Brian Randall Kahn, the CEO of Franchise Group, Inc. (FRG, Financial), has bought 1.725 million shares of his own company over the past year:
- His spree began on July 30, 2020, when he purchased 400,000 shares at an average price of $23.25 and a total cost of $9,300,000.
- On Sept. 2, 2020, he added another 175,000 shares at an average price of $25.50, at a total cost of $4,462,500.
- Two weeks later, on Sept. 15, he bought 149,785 shares at around $24.99 each, for a total of $3,743,130.
- The latest installment took place on May 21, 2021, when he acquired another 1 million shares for approximately $36 each.
This kind of buying suggests a long-term approach. Even so, Kahn has done very well in the short term. Based on the share price at the close of trading on May 25, he has enjoyed significant gains.
Given this positive sign from the CEO, should investors follow in Kahn's footsteps and buy his company's stock? Is Franchise Group the kind of company we would want to buy and hold for the next five or 10 years?
What is the Franchise Group?
Based in Virginia Beach, Virginia, the company calls itself an owner and operator of franchised and franchisable businesses. In its 10-K for 2020, it says it adds value by applying its operating and capital allocation philosophies to generate strong cash flows.
Its best-known franchise is Liberty Tax Service, but it also owns and/or operates American Freight, The Vitamin Shoppe and Buddy's Home Furnishings.
In its 10-K, it explained that it uses an asset-light business model designed to generate consistent, recurring revenues and strong operating margins. Each business operates independently, but the parent company provides a shared service platform for economies of scale and efficiencies.
Much of the company has been acquired in the past two years:
- August 2019: Acquired 41 Buddy's Home Furnishing stores.
- September 2019: bought another 21 Buddy's stores.
- October 2019: Purchased Sears Outlet.
- December 2019: Completed acquisition of The Vitamin Shoppe.
- February 2020: Bought American Freight.
- December 2020: Finalized the purchase of Furniture Factory Ultimate Holding.
- January 2021: Entered into a definitive agreement to buy Pet Supplies Plus for $700 million.
At the end of the company's fiscal year 2020 (on Dec. 26), the company was operating 4,023 locations in the U.S. and Canada. Of those locations, 2,743 were franchised locations and 1,280 were operated by the company. The majority of those locations, 2,490, were Liberty Tax Service offices (it also offers an online digital, do-it-yourself tax service in the U.S.).
However, you can expect that profile to be radically revised this year if it successfully sells Liberty to the Canadian firm NextPoint Acquisition Corp (NAC.U). The deal is expected to close in the second quarter of 2021 and will net Franchise Group at least $243 million in cash and stock. That works out to $182 million in cash and $61 million in NextPoint stock. The cash proceeds are earmarked mainly for debt repayment.
Given that NextPoint is a new and relatively small company - in fact, it is an SPAC, a blank shell that exists only to effect an acquisition with another company - Franchise Group will have what it calls a significant stake in it. NextPoint has a market capitalization of $57.21 million; Franchise Group's stake of $61 million suggests it could own slightly more than half of NextPoint.
The idea behind the deal is that Liberty's hookup with NextPoint means Liberty will be able to offer a broader package of consumer financial products and services. In turn, that means Liberty offices should generate revenue throughout the year, rather than just during tax season.
Financing
Where did Franchise Group get the capital to make all these purchases? By issuing new shares and taking on a heavy debt load. Here's a chart showing how the number of shares outstanding grew:
Interestingly, Kahn was buying even as the company was diluting its shares.
We see a similar picture when we look at a chart of long-term debt and capital lease obligations:
What we have found is a company that raised a lot of new capital in the past two years and used it to buy many new franchises or franchise-type businesses. We'll look more closely at the effects in the financial strength and profitability sections.
Risk factors
Several risks arise out of the many deals the company has made, and more are inherent in the types of businesses in which it operates. They include:
- The effective integration of the many pieces into a synergetic whole; this must also include the subtraction of Liberty Tax from the whole.
- Being able to service all the new debt it has incurred.
- The Covid-19 pandemic has had a negative effect on its business and may continue to in the future.
- Maintaining good relationships with franchisees.
- Ownership concentration: As of Feb. 1, 2021, Vintage Capital Management, LLC and B. Riley Financial, Inc. owned shares representing roughly 19.0% and 11.3% of the outstanding stock, respectively.
Competition
Franchise Group's competition comes on a segment-by-segment basis:
- Vitamin Shoppe competes with peers in the U.S. nutritional supplements retail industry.
- American Freight competes with discount furniture and mattress retailers, as well as with big-box retailers and locally-owned appliance retailers.
- Liberty Tax competes with local, regional and national tax preparation services, as well as with individuals. That list has to include the giant H&R Block (HRB, Financial) organization.
- Buddy's competes with other rent-to-own businesses that are both bricks-and-mortar and online.
Financial strength
As noted, this is a company that's taken on a lot of debt in the last two years; this chart captures the situation:
This deluge of debt has led to low ratios, including cash-debt and interest coverage; both are worryingly low.
The Piotroski F-Score and Altman Z-Score seem unstable, but at this time the company is just getting started with its expansion and an assessment at this point would be premature.
Note, too, that the return on invested capital (ROIC) is well below the weighted average cost of capital (WACC). That ratio will need to improve if the company is to be successful.
Profitability
Due to the rapid expansion, Franchise Group gets a surprisingly good rank for a company with many profitability challenges.
In the 10-K, the company talked about strong margins, yet we have scant evidence of that:
However, after nearly 10 years of declining margins, the expansion strategy may turn the margins around. It certainly brought up revenue:
Ebitda also shot up:
But the trend did not reach the bottom line, as earnings per share (diluted) remain low:
All of this information should be considered in light of the broader context, which is that this company has only a short history of operating at current levels.
Dividends and share buybacks
This picture tells the story when it comes to Franchise Group's dividend payments:
This is how the dividend yield looks in relation to the share price:
And as we saw above, the company has been issuing new shares rather than repurchasing them.
Valuation
For long-time holders, the share price is finally back to where it was in 2014:
Going by the GuruFocus Value Chart, we would be very shy about investing in Franchise Group:
Once again, though, we have a rating based on a very short run of data. The price-earnings ratio of 11.08 is exactly half that of the overall Personal Services industry's 22.16.
Among the few metrics available, the price-book ratio points to a high valuation at 3.19, while the price-sales ratio points to a low valuation at 0.65.
Based on the data available, it appears that the company is somewhat undervalued. And because the company began transforming itself two years ago, I would hesitate to call it a value trap, though of course it could be one if the management intends to milk the company for money before heading to the exit, which seems a possibility given the sudden acquisition spree, increase in debt, increase in dividend payments and CEO buys.
Gurus
Gurus began taking an interest in the Franchise Group last year, but recently they've done a lot of selling and no buying:
Only two gurus had positions in the company at the end of the first quarter:
- HOTCHKIS & WILEY owned 111,500 shares, good for a 0.28% stake in Franchise Group and just 0.01% of its assets under management. During Q1 2021, the fund reduced its holding by 14.46%.
- Jim Simons (Trades, Portfolio) of Renaissance Technologies owned 28,100 shares after a reduction of 63.51%.
Conclusion
CEO Brian Kahn of Franchise Group has certainly benefited in the short term from his insider buying, and it seems likely he will do even better in the future. As we've seen, the company had been flat for many years before it began remaking itself.
Because of debt used to buy new franchises and assets, it shows poorly on measures of financial strength. However, it is reasonably profitable and should do even better as it tries to wring out synergies from its various acquisitions (and now a major disposal). Valuation is also difficult because of the short history of operating the new version.
Value investors will want to avoid the company; it has too much debt and establishing a valuation will depend on guesses. Growth investors who see this story continuing may want to do more due diligence. Income investors might find Franchise Group an interesting prospect, but the business model hasn't yet been proven in practice.
Disclaimer: I do not own shares in any of the companies named in this article and do not expect to buy any in the next 72 hours.
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