We met recently with management from 1-800-Flowers.com (FLWS) to discuss the company. FLWS has a market cap of $313 million and recorded $738 million in sales over the past 12 months. We like to invest in online category leaders and think well of the company's brands. After breaking $7 this summer, FLWS shares sunk to around $5, so we wanted to learn more.
The business has three segments: consumer floral (56% of sales), BloomNet (a wire service that competes with FTD and Teleflora, 11% of sales), and gourmet foods and gift baskets (33% of sales). Jim McCann, who founded the company over 35 years ago, is chairman and CEO.
The revenue growth is there, although it's rather modest. Over the past three fiscal years it has averaged 4.5%. The September quarter was up just under 3%. Growth is driven by mobile, e-commerce, new product categories, BloomNet, and gift baskets. The consumer floral segment is more challenged. Historically, the company has grown the gift basket business by acquiring brands at five to seven times EBITDA. Management has also created de novo brands when they saw an opening in the market. Long term, the company is targeting a mid-single-digit growth rate on the top line. That seems feasible, even conservative to us, if they do the job right.
One of the key things we wanted to hear about was the opportunity for margin improvement. With gross margins historically around 40%, operating margins in recent quarters look lighter than we would expect. The company explained that marketing, brand support, and call center operations are all expensive. After falling from 5.2% to 4.6% from FY 2009 to FY 2010, adjusted EBITDA margins have been on the mend. They jumped to 6.0% in FY 2011 and then expanded 30 basis points in FY 2012 and again in FY 2013. Management's long-term goal is a double-digit EBITDA rate. How likely margin expansion is and how long it will take are key questions here.
The balance sheet has strengthened over the past few years, with $130 million of debt paid down since FY 2008. As of September 2013, FLWS reported $71 million in current maturities of long-term debt and $4 million in cash, but there's some important commentary here. Management explained that the $71 million went to build inventory ahead of the holiday season and is expected to be paid off by December. The company still has about $130 million of availability on their credit line, which will revert to $200 million once the $71 million is paid down. The company is making money and guiding to be free cash flow positive this year, to the tune of $20 million.
There aren't many precedent transactions in the industry, but we've seen that FTD and ProFlowers changed hands at 10x EBITDA or above. Benchmark Capital said their e-commerce group is averaging 10x EBITDA, which is several turns higher than where FLWS trades today. Benchmark has the company at 5.5x CY 2014. Brean Capital is expecting over $50 million in EBITDA for the current FY 2014, and over $55 million in FY 2015.
Using some back-of-the-envelope calculations, if FLWS grows revenues by 10% in aggregate over the next couple of years, gets EBITDA margins to around 7%, and is awarded an 8x EBITDA multiple -- an optimistic yet plausible scenario -- the stock should be north of $7 a share. In a transaction, or if management hits its long-term targets, it can be dollars higher. Heavy ownership by the McCann family does reduce the likelihood of an unsolicited offer or activist involvement, although it also means someone is minding the (flower) store. The growth profile and margin opportunity aren't as obvious as we'd hope, but we still might do some more work on this one.