Trading at $5.94 as of May 3, 2002
Mom, let me assure you that this isn't a rerun from last year. Would I ever give you the same gift two years in a row? OK, never mind.... Yes, FTD.com
Let's start by looking at the overall business of IOS Brands. IOS is a holding company with a single operating subsidiary, FTD Inc. (of which FTD.com is a subsidiary segment). In other words, IOS Brands is FTD Inc. -- it's no more complicated than that. That's why, after the merger is complete, IOS will take the name FTD Inc., with a proposed Nasdaq ticker symbol of FTDI. (Hereafter, then, I'll refer to FTD Inc. as FTDI.)
FTDI is the world's oldest floral organization, founded in 1910. Originally a non-profit cooperative association, Florists' Transworld Delivery Association was founded by a group of retail florists to encourage flowers-by-wire transactions between member florists. IOS acquired the cooperative in December 1994 and transformed it into a for-profit enterprise. Today, FTDI links approximately 20,000 florists throughout the U.S. and Canada. Through its international affiliates, FTDI connects more than 48,000 florists in 154 countries around the world.
FTDI is composed of four business segments: a florist membership network ("Member Services"), floral industry hardware and software ("Technology Products"), a florist-related supplies business ("Specialty Wholesaling"), and, finally, a direct marketing business by Internet and telephone ("Direct to Consumer"). This last segment is the FTD.com business, which includes orders by the www.FTD.com website and the 1-800-SEND-FTD telephone number. By utilizing a network of independent FTD-member florists, FTD.com provides same-day delivery of floral orders to nearly 100% of U.S. households.
Here's how revenue and year-over-year growth breaks down between these segments (for the nine months of the current fiscal year, which ends in June):
Segment Revenue % Rev Growth Member Services $71.8M 31% -3.8% Technology Products $24.4M 11% -11.3% Specialty Wholesaling $33.1M 14% -26.8% Direct to Consumer $101.3M 44% 29.5%
As you can see, the Direct-to-Consumer segment, or FTD.com, is what's driving the growth of the company. And given FTD.com's low capital requirements and growing profit margins, it's this segment that's driving the value of the enterprise. It's no surprise then that the terms of the merger agreement implicitly allocate 75% of the combined company's value to EFTD. (See Zeke Ashton's recent Fool on the Hill column, FTD.com's Rosy Ending?, for an excellent discussion of the merger's terms and implications.)
In considering EFTD's current stock price, it's necessary to value the company based on its eventual participation in the entire FTDI enterprise. I'm expecting the combined company to achieve about $90 million in fourth-quarter revenue (ending in June) based on what I believe to be conservative assumptions: 30% revenue growth for the Direct-to-Consumer segment (Q4 is the strongest quarter for this segment) and 10% declines in each of the other segments. These results would give the company total fiscal 2002 revenue of $320.5 million.
The next step in the valuation is an estimate of free cash flow generation. FTDI has been expanding its free cash flow (FCF) margin over the past several years due to the accelerating positive economics of the FTD.com segment. I'm expecting this trend to continue, especially as EFTD becomes a larger segment of the overall business, and so I think it's reasonable to expect an overall FCF margin of 6.2% for fiscal 2002. This level of cash profitability would translate into $19.9 million in FCF.
To arrive at FCF per share, let's consult the merger announcement to see that the combined company will have 64.3 million shares outstanding, with each existing EFTD share being converted into one new FTDI share. I've worked through the numbers and I think diluted shares outstanding may total 65.2 million, so I'll use that number. Taking the $19.9 million divided by 65.2 equals FCF per share of about $0.30.
The final step in this back-of-the-envelope valuation exercise is to assign a reasonable FCF multiple. FTDI has been around for almost a century and its floral-related businesses are steady and predictable. In addition, the company has a well-known consumer brand and very modest debt. This is the type of consumer franchise that merits something close to a market multiple (currently 27x), although I won't be that aggressive initially. With only modest growth, I would think a 20x multiple to be reasonable.
But a key component of FTDI's value is its expanding FCF margin, which has been growing steadily over the past two years due to the growing size and profitability of the FTD.com segment. If FTDI can expand its FCF margin from 6.2% in FY02 to 8.0% in FY03, along with just a 5% increase in overall revenue, that would result in 35% free cash flow growth. Admittedly, this is just a guesstimate, but I don't think it's at all unrealistic. With this kind of FCF growth potential, I think FTDI could easily reach a 30x multiple of its FY02 FCF per share of $0.30, which would be a price of $9. At a recent price of around $6, that's 50% upside potential over the next year or so.
Next: Smithfield Foods »
Matt Richey is a senior investment analyst for The Motley Fool. This year, he's actually going to give his Mom something other than flowers for the first time in quite a few years. At the time of publication, he was long EFTD. Matt's personal portfolio is available for view in his profile. The Motley Fool is investors writing for investors.
A Stock for Mom represents the opinion of one Fool and should in no way be taken as the opinion of either The Motley Fool, Inc. or the company in question, or as representative of anyone or anything other than that specific Fool's thoughts.