YogaWorks: Price Target Of 15 Cents Per Share

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About: YogaWorks, Inc. (YOGA)
by: Long Wave Research
Summary

We believe that significant downside exists for shares of YogaWorks.

History is now proving that YOGA is a "melting ice cube business," with secularly declining revenue and negative profit margins.

Hindsight suggests YOGA should have remained private until the studio portfolio produced positive same-store sales and/or positive cash flow.

YOGA management has yet to be asked by the sell-side analyst community about various restructuring or bankruptcy scenarios under its inability to raise additional capital.

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YogaWorks (NASDAQ:YOGA) is a nationally branded chain of 68 studios focused on enriching and transforming their customers' lives through offering yoga classes and instruction. The business has proven to be a "melting ice cube," with same-store sales revenue declining every quarter since the 2017 IPO. Management has acquired new studios to help offset this revenue decline and attempt to scale to profitability, but so far that has been unsuccessful. The most recent quarter generated losses of over $3 million, or $0.20/share on total revenue of $15.6M. Here's some important data about the company:

  • Recent share price: $1.05/share, market cap of $18 million
  • Estimated price target: $0.15/share, market cap of $1-$3 million
  • Estimated YOGA share performance: approximate price decline of ~85%

Unfortunately, YOGA's lack of execution on their strategy has led them to become a "busted IPO" that hasn't been friendly to shareholders, as GAAP losses have occurred in every single quarter. Management has had a very difficult time turning around a constant cash burn problem, even after acquiring numerous additional studios for their portfolio.The IPO occurred in the summer of 2017 at a price of $5.50/share and equated to a market cap north of $90 million, while generating over $35M of cash proceeds for YOGA. To no one's surprise, the poor business results have caused YOGA's share price to decline in lockstep, with prices dropping as low as $0.40/share in late 2018. Today, the company faces dire financial circumstances when analyzing the fundamentals based on the latest SEC filings.

Oddly, in terms of YOGA's share price, early 2019 has proven to be very kind with the stock price more than doubling to around $1.10-plus - even as the company recently reported another negative cash flow quarter in Q1 2019. Today, YOGA faces heightened liquidity concerns with only $6M of cash and a burn rate just under $1M per month. Investors appear to remain in the dark with no signs or indications of a turnaround producing anything close to profitable operating levels, based on management's latest remarks on the Q1 2019 conference call.

The recent run-up in YOGA's share price could have been driven by day traders and technical investors, as they have their moment trading a tremendously volatile stock with huge daily swings on the back of no news, updates, or analyst reports. But the reality is that, in our opinion, the declining business fundamentals support an equity value much closer to zero - if not zero - as the coming quarters drain the remaining cash balance and shareholders face a reorganization that is likely to wipe out their equity interests.

Company Background

YOGA is headquartered in California and generates a large majority of their revenue by offering classes, with a smaller amount of revenue from other offerings such as apparel sales, online access to virtual classes, and a teacher certification program for training and workshops.

The company operates in regional markets through clustering their studios in major MSAs (metropolitan statistical areas). The company's portfolio of studios span from Los Angeles to Orange County, northern California, Houston, Atlanta, Washington, D.C., Baltimore, New York City, and Boston. Year to date in fiscal 2019, 62% of YOGA's revenue is generated from the State of California, with every other region contributing less than 10% individually.

In 2018, the company generated about $59 million in total revenue and $39 million in losses, equating to a loss of $2.14/share. That includes a significant write down of goodwill along with asset impairments, but excluding these "non-cash" charges, YOGA lost over $.60/share. The company ended the year with $11.4 million in cash and $14 million in current liabilities.

Opportunity

This presents today's investor with a great short opportunity to take advantage of a highly speculative valuation at around $1.10/share. After all, how many companies in highly cyclical industries such as the yoga industry (consumer retailing), with a business model lacking a history of profitability, trade at such a wide premium to their quickly depleting level of cash?

According to Nasdaq, there are 129K shares short as of April 30, 2019, representing about 4.6 days to cover based on average volume of about 28K per day. YOGA shares can be borrowed from brokerages with single-digit annual borrow rates. We think this presents a very attractive risk/reward scenario, where we see significant downside in the shares in the coming two quarters as liabilities mount and cash flow remains negative.

Risks

The risks to our investment thesis are as follows:

Same-store sales could turn from negative to positive, and growth could be able to bring margins from losses to profits. We do not see this happening in the short term, but investors must consider all scenarios.

YOGA could increase its class and membership prices and customer volume does not fall substantially. Based on our estimates YOGA needs to raise prices significantly, to the tune of at least 15%, to start generating positive cash flow.

YOGA could raise enough debt or equity capital to become a going concern at terms that do not significantly dilute current YOGA shareholders. On this topic, one must wonder who will come and rescue YOGA with a capital injection into a portfolio of yoga studios with declining revenue with negative cash flow. What costs can be trimmed in the future to entice such a lender to see the light at the end of tunnel - reduced overhead, reduced management salaries, reduced public company auditing, and listing costs?

Industry

The yoga industry is highly competitive, with countless local competitors in every major city. A quick look at Yelp shows 2,900+ studios in Los Angeles, 1,000+ studios in Chicago, and 550+ studios in Dallas. Yoga studios exist as standalone locations, sometimes attached to modern gyms, or public places such as a park or beach. The opportunity for people to practice yoga also exists at home in front of their TVs or computer screens.

YOGA has an online offering that allows their customers to attend online recorded classes, and YOGA even has a teacher training certification program. However, with all the ways to access yoga, one can see the intense competition in the yoga industry - new competitors can enter the market and try to win business from existing studio owners with a fresh concept or differentiated model. Competition is able to easily arise with very little capital, as landlords generally only require a few months' rent upfront to sign a lease and turn empty space over to an aspiring yoga studio owner. The yoga business requires very little if any specialized equipment or specialized government license/permitting, unlike a bar or restaurant.

What does all this mean? Given the intense competition, it means that YOGA has had to resort to acquiring new studios to replace revenue lost from their declining studios that have been intensely competing for customer traffic. Essentially, YOGA must constantly reinvest capital to acquire new studios to offset their legacy studio revenue decline.

Take a look at the table below depicting revenue per studio over time:

Source: Compiled from YOGA's 10-K and 10-Q SEC filings.

Since going public in summer 2017, YOGA's studios have produced lower revenue every single quarter. Last quarter, the company produced the lowest amount of trailing 12-month per studio revenue on record. The average studio was doing over $1.18 million in revenue and today is producing around $860K. Put another way, the company is now producing 75% of the per studio revenue that it did two years ago.

In the world of retail, staying relevant to your customer is crucial. Trying to run a business is very hard when downsizing budgets and cutting costs to remain equal with declining revenue. Unfortunately, YOGA management has not been able to do this as costs have increased in the face of declining revenue. Consumer retailing history proves this is nearly impossible to fix without a restructuring as the vicious cycle of cash burn unfolds faster with every quarter, as seen with the many recent bankruptcies in the retail industry over the last 18 months.

YOGA recently issued their 2018 annual report with the following noteworthy highlights:

  • For the first time as a public company, YOGA has negative working capital with current assets below current liabilities.
  • New risk disclosures about being a going concern and the potential for investors to lose their entire investment should they not be successful in raising more capital
  • Pending lawsuit/settlements that are going to significantly deplete the company's cash levels, forcing further liquidity risk

Before buying shares at today's price of $17M equity value, YOGA investors should contemplate the following:

  • Why hasn't one YOGA board director or senior manager purchased shares in the open market at such discounted prices from the IPO price?
  • Why do analysts on the earnings calls not challenge or even question YOGA management about raising money today? Or about reaching profitability soon as conditions have reached such dire levels?
  • How have the Wall Street analyst earnings models been so wrong every single quarter?
  • Why purchase YOGA shares today before management is about to massively dilute today's shareholders?
  • If YOGA doesn't raise money soon, wouldn't a restructuring or bankruptcy leave today's shareholders at risk of a full loss of capital?

Current Valuation

For the sake of applying a rational valuation framework, let's focus on the $6M of cash the company presently has going into Q2 2019. This works out to ~$0.36/share. The company recently settled a lawsuit over wages involving the California Labor Code with former YOGA employees that will cost the company $1M, or $0.06 per share, as described in the latest 10-Q filing. This leaves $0.30/share of cash.

In fiscal 2018, the company had ~$59M in revenue and ~$10M of cash operating losses (before depreciation, amortization, goodwill and asset impairment). This equates to about $0.60/share of cash losses in a 12-month period. Management is guiding to similar performance as last year for 2019, but let's assume for argument's sake they are actually able to reduce the cash burn by 50% to only $0.30/share for the year. This would imply that over the next two quarters cash burn will be approximately $0.15/share.

Without a drastic change in operating performance, YOGA is headed to around $0.10 of residual equity value for shareholders by Q4 2019.

[$0.30/share of cash] - [$0.15/share for 2019 operating losses Q2/Q3 ] = $0.15/share of residual equity value around Q4 2019

Legal settlements could further drain YOGA's cash and management's time. As disclosed in the recently filed 10-K and 10-Q, YOGA is facing many lawsuits that will further drain the company's cash balance stemming from class action lawsuits with former YOGA employees. The company has yet to pay out the $1M settlement it agreed to, which at this point is over 16% of YOGA's cash balance. Additionally, there are more lawsuits filed by stockholders for violations of the Securities Act of 1933 for alleged misstatements and omissions in offering documents related to YogaWorks IPO that took place in August 2017.

Conclusion

YOGA's business model was originally outlined as a roll-up acquisition model of yoga studios across the nation to capitalize on the fast-growing trends in the yoga industry. Early investors would have been wise to thoroughly read the S-1 filing and review net losses in every quarter (nine continuous quarters in a row) leading up the IPO. This S-1 filing revealed that total studio count had grown 20% CAGR from 2012-16, while revenue only increased about half the amount at 11% during this time period.

Has anything changed today? Unfortunately, the answer is no. Management has had to acquire new studios to offset the revenue decline from legacy studios. The cash proceeds from the IPO of around $37M have now declined to $6M reported at 2019 Q1, with now a negative working capital position. Absent a quick turnaround in performance in Q2/Q3 2019, the company will soon be unable to make payroll, pay their landlords, or honor their customers' gift cards - giving stakeholders substantial doubt about YOGA's ability to continue.

We estimate the current intrinsic value of YOGA shares is around $0.15/share. The company needs capital to stay in business beyond the next two quarters while quickly attempting to transition to positive cash flow. We believe that either of the following will occur in the next one to two quarters:

  • Chapter 11 filing: Occurs when YOGA cannot meet payment obligations on leasehold interests to landlords that are currently not portrayed on the balance sheet due to GAAP accounting policy, but is a very real ongoing cash obligation.
  • Highly dilutive capital raise: Occurs through last ditch efforts, possibly by management raising capital via a convertible debt issuance with their principal shareholder, Great Hill Equity Partner. Current shareholders must be ready for massive dilution.

Disclosure: I am/we are short YOGA. 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.