The Franchise Group (FRG) is a new member of the Russell 2000, but the company and its management have a much longer history worth expanding on in light of the recent equity raise. Brian Kahn is the CEO of the Franchise Group. Brian is also the Managing Partner of the private firm, Vintage Capital. Brian has a long history pre-dating his tenure at the Franchise Group as a deal maker and expert in improving operating efficiency in the businesses he owns. Vintage acquired a controlling stake of Liberty Tax (TAXA) in 2019. They merged it with Buddy’s Home Furnishings and then renamed the company “The Franchise Group”. The plan is to turn the publicly traded tax preparer into a diverse conglomerate of franchised businesses through a series of accretive acquisitions. Management moved quickly to build on the Franchise Group by acquiring the Vitamin Shoppe, Sears Outlet and American Freight. The model for the acquisitions is to improve operational efficiency within these franchise businesses, take advantage of a number of synergies within the franchise model, and sell the company owned stores to franchisees where it makes sense. Investors get the benefit of the improved efficiencies as well as a consistent stream of cash flows that will be paid out in dividends.
Covid hit just as FRG had used debt to fund their American Freight acquisition. A business that looked fantastic quickly had several questions raised about their ability to survive with a number of their businesses forced to close (including nearly all the American Freight stores). The equity traded down over 75% in 2 weeks. Many of those fears were put to rest in the company’s most recent earnings report where they not only hit their pre-Covid guidance, but raised guidance for the rest of the year as they demonstrated that the businesses performed quite well through the lockdown and further expect them to perform well through the recession.
Coming into the Russell 2000 rebalance, the company decided to raise additional equity capital. The company’s equity had recovered from less than $6 to over $20 per share. They initially planned to raise $50 million and with enough demand decided to increase the size to $100 million. Some investors may perceive the offering as dilutive, but based on the history of the management team, we view the offering as a major positive for the company.
The management team through Vintage Capital own over 40% of the company. Through the downturn, when other large holders have needed liquidity, they have been buyers. They are still in the early innings of building the Franchise Group into the business they expect it to become, and the opportunity set today to make acquisitions could be one of the best we’ll see in our lifetimes. While the S&P 500 has recovered well from the bottom, that is mostly the result of the performance of a handful of the largest companies in the world. If we were to take an equal weighted basket of all the public and private companies in the country, the index performance would paint a very different picture. As FRG looks to make acquisitions, and perhaps target some assets in bankruptcy, the $92 million they just raised will likely be put to work very quickly. By raising capital through equity, versus debt, the company also increases their flexibility and improves their ability to move quickly in an acquisition or acquire assets out of bankruptcy.
In this market, we are looking to find heavily discounted public companies, but we are also looking for companies that are expert acquirers in their particular field that can add tremendous value over the next few years through those acquisitions. A key component to that is partnering with a management team that shares the same incentives as their shareholders. FRG is one of our favorite positions for precisely that reason.
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Disclosure: I am/we are long FRG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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