Description

Telepizza Group SA (“Telepizza” or the “Company”) is a leading competitor in the global pizza delivery market. The Company has been executing well, generates huge returns on tangible capital, and has a long growth runway ahead of it. Despite this, shares today can be purchased at 12-13x earnings and/or free cash flow – a discount not only to intrinsic value, but less than half the trading multiple of its global competitors.

Telepizza is the 4^th largest global pizza delivery provider, with a network of roughly 1,400 locations. This compares to #1 Pizza Hut with 17,000 stores, #2 Domino’s with 13,000 locations, and #3 Papa John’s with 5,000 locations. Geographically, the Company’s focus has historically been on the Iberian Peninsula and South America, although it has recently begun expansion outside these areas through the sale of master franchises. Telepizza is #1 or #2 in most of its core markets, with particularly strong market shares in Spain (52%), Portugal (45%), Chile (49%), and Colombia (35%).

Telepizza’s predecessor was founded as a family business in 1987. It initially went public in 1996, and was taken private a decade later by Permira and the Ballvé family (the control shareholder at that time). The Company came back to the public markets roughly a year ago, listing in Spain, with a diverse shareholder base (pre-IPO) that included not only Permira, but KKR, Oak Hill, and host of other institutions. KKR retains roughly 20% today, with 10% continuing to be held by Permira/Ballvé. The offering priced at €7.35, and has subsequently consistently traded below that level. The poor trading dynamics post-IPO can be attributed to a number of factors, including aggressive initial pricing on the IPO, a difficult Spanish equity market during the trading period immediately post-IPO, and operating leverage that has been below early expectations. In addition, the shares had transfer restrictions on US owners for a period of 60 days post-IPO that I believe caused many US investors to step away from the offering, lose interest, and not return.

Telepizza’s management has been pursuing an asset-light approach to expansion, primarily through the use of franchising. Today, roughly 2/3 of locations are franchised (up from 60% in 2013), and there has been an accelerated use of the sale of master franchises to enter new countries. Although this move to a more fully franchised model is preferable from a return on capital, margin, cash flow, and (ultimately) trading multiple perspective, it obscures the attractive underlying growth metrics of the Telepizza “concept” since the top line contribution from a franchised location is far less than that of a wholly-owned location. Despite having grown both locations and system-wide LFL sales by about 5% each annually over the last two years (10% total annually), Telepizza’s reported top line has only grown by about 2% annually, giving the impression of a slow-growth business. This is decidedly not the case.

Notwithstanding the Company’s asset-light approach to expansion, calculated returns on capital are paltry given the presence of massive amounts of intangibles on the balance sheet. At year-end 2016, over 85% of the Company’s assets were attributable to goodwill and other intangibles. These intangibles are, overwhelmingly, a legacy of the Company’s LBO. As such, they do not represent a company (or management team) with an aggressive approach to low-return M&A activity. With the lion’s share of these intangibles carved out, Telepizza presents ROICs and ROEs in excess of 30% and 50%, respectively – much more in-line with what one would expect for a quality franchisor. This large slug of intangibles negatively impacts reported financials in another way. The Company is required to amortize roughly Є6mm of intangibles annually. This equates to €0.05/shr of EPS after-tax, which contributes a headwind of roughly 15% to the Company’s reported earnings (and associated P/E multiple).

Operating leverage, and associated margin expansion, has been lower post-IPO than investors (and the sell-side) had expected. In large part, this has been due to input pricing headwinds. The pizza delivery business is price sensitive. Management must constantly balance pricing dynamics with the need/desire to maintain share, and at some level they are a price taker. Qualitatively, I believe that they have been thoughtful and disciplined in this regard to-date. An important component of their approach has been to push aggressively into the digital realm. Today, in its home market (Spain), Telepizza gets 40% of its delivery sales through digital platforms. This is up from 25% three years ago. Digital helps provide a hedge against pricing headwinds, as digital delivery sales command a nearly 40% average ticket premium vs. phone sales (up from 25% three years ago). Digital expansion should also drive market share gains going forward, as many of the local mom-and-pop operators can simply not afford the costs associated with development of anything more than the most rudimentary digital platform.

I expect Telepizza to do roughly €0.36/shr in cash EPS this year. Note that my “cash” EPS is a fully-taxed number, but includes add-back of the aforementioned acquisition-related intangibles amortization. This puts shares today at 13x cash EPS. Telepizza has >€200mm of loss carryforwards (various jurisdictions), worth about €0.40/shr (undiscounted for time value). In addition, due to limitations in Spain on the amount of interest that can be deducted annually for purposes of income tax calculation, the Company has €165mm of “interest carried forward” that can be used in future periods to offset taxable operating income. As a result, management expects the cash tax rate to be in the mid-teens range for the foreseeable future, well below Spain’s 25% statutory rate. Thus, free cash per share should run in excess of cash EPS (as defined), and I estimate a current run-rate for FCF/shr of €0.40 – putting the shares today at 12x FCF. Telepizza carries a modest amount of debt (€200mm gross, €135 net), indicating 2x debt:EBITDA leverage.

In today’s market, 12-13x EPS/FCF is a reasonably attractive multiple for a high-return business with ample runway for growth. Telepizza’s geographic profile is more attractive than its top 3 competitors, as they are all highly exposed to the overbuilt U.S. market and its casual dining headwinds. Despite this, Telepizza’s 12-13x multiple compares to an average P/E multiple in excess of 25x for Yum! (Pizza Hut’s parent), Domino’s and Papa John’s. On an EV/EBITDA basis, the discount is large as well. Telepizza trades at 9.5x, with the three competitors averaging over 17x. Admittedly, these three competitors have a higher concentration of franchised locations (94%, 97%, and 85%, respectively); however, Telepizza’s returns on tangible capital are actually in-line with those of both Yum! and Papa John’s (all three are in the mid-30s).

Over time, I expect that continued earnings growth driven by a combination of LFL sales and new locations, in conjunction with multiple expansion driven by improved franchise exposure, should generate attractive returns for Telepizza equity.

Catalyst

Continued LFL system-wide growth, new locations, new master franchises, higher % of franchise income