FTD Companies - An Undervalued Spin-Off
The Opportunity - FTD Companies
The recent spin-off of FTD Companies (NASDAQ: [[FTD]]) allows investors the opportunity to purchase shares in a high quality business trading at 10.5x trailing free cash flow2 and with the potential for 50% - 75% price appreciation over the next year . FTD was formerly a wholly owned subsidiary of United Online, a company best known for providing dial-up internet service under the NetZero and Juno brand names. Highlights of the investment are as follows:
- Given the recent spin-off, there has been little time for true price discovery to occur and, as such, astute investors have the opportunity to capitalize on this inefficient corner of the market. FTD will begin reporting as a separate company in the fourth quarter and I anticipate that the stock will appreciate as investors begin to understand the merits of FTD.
- FTD is a good business with high barriers to entry, low capital requirements, a strong market position, and a stable industry structure.
- FTD trades at an attractive absolute valuation but is also cheap relative to the broader market as well as its one publicly traded competitor.
History of FTD / How the Business Works
FTD is a business that has existed for over 100 years in various forms, first as a cooperative owned by florists and later as both a public company and also under private equity ownership twice before. In 2008, FTD was acquired by United Online ("UNTD") and remained as a wholly owned subsidiary of UNTD until it was spun off to shareholders on November 1st of this year.
Today, FTD reports its business in two segments: Products and Services. On the product side, FTD operates the website ftd.com where consumers can go online to purchase flowers and have them delivered, via a local florist, anywhere in the US and several international locations. FTD keeps a portion of the revenue collected from consumers and remits the rest to the local florist as compensation for arranging the bouquet and delivering the flowers. FTD's Product segment accounted for approximately 78% of revenue and had a 23% gross margin in FY 2012.
On the service side, FTD charges member florists to be part of its floral network and, in exchange, the local florist is allocated orders that FTD receives through its website-orders that, for the most part, are incremental to the local florist's business as the order frequently originates outside of the florist's local area. FTD's Service segment accounted for 22% of revenue and had an 85% gross margin in FY 2012. It's worth noting here that although FTD has historically reported Products and Services as separate revenue streams, both sides of the business depend on each other and the business is best thought of as a single entity.
FTD competes against other floral networks, such as 1-800-FLOWERS ( FLWS ) and Teleflora, and less directly against flower delivery services that drop ship flowers to consumers, such as ProFlowers and Amazon ( AMZN ).
Below are summary financials of FTD for the past 3 fiscal years per the FTD Form 10:
Note that historical free cash flow has been adjusted to reflect the current capital structure (recent refinancing with a lower interest rate) and to reflect increased corporate costs from being a standalone public company.
FTD Business Strengths
Before discussing valuation it is worth mentioning a few points on why I believe FTD is a quality business and will help provide some frame of reference for the valuation. The following bullet points highlight what I view to be some of the key strengths of FTD:
- High Barriers to Entry - Starting a floral network from scratch is a monumental effort and one that is almost destined to fail. To get local florists to pay thousands of dollars a year to join, a floral network needs to be able to deliver orders to those local florists. In order to deliver orders a floral network also needs a website with significant consumer orders, which it can route to those local florists. To get those consumer orders, the network has to provide for local delivery of the order. In other words, to get the florists you need orders and to get orders you need florists. Because of this interrelationship between orders and florists it is extremely difficult to displace the incumbent in this industry.
- Dominant Market Position - Although FTD does not disclose penetration statistics, comparing annual service revenue to membership fees for FTD suggests penetration rates of over 90% of florists. Although anti-trust complaints are not necessarily desirable, it's worth noting that FTD has been in trouble several times in the past for abuse of its market power, most recently in the mid 1990s (see: here ). I view these antitrust inquiries as indicative of FTD's market power.
- High Returns on Invested Capital - FTD consistently achieves returns on equity of over 20% even when I include all intangibles in book equity. Return on tangible equity is distorted by large intangible balances from UNTD's acquisition of FTD, but suffice it to say that the 20% return on equity figure above is conservative.
- Stable Industry Structure - The floral network business has operated in an oligopolistic structure for several years now and market share has remained relatively stable. This is not to say that price competition is non-existent, but each participant has incentive to be rational.
- Fragmented Buyer Base - The typical buyer of FTD is an individual that purchases flowers one or more times per year. There is no significant customer concentration and thus it is unlikely to be an area that pressures price for FTD.
- Recession-resilient Business - FTD's business is not prone to drastic cyclical swings. From peak (2007) to trough (2009) during the most recent recession FTD order volume decreased approximately 5% and average order value decreased approximately 7% while operating margins remained relatively stable in the 12% - 14% range.
Current Opportunity / Valuation
FTD Companies began regular-way trading on November 1st after having traded in the when-issued market as a separate entity from its former parent on October 10th. At FTD's closing price of $31.04 on November 8th, investors are able to purchase FTD at a multiple of 10.5x trailing free cash flow, a level that is attractive both from an absolute standpoint and a relative standpoint, particularly given the quality of FTD's business. The following bullet points outline a few ways to think about the valuation of FTD:
- FTD in an absolute sense / as a bond - if I were to think about FTD as a bond, am I happy to hold a ~10% coupon bond where the coupon can grow mid to high single digits or even low double digits? Given the stability of FTD and the high barriers to entry, I'm happy to hold such a bond.
- FTD vs. the broader market - the S&P 500 trades at approximately 16x trailing earnings and free cash flow for the average company in the S&P trails earnings, meaning the average company in the S&P trades above 16x FCF. FTD has higher operating margins, is more capital efficient, is more recession-resilient, and operates in an industry with a more favorable industry structure (oligopolistic industry) than the average S&P company.
- FTD versus public competitors - although FTD has more floral network members, higher operating margins, and is less capital intensive, it trades at a significant discount to 1-800-FLOWERS, its only publicly traded competitor, which trades at nearly 19x average 3-year trailing cash flow.
Using the multiple of the average company in the S&P, FTD would trade at $46.50 / share (nearly 50% upside); using 1-800-FLOWERS' multiple, FTD would trade at $55.50 (over 75% upside).
Opportunities to Drive Additional Value / Potential Catalysts
Although I believe FTD has the chance for price appreciation of 50% - 75% over the next year, there are incremental levers, which the company has at its disposal that could drive that upside higher. These include:
- Buyback - Earlier I made the case for why FTD is attractive in both an absolute and a relative sense. Given that I believe FTD trades below its intrinsic value, one way to increase intrinsic value would be to buy shares at a discount. As a newly independent public company, FTD does not yet have a buyback in place and the board of directors for the company was only recently formed; FTD, however, would be wise to follow in the footsteps of its former parent company and put a buyback plan in place. For every 10% of the company that is repurchased at current prices, per share intrinsic value (using the midpoint of my value estimates above) increases by approximately $2 per share, or 4%.
- Dividend Policy - Although a dividend in and of itself does not create value it would do several things that may increase the price at which FTD trades. First, it sends a signal to investors that management will be prudent with capital and will not waste it on large acquisitions (see risks below). And second, depending on the payout ratio, it increases the likelihood that FTD will be valued at a premium given investors' hunger for yield. In addition, there are a number of dividend ETFs and paying a dividend may drive FTD's price higher as index funds purchase the stock.
Bear Case and Risks
Although I believe FTD to be an attractive investment at these prices, there are a number of risks worth mentioning:
- Competition - While competition is not new and FTD has maintained its dominant industry position for years, competition is still a risk. 1-800-FLOWERS could always become more aggressive on price or discounting to win market share. Additionally, Amazon has begun offering its own collection of "Amazon Curated Flowers." Amazon competes in the drop-ship segment of the industry, meaning they package the flowers in a box and ship them to the recipient, and is more accurately characterized as a direct competitor to ProFlowers.
- Acquisition Risk - For the past 5+ years FTD has been part of the broader United Online organization and has thus been subject to the capital allocation policies of the parent company. In the past this meant up-streaming cash to the parent in order to help fund UNTD's dividend policy. As a standalone public company FTD will develop its own capital allocation policies and the risk of an acquisition must be considered.
The recent spin-off of FTD provides investors the opportunity to purchase a good business at an attractive price of 10.5x free cash flow. As FTD begins to operate and report results as an independent company, I believe the market will realize the value inherent in FTD and accord it a more fair valuation.
2 Defined as average three-year trailing free cash flow to normalize for working capital swings. Note I believe this free cash flow figure likely understates forward free cash flow for FTD.
Disclosure: I am long [[FTD]]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.