About three months ago, I purchased shares of FTD Companies (FTD) for my Real Money Portfolio on a simple premise: That the flower hocking industry's seemingly horrible dynamics belie an outstanding business, and as a recent spin-off, the market doesn't properly appreciate the FTD's very attractive qualities. Where operating a florist is a decidedly miserable existence, FTD actually operates a network of florists -- connecting the flower gifting populace with florists, and taking a fee in the process. Though one might expect irrational price-related competition to reign, FTD sports a history of remarkably stable sales growth, margins, and cash generation -- compliments of an oligopolistic industry dynamic, dominated by 1-800-FLOWERS, Liberty Interactive's Proflowers.com, and privately held Teleflora.
Two months after my first purchase, shares are off 9% and only two analysts manned the last conference call, and shares trade hands at 11 times my estimate of free cash flow. FTD shares remain under appreciated, and I'm buying more -- adding a position equal to 1.5% of my portfolio's capital. In addition to the fundamentally attractive, under-appreciated qualities of the business, the possibility of a buyout, value-accruing share repurchases, and untapped growth prospects increase my confidence that this investment will end up smelling sweet.
1. A huge bouquet: Maybe it's coincidence. But, as noted in my last piece, it seems like FTD's primed to sell: Chief Executive Officer Robert Apartoff presided over the sale of Rand McNally's consumer business to Patriarch Partners in 2008, thereafter spent a stint managing the private equity's consumer practice, and FTD sports a long history with the private equity clique -- twice going private. It's not hard to understand why: FTD's model produces regular and stable cash flows, and its capital-light platform produces outstanding returns on invested capital.
Not to be dismissed, Apartoff and Co's incentives overwhelmingly favor selling out: Apartoff could receive an $11.2 million payday, and Chief Financial Officer Becky Sheehan might collect $4.2 million. The math works, too. FTD's net debt currently sits at about 1.9 times EBITDA. Should a prospective buyer pay a 40% premium -- a bit south of my fair value estimate -- and contribute 45% equity. That would put net debt/EBITDA at 6.7 times, which at an 8% rate, is comfortably serviced by FTD's cash flow. Though high by LBO standards, FTD's 2004 dance with private equity brought total leverage to 10 times EBITDA. So, certainly, it's possible.
That probably won't happen for a little more than a year, because of spin-off related tax complications, but if rates and capital markets are willing, don't narrow it out.
2. Invest in yourself: In the absence of a take-out, management can accomplish a substantially equivalent measure by its own devices. FTD's currently sitting on just more than $60 million worth of cash, and as above, net debt sits at a comfortable 1.9 times EBITDA. Because of its capital-light qualities and negative working capital model, it doesn't need to carry much, if any, cash for day-to-day operations. Were management to increase leverage to, say 3 times net debt/EBITDA, the company could repurchase near 30% of its shares.
As FTD shares trade hands near a 40%-50% discount to my estimate of fair value, that would compound value to shareholders at an astronomic rate. Financed at a 6% rate, that would put FTD shares at a measly 9 times my estimate of normalized free cash flow.
3. In need of fertilizer: In recent years, FTD and companion 1-800-Flowers have logged fairly anemic growth -- in the low-single digit range -- despite e-commerce's explosion. I'd wager part of that owes to the flower-buying process, which typically entails ducking into a florist or grocer at the very last minute, ripping off the price tag, and hurrying on your way. Even so, the opportunity seems huge, as commerce moves online at an ever-increasing rate: Management estimates FTD and its three largest competitors comprise just a few billion dollars worth of sales, where retail florists cleared $7 billion in 2011, supermarkets/mass market channels moved $7 billion in 2007, and the total market at $34 billion.
Looking a bit deeper, I wouldn't be surprised if FTD's growth, or lack thereof, owes to its recent past -- and is poised to accelerate. It's no secret that wards of private equity run lean, and that management teams at spin-offs have a way of uncovering previously dormant opportunities. I wouldn't be surprised to learn that, as a segment of United Online, FTD was a touch mismanaged. That makes me wonder whether FTD -- a newly spun company -- might stumble upon previously untapped growth opportunities, as is characteristic of spin-offs.
These factors in mind, I'm buying a gift that lasts -- FTD shares over flowers.