Since our initial report on Creative Learning Corporation (OTCQB:CLCN) many new events have occurred, yet the share price has fallen. Franchise count has grown significantly to 600 franchisees from the ~513 as of March 31. The company has also announced a Master Franchise Agreement in New Zealand for the development of 18 Bricks 4 Kidz franchises and the company launched the Sew Fun Studios franchise. We think the market is taking the announcement of a new independent auditor as a negative, which has driven down the share price.
On June 26, 2014, Creative Learning Corporation dismissed Silberstein Ungar, PLLC as its independent registered public accounting firm and retained Hartley Moore Accountancy Corporation. According to the filing, the company and auditor did not have any disagreements, but anytime we see an auditor change we want to make sure we can't find any problems with the break up. Digging further into the situation we find here that Silberstein Ungar, PLLC merged with KLJ & Associates LLP and it could be likely that Creative Learning did not want to be associated with KLJ. This could be a justifiable reason or could be a coincidence, we think more of the former than the later. If the market were selling off due to this one change, then we believe the drop in price is not warranted since the company has been performing well.
Company Performance And Valuation
87 franchises opened since March and now have 600 franchisees. We estimate initial franchise fees to be around $1.4 million (@20k per franchise). The company also announced that it completed a Master Franchise Agreement for 18 Bricks 4 Kidz (NYSE:BFK) in New Zealand. The MFA would increase the store count to 618 and add a conservative $150,000 in initial franchise fees (MFA have averaged $81k and assume $2k/franchise fee as % of sub-franchisee setup). The initial fee could be materially higher and the extra % fee from the sub-franchisee also could be higher.
Brian Pappas has mentioned that they anticipate on achieving 650 franchises by September 31 of this year or 32 additional stores more. Since each franchise concept has different set-up fees, $17.5K for Challenge Island and $25.9k for BFK, the weighted average initial franchise fee is estimated to be $20k or $640k total for 32 franchisees. Totaling all of the extra initial fee revenue, we expect the company to produce an additional $2.5-$3 million in revenue this year just from initial fees. Over the first six months the company produced $3.1 million.
Royalty revenue will also materially increase from the $1 million in 2013 to approximately $1.8 million this year from the additional stores. Our estimate is based off the assumption that 650 stores generate an average $40k in revenue per year (back of the hand calculation of previous performance) or $26 million in total and apply a 7% royalty rate.
Totaling all of the initial franchise fees, corporate owned franchises and royalty stream, we estimate that CLCN will generate approximately $8 million in revenue for the year. We do not expect corporate expenses to grow significantly since the company can scale on its current corporate personnel. It looks as though the related party franchise consulting expenses are the bulk of the expenses, which we guess will rise moderately with more franchisees. Last year $3.8 million was spent on operating expenses and $1.8 in the last six months, so $6 million for the 2014 year does seem reasonable. Earnings before taxes then could be around $2 million.
The company does generate significant amounts of cash, $1 million FCF was generated in the first six months. We expect the company to generate at least that much for the next six months or around ~$2.4 million. The earnings yield (FCF/EV) at today's price is 10.5%, which is an attractive yield. The question is whether the company will continue to find new franchisees, which is where a majority of their revenues are currently derived from, and if they can continue to grow royalty revenue. The company has a significant ability to grow internationally, especially in Asia were child education is a large industry, but we will not fish for pie in the sky numbers.
The large cash generation is likely to drive the cash pile to ~$4.4 million and potentially to $5 million by the end of the year. Our main concern with the growing cash pile is how the capital will be allocated.
Although there is significant growth potential from the company still here in the US and internationally, the barriers to entry seem fairly low for a competitor. As we discussed previously, the company is growing faster than competitors because we believe that the CEO Brian Pappas has better experience than current competition in growing franchises. Further growth and more marketing would help create and build a consumer franchise, but we will wait and see if the company is successful.
Any speed bumps in the company's growth could lead to fewer initial franchise fees, which would materially impact the company's earnings. As we stated above, it still looks like there is a large runway for growth, so that is a slight mitigator. We are weary though that the company might be growing at any cost and signing up anyone with the minimum capital requirements and a pulse. GrowBiz, the predecessor of Winmark Corporation (NASDAQ:WINA), in the later 90's is a good example of a franchiser growing at any cost. The only difference is that the capital requirements of Creative Learnings' franchises are very low.
Creative Learning Company is even cheaper today than it was when we first wrote about it, yet the business has been performing well. We think the market is depressing shares because of the auditor change, but it looks like it was a measure to leave before KLJ took over their previous auditor. The company continues to generate significant cash, so we will keep an eye on capital allocation.
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