Description

Situation Overview:

Jamba Juice Inc. (the “Company”, “Jamba Juice”, or “JMBA”) is an 800+ unit franchisor and operator of smoothie and juice shops, and is nearing the end of a fundamental business transformation from company-owned stores to franchised units. The transformation from an operator to a franchisor has massively improved marginal profitability and reduced capital requirements. With refranchising largely behind the Company and a new executive team in place, franchisees are eager to add additional units. One-time issues mask a business with an attractive medium-term cash flow profile and take private potential, and give public investors the chance to capitalize on short term market inefficiency with 45%+ upside.

Overview:

We recommend Jamba Juice Inc. as a long with a target price of ~$13.00 (~45% upside)

Jamba, Inc. is a franchisor and operator of Jamba-branded shops which sell smoothies, juices and light food items Founded in 1990 in southern California, the Company has grown to over 800 units throughout the world. The Company went public via a SPAC in 2006. The recession just a few years later severely hampered discretionary spending, and the Company found itself with an expensive, bloated cost structure.  

In 2014, the Company began a refranchising initiative, selling company owned stores to franchisees, which dramatically reduced the cost structure and capital requirements of the business. Roughly a year after the refranchising initiative began, Engaged Capital, an activist investment firm, took a large position in the Company and has been active at the board level. In 2016, Dave Pace, an industry veteran formerly with Bloomin’ Brands, became CEO. Since Pace took over, the Company has taken many steps to further streamline the business and improve relationships with franchisees while continuing the strategy of refranchising company-owned stores. With the bulk of this refranchising behind them, and management improving operations and franchisee support, JMBA is well positioned to grow units and profitability.

Our thesis centers on a few key points:

1)       Re-franchising is largely complete which has successfully transitioned the business to a high margin asset light structure.  Management focus on key initiatives to grow both units and comparable sales will dramatically increase EBITDA. Market has not fully appreciated the shift to an asset-light economic model; re-rating in-line with other franchisors should drive material share price appreciation.

2)       Stock price is artificially low due to onetime issues which prevent large portions of the investment community from purchasing the stock. These issues are not material and do not affect the fundamental value of the business.

3)       Potential take private given undersized market cap and relative concentration of investor base. Management has expressed openness to a transaction while franchisees think that the Company would be more focused if it were not beholden to quarterly reporting demands.

Investment Thesis:

1)    Fundamental business transformation nearing completion with company set to grow units and revenues.

Over the past three years, the Company has transitioned from company-owned and operated units to an asset-light, franchising model with over 90% of the Company’s units now franchised. The Company further strengthened relationships with franchisees by closing all of the self-serve machines in Target which was an ongoing source of brand dilution and contention.  In addition, the Company has completed a cost reduction in both cost of goods sold, by leveraging its national purchasing scale to renegotiate its produce costs, and SG&A, with headcount and wage reductions achieved in conjunction with moving corporate headquarters from California to Texas.

Attractive unit economics provide a tailwind to unit growth. With an average store size of 1,000-1,200 square feet, AUV’s in the low to mid $600K’s and an average payback period of 3-4 years, Jamba Juice offers an attractive economic model to franchisees. On AUV’s, there is a wide dispersion between the Company’s most successful stores, which tend to be in warm climates like Southern California and Arizona, and least successful stores which tend to be in cooler climates. New drive-thru locations in California are doing well with over $1mm a year in revenue, while the smallest markets have AUV’s in the $400K-range. The Company is aware that it needs to invest in technological improvements, and is investing in online ordering, an improved loyalty offering, and a new POS system, allowing the Company and franchisees to better analyze the business and control costs, especially labor.

New product offerings in the pipeline further enhance the value proposition, particularly in cooler areas of the country, while bolstering same store sales. One of the chief concerns among investors is the inherent seasonality of the business; it’s difficult to convince people to buy an ice-cold smoothie on a snowy January afternoon in Chicago. This has limited JMBA’s growth, as warmer climate locations enjoy far more attractive unit economics than cooler locations. Over the past few years the Company has experimented with different product offerings to address this seasonality, most recently introducing Acai bowls and other health conscious offerings, hoping to expand the appeal of the Company’s menu. In addition, JMBA now offers more filling smoothies, including smoothies which include ingredients like proteins and whey powder.

The market for smoothies and juices has many players. The Company distinguishes between its core Smoothie business and the rapidly expanding and fiercely competitive “juicing” category, as the two markets tend to have different customer bases and price points. In smoothies, the primary national competitor is Smoothie King, a 900-unit franchisor primarily located in the American Midwest and southeast. Smoothie King’s products are similar to Jamba’s, with both offering standard fruit mixes and enhancements like wheat grass shots and protein powders. In addition to Smoothie King, the Company competes with companies like Planet Smoothie, Tropical Smoothie Café, Maui Wowi and Nektar, as well as companies like Whole Foods, whose prepared food counters offer both juices and smoothies. The juicing category is much newer, far more competitive, and far more fragmented. Juice offerings tend to be much more expensive than the typical smoothie, given their concentration of only fruit juice and lack of ice, milk, and ice cream. Competitors include Juice Press and many other regional competitors. Some firms in this space have struggled given the challenge of trying to produce adequate unit economics with such a high-priced product; Organic Avenue filed for bankruptcy in 2015. While Jamba does offer some juices, they are a small piece of the business.

The key distinguishing factor between Jamba and some of the competition is its franchisee base. For example, the average SK Franchisee owns less than two locations, and follows an owner-operator model, with the franchisee “buying a job”. In contrast, Jamba has focused on attracting high quality, multi-store franchising partners like Vitaligent, run by a former president at Anheuser Busch, and Las Vegas Coffee Investors, a multi-unit franchisee with locations in Nevada and California. This higher quality mix positions Jamba better operationally than some of its competitors. As Jamba has been going through its restructuring, we believe the professional operators have grown to represent a larger portion of the franchise base – i.e., lower-quality operators have been churning out of the system, while higher-quality operators have been increasing their unit count.

Despite the competition, the franchisee base of large, professional firms, sees the growth opportunity for the Jamba brand and are both expanding in current markets and penetrating new markets.

2)       Lack of audited financials since Q3-2016 has made the Company un-investable for many and has artificially depressed the stock price.

The Company delayed the filing of its 10K in early 2017, and has not published financials since 3Q 2016, making the company un-investable for many mutual funds and artificially depressing the stock price. Based on conversations with management, we believe the filing delay is in large part due to the Company’s newly lowered GAAP accounting materiality threshold. As the Company converted to franchised units, revenue and GAAP reported profitability fell substantially. As a result, previously non-material discrepancies are now material. Given the inherently small sums involved, and our positive conversations with franchisees, we do not view this delay as a material risk to the investment thesis. We believe the limited research coverage combined with the Company’s poor communication on this point has created an opportunity to buy additional shares at attractive prices.

In its 8-K filed February 12, 2018, the company stated that it is working with its new auditor to complete the calendar year 2017 financials and hopes to be able to file those soon. The same day, the company filed its delayed 10-K for calendar 2016. We view the filing of the 10-K as a large positive, as it gives comfort that there is no material problem with the financials as a result of the restructuring; the calendar 2017 financials should be comparable to the 2016 financials in terms of reporting structure, auditing, etc.

3)       Clean balance sheet, strong cash flow potential, concentrated investor base, and shareholder-dominated board creates an attractive take private target.

Having transitioned to a franchising model, the required capital to run the Company has decreased and cash conversion on incremental sales and unit growth have improved. The Company also noted in its 2/12 report that it currently holds $10mm in cash, as compared to $7.1mm at January 3, 2017, which suggests that despite the elevated level of SG&A given the operational restructuring and the prolonged audit / restatement process, the business is still generating cash. The combination of an improved business model, small market cap, low valuation, and concentrated investor base make Jamba Juice an extremely attractive private equity candidate.

Valuation:

We think Jamba should trade at a double-digit multiple of EBITDA given the asset light franchise model. While trailing EBTIDA is depressed due to onetime issues and abnormal spending on professional services, looking to 2018 earnings power, the Company will generate approximately $16mm in PF EBITDA at the midpoint of management’s guidance issued on 2/12/2018. Our forecast is supported by conversations with current franchisees, and assumes 2% unit growth, and modest 2% growth in AUVs. The Company has commented that exiting 2017, corporate G&A expenses should decrease an incremental 10% to approximately $21mm per year.

Over the past 4 years the Company has increased both Gross and EBITDA margins, reflecting the impact of the switch to a franchising model. Because the Company has not filed audited financials for CY 2017, we based our estimates on the limited disclosure the company has released. For 2018, we assume 2% unit growth with moderate comps growth of 2%. It is important to note that for every 1% increase in comps EBITDA increases ~4%. The company does not disclose franchise level AUV’s for both domestic and international stores, but we have backed into a number based on the company’s royalty rate of 6% and franchise revenues (we assume international stores have AUVs of 80% of the domestic franchisee base, on average). Based on these assumptions, we derive EBITDA for 2018 by holding margins constant and taking management’s G&A guidance of $21mm.  Below is an income statement based on our estimates for 2018:

Despite the Company not having formally reported revenue numbers during the financial restatement process, they have been reporting SSS data (reproduced above for reference). Our modeled EBITDA is roughly consistent with management’s guidance for 2018, which we are using for our target valuation. Using this as the underwriting case we can get a valuation range; peer franchisors trade at ~10-14x EBITDA (with some outliers above the range) depending their growth prospects, operating trends, and track record.

Risks:

§  Labor Costs: In our conversations with franchisees, competitors and other players within the food service industry, labor represents the most significant near-midterm risk to profitability. In California, the Governor signed a bill which will gradually increase the minimum wage to $15 per hour, with several states following suit. In response, Jamba is rolling out labor optimization tools for franchisees to better manage their labor costs so that they aren’t over staffed during non-peak hours. In addition the Company is hoping to leverage online sales and introduce kiosks to automate the ordering process. Should franchisees be slow to adapt, their profitability would suffer, lowering their incentives to grow incremental units.

§  Lack of Audit: Jamba is now approaching one year without audited financial statements. While we understand the reason for the delay, and appreciate that the required tightening of controls takes time and testing, such a long delay gives investors pause, which is reflected in the current multiple. If any new issues emerge during the audit that would be a detriment to the stock. In early October 2017, the Company announced a deal with its largest franchise whereby they agreed to acquire the units of another franchisee, and they also committed to building out the Seattle market, committing to 12 units within 5 years. This is supportive of our growth thesis, particularly in a cooler climate like Seattle, and we believe decreases the risk of any material financial issues; a major franchisee like Vitaligent would not have the enthusiasm to invest in the brand and grow units if they had serious concerns about the books. Additionally, the recent filing of the 10-K for 2016 and the 2017 10-Q's, along with management’s reiteration that they are almost done with the more recent financials, is positive for the thesis.

§  Dependent on Discretionary Spending: Smoothies are a discretionary product, so any sort of consumer recession would have an outsized impact on Jamba. While we think the Company is well positioned to weather any storm with no debt and a capital light model, any drop-in consumer spending would reduce royalty revenue and therefore EBITDA. We think the Company’s new offerings and focus on healthful lifestyles, in addition to the roll-out of loyalty programs, would help buttress sales during a downturn.

Catalyst

1) Release of 2017 10-K

2) continued SSS improvements / franchisee consolidation

3) continued store openings / growth

4) potential take private transaction