FTD Companies (NASDAQ:FTD) is the leading floral and gifting e-commerce company with a large global footprint networked into 150 countries. The wire services industry has consolidated significantly in the last five years aided by FTD acquiring ProFlowers, Shari's Berries, and Personal Creations brands. While floral arrangements and plants are their primary product offering, they also market and sell gift items, including gourmet chocolate-dipped strawberries and other sweets, personalized gifts, and gift baskets.
The company participates in a faux oligopoly within the industry with 1-800-FLOWERS and Teleflora being their main competition in the wire services space. But we would note that grocery stores are a strong competitor and that the oligopoly only exists for those who are not going to personally deliver the flowers themselves and live in another location. Even within that space, there are a number of online competitors with differing business models which are a threat to FTD's network. FTD simply enables customers to order flowers online for delivery anywhere in the US. The company generates revenue by taking a percentage (commission) on the sale and by changing the local florist who is fulfilling the order a membership fee.
We think the shares represent a solid value trap, despite the market leading industry characteristics that we crave in a name. The valuation is still quite frothy as we do not see what will cause them to generate the growth needed to support the current share price. We think the shares will slowly bleed lower as it becomes apparent that John Malone's Liberty Interactive is not going to do anything with the company in which it owns 35% of the outstanding shares. The downside catalyst will come when/if they announce their intention to sell their stake.
Short Setup Due To Acquisitions
Looking back, the short setup was obvious when John Malone and Liberty Interactive made a deal to sell FTD their chunk of Provide Commerce Inc., in a transaction that made FTD the largest online floral company. Upon the completion of the deal, Malone's company owned approximately 35% of the new company. The acquisition changed a piece of their business - instead of filling floral orders through FTD florists within their network, it could now fill them directly. This is a good way to obviate the large base of florists that pay to be on their network and be the ones fulfilling the orders.
The shares were above $30 in the early autumn of last year and above $36 at the end of 2014, all due to the 'Malone effect'. The enthusiasm surrounding his large stake in the company clearly led to some investor irrationality. The company only went public back in November 2013, for the third time in their history, after spinning off from United Online. At that valuation, the shares were implying significant growth, approximately 20% EPS growth per year for at least the next five years if we were to use a terminal 17x market multiple.
The 20% growth rate is the forecasted growth rate by the two analysts that cover the name. We think investors may have been under the perception that Malone thought the deal was good because FTD was a solid buy. But we would counter that maybe he just wanted to rid himself of Provide and take the $121 million in cash and 10.2 million shares of FTD, and run. We will see if they decide to unload the shares or wait for a rebound and then use that opportunity to sell.
Lack Of Growth Initiatives
Looking at their most recent investor presentation, management has gone over their growth drivers which rest on their ability to exploit their Provide Commerce acquisition and continue to add to their gifting portfolio via acquisitions. On the latter, we just don't see how adding more gifting channels to their already large portfolio including Shari's Berries, Personal Creations, Sincerely, Gifts.com, and Red Envelope, will change much other than if they can get them at a true value price. But right now, the company already controls much of the gifting pieces needed and further acquisitions will simply consolidate the space without adding what they truly need, which is organic growth.
Revenue over the last four years has grown at a 4% CAGR despite the rebounding economy and improved labor market. We think future revenue growth is likely to fall short of that 4% growth estimate as they focus more heavily on the gift basket and chocolate-dipped fruit market. These are much more competitive pieces of the gifting industry and gets them out of their wire services wheelhouse where they do have an oligopolistic presence.
Management has also touted their potential for $25 million in cost and revenue synergies as a result of the Provide Commerce acquisition through procurement and fulfillment, marketing, technology, and G&A expense reductions. More importantly, they see the potential for revenue synergies, something we've always been hesitant on incorporating into our analysis as in most industries, it is difficult to pinpoint. We think focusing on a mere $25 million in synergies which simply boosts EBITDA margins by 160 bps to 27% highlights the lack of opportunity.
Decline Of The FTD Network
But we think the largest negative to the shares is the decline in the FTD network of florists. The decline was already starting before the Provide Commerce acquisition noting on a call following the acquisition that the number of florists in the US has declined by 4% in the last ten years. While this isn't a huge number, it does illustrate that the business is not growing and their core cash flow generator is relying on a small amount of florists to deliver the same amount of revenue.
We think the combination of this existing model and the new Provide Commerce model is likely to come back and bite them. The company, already trying to stem the tide of florists out of their network, sent an email to their florists in mid-2014 in an attempt to assuage their concerns. Florists already hate the FTD network but see it as a necessary evil to get incremental sales volumes even though they are low-or-negative margin.
We think the rising costs to be in the network - there is typically a price escalator each year - and the fact that the local florist makes little to no profit on the wire services will lead to further erosion in the number of florists to FTD. The fees aren't disclosed by FTD, but a search shows that many pay commission rates of 25% to 27% and an annual membership fee of approximately $2,500 per year.
CNN was able to break down an actual order for an arrangement of roses and carnations from a Reno florist. FTD advertised the arrangement for $44.99 ($63 with delivery) but after $10 in raw material costs, $26 in overhead, and $13 in delivery, the florist would need to charge $49 to break-even. But in reality, he had to pay at least 27% in network fees and commissions, resulting in a $47 order or a $2 loss. We believe that with new entrants into the space with new business models, the amount of florists on the network will continue to decline driving their core revenue lower.
Despite the 30% drop in the last year, we think the shares are still overvalued simply because there is no growth. Our short thesis rests on more and more leaving the FTD network at an ever faster rate given the new options available to consumers like Flowershopnetwork.com. At 10x ttm EV/EBITDA, and little EBITDA growth expected by us over the next few years, we think a lot of expectations are priced into the shares.
The company has a significant amount of debt which the longs will say will be paid down by the free cash flow, expected to rise to $70 million this year. But the debt is due in 2019 and amounts to $305 million or 3.3x net debt to EBITDA. While this isn't egregious nor or are we thinking they will default at some point, but our rationale is that if the free cash flow is being devoted to debt pay down, it is likely not being allocated to growth initiatives like M&A opportunities.
We compared the company to 1-800 FLOWERS (NASDAQ:FLWS) which has a better growth profile and we think a better business model as they have the better brands including Harry and David. The shares trade at roughly the same valuation (and we would not recommend FLWS either). Ultimately, we think the business is focused on a luxury good and is susceptible to downturns and a possible intangible impairment. The latter represents nearly 30% of total assets with goodwill at nearly 50% of assets.
We think that FTD will eventually have to reduce their network membership fees and commissions in order to sustain the business model long-term. There is just too much competition and new technology to justify that kind of expense to florists. This will likely crush their net margins, which are already tight as it is, given the 80% gross margins in this "licensing" piece of the business.
Our price target is $17.45 based on earnings growth of 10% for the next ten years, something we believe may still be aggressive, and a terminal growth rate of 3% discounted at 10%. But if we use a more rational growth rate of 6%, then our intrinsic value comes to $14. Our risk to this price target would be if Malone comes in and acquires the remaining portion of the company. But we think it is just as likely for him to unload his stake sending the shares reeling.
We think shares of FTD represent a faux oligopoly and an old-school business model that is likely to come under pressure. Given the high commissions and fees and the number of complaints by florists about the wire service, we think the model is likely to shift away from them. The Malone premium is likely sustaining the share price but as nothing happens (our assumption), we think the shares will continue to decline. We believe the acquisition of Provide Commerce is a defensive move as they see the industry shifting away from them. But ultimately, we think the two business models cannot co-exist and that florists are likely to bleed away from the network. We just do not see any true growth to justify the current valuation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.