JRJR Networks (NYSEMKT:JRJR), formerly CVSL, creates value by turning around underperforming direct selling companies, which it aims to acquire for ~0.10-0.15x sales. Its strategy is three-pronged: First, it turns around negative revenue trends through reinvigoration of the sales force & product line. Second, it improves EBITDA margins to an industry-standard 15% through centralisation of costs, best practice and synergies. Finally it boosts cash flow through optimization of working capital and monetization of PPE.
To achieve this, JRJR draws upon its executive team's long experience in the direct selling industry, which includes successful stints at industry heavyweights Mary Kay and Avon. It also draws on its decades of experience in private equity: CEO/Chairman John Rochon's investment vehicle - Richmont Holdings - has generated a 92% IRR over 27 years. Given management owns over 50% of the common stock, its interests are aligned with shareholders.
So far, JRJR has made 10 acquisitions to date for a total consideration of $26.9m and at a cumulative sales multiple of 0.105x. The following table summarizes the transactions to date:
If JRJR can deliver on its strategy, the value creation potential is enormous - at a 0.15x purchase price and 15% margin, JRJR would be turning each $10m spent on acquisitions into $50m of intrinsic value. I will show that if JRJR can invest at these returns for 15 years, the stock is worth $14 today. At a 10% peak margin instead of 15%, JRJR would still be worth $8.
With the stock price at $1, it is clear that the market does not believe in the strategy. And who can blame it? While JRJR has acquired at low prices, it has provided seemingly little evidence of being able to turn these acquisitions around. Sales are declining (ex M&A) and losses remain significant - at the 9M15 run rate JRJR's cash will not last much longer. Add to this the departure of top-ranking distributors from Agel in October and the recent investigation of the Betterware acquisition by the UK competition authorities, and it becomes easy to understand why JRJR is trading at only 0.22x sales.
I, however, believe the market has given up too early. JRJR has, in fact, showed signs it is capable of implementing its strategy. A deeper analysis shows that management has already turned around sales trends and improved the cash flows of acquired businesses. Furthermore, while JRJR has yet to generate a profit, there are concrete reasons to believe it will do soon: recent losses were caused by factors that are about to normalize, and cost saving initiatives should drive a swing to healthy profitability in 2016. The Agel departures and Betterware investigation are red herrings distracting the market from these positive underlying trends - both, I will show, are non-issues.
I believe that a swing to profitability and return to base business sales growth will force the market to radically reassess its view of the chances of JRJR's strategy working, resulting in a stock price many multiples higher. Given the existence of a large short interest in what remains a relatively illiquid stock, I expect that this repricing may happen quickly.
Investors should, of course, remain wary of the risks. Turnarounds are difficult, and JRJR's lack of profitability means that any adverse event could force it into raising capital at dilutive prices.
Why The Market Is Bearish
I believe the market is putting a low probability on JRJR's strategy working for the following reasons:
- Sales are declining fast: while 9M15 sales grew 39%, excluding M&A they declined ~13%. Longaberger declined ~30% and annualised sales are now 65% lower than at the time of acquisition, while Agel sales declined 23% even before any impact from recent departures. Sales declines of this magnitude call management's ability into question and make it near impossible to achieve profitability given negative leverage on fixed costs.
- JRJR remains heavily loss-making: JRJR posted a 9M15 EBITDA loss of $9.6m, a -9% margin. This is extremely slow progress versus the $11.6m in 9M14, a -15.5% margin.
- Cash won't last long: Given this rate of EBITDA loss, JRJR's ~$11m available cash will not last long - especially considering that $6.9m will go towards debt/lease repayment and interest in 2016.
- Problems at Agel: Top-ranking distributors often take their networks with them when they leave, at great cost to the revenues of the company they are leaving. An exodus can also show signs of trouble: several direct selling websites reported disputes over payout of commissions.
- Betterware deal at risk of falling through: In December the UK Competition and Markets Authority announced that it was looking into whether JRJR's acquisition of Betterware is anti-competitive. If the deal fell through, JRJR would lose the acquired EBITDA (low single digit $m) as well as anticipated synergies.
Why The Market Is Wrong
Top-line performance has been much better than it seemed
I estimate that 11% of the 13% 9M15 sales decline was caused by depreciation of key currencies…notably the EUR (18% weaker in 9M15), RUB (40%), UAH (48%) and AUD (17%). Recent sales trends have in fact been encouraging:
- Longaberger has been the blemish on JRJR's track record to date, but has recently shown improvement. 9M15 sales were down 30% only as a result of a strategic decision to close down outlet malls, which drove an improvement from a ~$2.2m loss per quarter in 2014 to a ~$0.7m loss per quarter so far in 2015. After this reset, sales have finally returned to q-o-q growth.
- Your Inspiration at Home (YIAH) has been the star performer of the portfolio. Annualised sales currently stand at ~$23m, versus $1.3m at the time of acquisition. 9M15 sales grew 186%, or closer to 250% in constant FX.
- Agel's 9M15 sales were actually flattish excluding EUR/RUB/UAH pressures. Annualised sales are around $30m, which in constant FX terms is higher than the $38.6m level at the time of acquisition - an impressive reversal of significant declines under previous ownership. The 2016 outlook looks positive given the Sep'15 launch of the Caspi skincare line and moderating FX headwinds.
- Kleeneze returned to q-o-q sales growth shortly after the acquisition in Feb'15, following 21%/6% declines in 2014/2013. It is currently running at a ~$53m run rate. We do not yet have any data points on Betterware, although JRJR has guided to annual revenues between $35 and $40m. Both have suffered from GBP weakness.
I expect that JRJR's sales can grow as much as 4-5% in 2016 (excluding acquisitions). This impressive sales reversal will provide the market with concrete evidence of management's abilities.
Current EBITDA losses are driven by factors that will normalize in 2016
While JRJR's adjusted/reported EBITDA margin was -4.3%/-9.2% in 9M15, losses were largely a result of two factors that will normalize in 2016:
- Investment in YIAH: YIAH's gross margin of 36% in 9M15 was the result of significant investment into sales growth. Without this investment, margins would likely increase to 65% or higher given the high margin nature of gourmet food products. I expect YIAH will dial back investment in 2016 as its home market of Australia matures.
- Service agreement with Findel: JRJR agreed an expensive service agreement with Findel, the previous owner of Kleeneze, essentially as part of the purchase price for the business. JRJR has previously stated that it expects almost £2m savings, equating to ~$0.65m per quarter, when this expires in Sep'16.
Adjusting for these factors, JRJR's 9M15 adjusted/reported EBITDA margins were +1.1%/-3.3% and its combined 2-3Q15 margins were even better at +2.4%/-1.8%. I believe adjusted EBITDA, which strips out one-offs and recurring M&A expenditure, is the best gauge of JRJR's operational progress, and I note that M&A expenditure could be switched off at any time.
Cost savings should drive healthy profitability in 2016
I expect JRJR to arrive at a 6.1% adjusted EBITDA margin runrate towards the end of 2016, from an expected 3.5% loss in 2015, driven by the following:
- Gross margin improvement of 160bps, driven by lower investment in YIAH as the business matures. This is based upon YIAH gross margins improving from 38% to 55% - still below a normalized margin as I expect that JRJR will continue investing for growth outside of Australia.
- Fixed SG&A savings of $11.5m, driving an 800bps y-o-y improvement in fixed SG&A. This is based upon: i) Kleeneze/Betterware synergies of $3.5m, of which $2.6m or so comes from the Sep'16 expiration of the Findel service level agreement; ii) Estimated headcount reductions of $4.5m, most of which took place during 4Q15; iii) Estimated miscellaneous savings of $3m - a collection of smaller initiatives including the closing of certain foreign offices and IT efficiencies; and iv) YIAH advertising savings of ~$0.5m.
While this cost saving forecast might seem ambitious, JRJR only needs the relatively straight-forward Findel and YIAH savings to reach positive adjusted EBITDA, at which point we would no longer need to worry about cash burn. If it can deliver half of the other savings as well, it will have already achieved a ~4% margin. I note that JRJR's CEO/Chairman stated on the 3Q15 conference call that the company is targeting an 8-10% reported margin runrate during 2016, which implies a 9-12% adjusted EBITDA runrate. Given his historic tendency for over-optimism, I view this as a best case.
Because the aforementioned savings happen throughout 2016, I estimate that my runrate margin of 6.1% equates to a 2016 margin of 3.7%, implying adjusted EBITDA of $7m.
Cash management indicates that JRJR can last longer than EBITDA losses suggest
JRJR has shown a keen focus on cash flow: unlevered cash burn to date has run at 58% of reported EBITDA burn, largely thanks to value extracted from working capital and sales of PPE - together accounting for a cumulative $15.3m inflow since 2012. This gain is significant considering that JRJR extracted this cash from businesses that only cost $19.5m in the first place. A continuation of this performance would mean that JRJR's cash would last longer than it might seem - if needed.
Note: these numbers do not include the cash inflow that resulted from the Longaberger sale leaseback
Agel departures & Betterware investigation are red herrings
I view the departure of Agel distributors as a positive, as i) The leaving distributors failed to take their networks with them, meaning minimal impact on sales (sales actually improved immediately after the departures), and ii) The departure of the highest paid distributors is positive for both JRJR's margin and the morale of those remaining.
I also expect the Betterware deal to go through. The UK Competition & Markets Authority is investigating whether the transaction has created a relevant merger situation. For this to happen, one of two 'thresholds' needs to be met: i) The target's turnover exceeds £70m, and/or ii) The transaction results in the creation of, or increase in, a 25% or more combined share of sales or purchases in (or in a substantial part of) the UK, of goods or services of a particular description. Betterware's sales are ~£25m, and combined Betterware & Kleeneze sales will be ~£60m - less than 1% of even the narrowest market definition of Homeware only (the companies also operate in other huge market segments of health & beauty, clothing, gardening, etc). Therefore it appears extremely unlikely that the CMA will reverse the transaction.
Two-Part Valuation Model Shows Staggering Upside
In the first section I explained why I believe the market should put a much higher probability on JRJR realizing its strategic vision. The next step is to calculate the intrinsic value in this scenario. To do this, I put forward a two-part valuation model where I value the base business and future acquisitions separately.
Valuing the existing business
JRJR's existing business has estimated sales of $189m. To value this, I use a simple DCF assuming inflation-driven sales growth of 1% into perpetuity, capex equal to 1.25% of sales and a tax rate of 35%. From there we just need to pick a WACC and peak reported EBITDA margin (reached in 2018), and take off the value of JRJR's lease liability.
The below model shows that at a peak EBITDA margin of 15% and WACC of 10%, JRJR's existing business on its own is worth $152m today, or $4.30 versus the current stock price of $1.
In the table below I show what the base business is worth per share at varying peak margins and WACCs. The table shows that JRJR's base business is worth more than the current stock price at most potential EBITDA margin scenarios (the green boxes). Even if JRJR only increases margins to 10%, the existing business would be worth $2.59 at a 10% WACC.
Valuing future acquisitions
JRJR is still at the beginning of its ambitious strategy - JRJR management fully expects to be a billion dollar sales company within the next few years.
We must therefore assign a value to future acquisitions. To do this I use two steps: first, I calculate the value creation from 1 year of acquisitions. The model below shows that at a 0.15x sales purchase price and 15% peak margin (reached in year 5), JRJR's acquisitions create value equivalent to 4.9x the purchase price.
Next, I value 15 years of acquisitions making assumptions on WACC, peak margin, purchase multiple and cash spent on acquisitions per year. I arrive at the NPV of these acquisitions by discounting the annual value created back to today. Below I show a scenario assuming a 10% WACC, 15% peak margin, 0.15x purchase multiple and where JRJR spends $10m on acquisitions in year 1, with cash spent on acquisitions growing 5% p/a after that.
In this scenario, JRJR's future acquisitions are worth $392m - equivalent to a stock price of $10.10.
- Is the starting acquisition run-rate too high? My assumption that JRJR will acquire $67m sales in 2016 is lower than the $100m target JRJR set itself on the 3Q15 conference call
- Is growth in dollar volume of acquisitions too high? My assumption of a 5% increase in cash spent on acquisitions means that JRJR will only be spending ~$15m p/a on acquisitions in 10 years' time. This seems very low versus the ~$100m EBITDA that JRJR would be generating at this point.
- Do a sufficient number of these cheap opportunities exist? Cumulative sales acquired of $1.4bn over 15 years equates to less than 1% of the global direct selling market - currently $178bn and growing. It is likely they will find a sufficient number of attractive turnaround opportunities.
- Is the implied IRR too high? The implied IRR on acquisitions of 26.5% does not seem overly high for private equity-style, turnaround acquisitions. I am also not assuming it into perpetuity. The further into the future acquisitions are assumed, the lower the IRR should fall.
Below I show how the per-share value of future acquisitions changes under varying purchase price and peak margin assumptions. Green boxes represent value creation, red represents value destruction.
Putting the two together illustrates huge potential upside
At a 10% WACC, the combined valuation at varying assumptions is shown in the table below. If JRJR delivers on its 15% EBITDA margin target and makes acquisitions for 15 years at 0.15x sales, it would be worth $13.77 today.
There are two important things to note here:
- This is the fair value today. JRJR would be worth substantially more in 2030 thanks to compound value creation, even if acquisitions stop at that point.
- This is not a 'blue sky' scenario, given
i. The assumed acquisition runrate is not aggressive
ii. The acquisition price of 0.15x sales is higher than JRJR's 0.105x to date
iii. It does not include any value from cash optimization
iv. It assumes a 35% tax rate, which may be too high as it assumes immediate repatriation of international profits at a full US tax rate (JRJR's tax rate is ~20% before repatriation thanks to its Swiss holding company).
I have shown that if JRJR proves it can deliver on its strategy, it is worth significantly more than the current stock price. Based upon progress so far, planned cost savings, and an impressive management team, I believe it is likely that JRJR executes on its long-term strategy. While any unprofitable company is at the mercy of unexpected adverse events, I expect the valuation gap to close as the market becomes more comfortable with this thesis.
Disclosure: I am/we are long JRJR.
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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