112 million shares and $1.24 billion in net debt, I

see a reasonable target of $12.37 for the stock by year’s end. 7.5x is a reasonable multiple given that

they own manufacturing operations for balloons, plates, etc. and the last buyout for the company by

Thomas H. Lee was done at 10x. There is likely upside to that multiple given the moat around their

business and the ownership of these manufacturing operations.

The Next Gen store opportunity will add an additional 7.5 x $65 million thereafter, or an additional

$4.35 per share by the end of 2022.

Getting helium to market prices would add an additional 7.5x $30 million or $2.01 in upside to that

target.

Management is incentivized to get the stock above $7.50 and $10.00 through large grants at the time of

the debt exchange of RSU’s.

After paydown of $70 million in deferred rent in Q4, it is my view that the company will thereafter be in

the position to pay down $125 million ($1.12/share) in debt in 2022 even with an accelerated Next Gen

store rollout. That equates to a FCF yield of 16.7% to the shares at today’s prices and assumes $350

million in EBITDA, $100 million in interest expenses, $90 million in capex and $35 million in cash tax.

While highly leveraged, the company has no meaningful covenants, and will realize the benefits of debt

paydown and interest cost savings as it gets its leverage to between 3-3.5x sometime in 2023.

In summary, this is a business whose core earnings power is mis-understood undergoing a

transformation with several near- and medium-term catalysts to light the path. The fears around

inflation are overstated and have been addressed in this robust demand cycle for the company and the

stock has undergone a 25% haircut in the last month.

While highly leveraged, the company has no meaningful covenants, and will realize the benefits of debt paydown and interest cost savings as it gets its leverage to between 3-3.5x sometime in 2023.

In summary, this is a business whose core earnings power is mis-understood undergoing a transformation with several near- and medium-term catalysts to light the path. The fears around inflation are overstated and have been addressed in this robust demand cycle for the company and the stock has undergone a 25% haircut in the last month. It has one shareholder of size owning 14.7% of the business and could be a candidate for a private equity led takeout (like Michael's) sometime in 2022.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Continued progress on the company's transformation plan over the coming quarters.

show sort by

			2021	2022
Price:	6.73	EPS	0	0
Shares Out. (in M):	112	P/E	0	0
Market Cap (in $M):	753	P/FCF	0	0
Net Debt (in $M):	1,260	EBIT	0	0
TEV (in $M):	2,013	TEV/EBIT	0	0