- In an 8-K filing, Schmitt Industries announced that it had acquired a business in bankruptcy proceedings called Ample Hills Creamery.
- Schmitt paid $1mm plus the assumption of various leases, the value of which is currently unknown. Ample Hills currently pays around $118k per month in rent.
- Ample Hills is a distressed but fast-growing ice cream chain that filed Chapter 11 bankruptcy in March. They do around $10mm in revenue and have pretty staggering losses.
- Schmitt’s CEO has a strong record of successful turnarounds and distressed situations, and Ample Hills is a rare wonderful business at a wonderful price. SMIT stock stands to benefit.
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Schmitt Industries Background
Schmitt Industries (OTC:SMIT) is a manufacturing company now controlled by activist hedge fund manager Michael Zapata. I first covered Schmitt in “Schmitt Industries: Special Situation With 25% Upside” in October of 2019, and have followed (and owned shares of) Schmitt since then.
Zapata is a former Navy Seal who attended Columbia Business School’s value investing program, and has developed a strong track record at his fund, Sententia Capital. He compares value investing to Special Operations missions, which are often viewed as extremely risky. Zapata contradicts this idea, since taking precautions for known risk effectively makes the mission less risky than one that is viewed as low-risk, and therefore does not require precautions.
Since Zapata taking the helm of Schmitt, costs have been slashed and assets divested. Schmitt recently announced a modified Dutch tender offer between $3-3.25 per share. I don’t plan to participate, since that’s far too cheap relative to Schmitt’s liquidation value alone. Zapata has stated that he likes to look for distressed opportunities: “We look for... smoke or fire.” Despite its apparent lack of synergy with Schmitt’s industrial manufacturing businesses, Ample Hills looks like a bet with major future potential.
Assorted Ample Hills ice cream flavors.
Ample Hills Acquisition
Schmitt surprised investors with an 8-K filing stating that they will acquire the assets of Ample Hills Creamery, a fast-growing ice cream brand that has been hit hard by coronavirus shutdowns. They are quite leveraged, with only about $190k in assets and over $10mm in liabilities. They laid off all employees and filed for bankruptcy in March, citing insolvency due to opening a massive manufacturing facility in Brooklyn.
Ample Hills was founded in 2010-2011 by husband and wife team Brian Smith and Jackie Cuscana out of a push-cart, and later a small brick and mortar storefront. They received an overwhelming response, selling out of ice cream within four days, which forced them to close temporarily to make more. Their flavors are both creative and delicious, ranging from “Boozy Breakfast” to “Fluffernutter Fudge.” Ample Hills has been called “New York’s best ice cream” and is often viewed as a Brooklyn destination following their wild success.
The popularity and respected brand of Ample Hills begs the questions: how does such a company have to fire over one hundred employees – who appear to be very valued by management, according to the Ample Hills website – and file for bankruptcy virtually overnight? In just a couple of years, Ample Hills went from being a venture-backed up-and-comer to Ben and Jerry’s with the backing of Disney’s CEO (with plans for “world domination”) to selling for pennies on the dollar.
My take on this is that it’s excessive leverage and poor stewardship of capital – who manufactures ice cream in the middle of NYC? Wouldn’t a factory in Idaho be just fine? I suppose it’s more or less par for the course in high-growth, venture-backed startups that invest aggressively in growth while doing perhaps less due diligence than they ought to have done.
Ample Hills’s Disney Springs location
Ample Hills’s Story
Ample Hills had raised over $12mm in funding, largely from venture capital. It’s a high-growth business, often viewed as an up-and-coming Ben and Jerry’s. Their strong social media presence and beautiful website suggest that it’s a desirable, high-end business – there’s even an Ample Hills Creamery in Disney Springs of Orlando owned and operated by Disney that pays around $80k per year in royalties. It appears to be closed, even as the rest of Disney Springs is open for business – at limited capacity. Ample Hills has been able to successfully license the Star Wars brand from Disney and produce various limited edition Star Wars-themed flavors.
Their relationship with former Disney CEO Bob Iger has paid dividends far beyond licensing agreements: he introduced it to various other titans of industry, ranging from Tim Cook to Steven Spielberg and even Oprah, who called it “her favorite ice cream.” The brand value here is unbelievable – how many startups get (arguably) the most coveted celebrity endorsement while still doing single-digit millions in revenue?
The company generates about $10mm in sales, but over the past year managed to lose nearly $7mm despite selling ice cream pints at ~$10 a piece on their website. Food is a difficult business to be in, but Ample Hills should not have any trouble running higher net margins than -70%. In fact, their original store had EBITDA margins of 20%.
The capital structure may be to blame: individual ice cream shops are reported to be profitable, but due to an over-leveraged capital structure and bloat from opening the Brooklyn factory, they were forced to begin looking for a buyer in 2019. These troubles were exacerbated by strict shutdowns in New York City, and Ample Hills was stuck with a massive, expensive factory that couldn’t produce and stores that could only sell at 25% of their potential.
Obviously, selling the business was unsuccessful: Ample Hills couldn’t find a buyer, citing excessive liabilities made up of $3.6mm in secured claims, $47k in priority unsecured claims, and $8.3mm in remaining unsecured liabilities for total liabilities just shy of $12mm. From what I can gather, around $10mm of this is considered long-term debt. That’s a tall order for a buyer of equity outside of bankruptcy court.
Restructuring will allow the new owner, Schmitt, to operate a successful business that generates 15% EBITDA margins per store on average and has whopping gross margins of 75%. This is an exceptional business held back by poor capital allocation and too much leverage, and is a classic candidate for a successful emergence from bankruptcy.
Inside an Ample Hills store
From what I can gather, this implies about $2mm in other obligations besides leases that Schmitt may be liable to assume – this figure could be more, due to unclear reporting in court filings. Schmitt is assuming seven out of ten leases, but without more granular information it’s impossible to determine the value of them. Therefore, I will assume Schmitt will be liable for all leases and value the $120k/month rent obligations at $1.4mm – roughly the annualized rent, since they could likely be broken at that cost. Admittedly, this is a bit of a shot in the dark.
These figures give us an adjusted (because all liabilities assumed are included here) enterprise value of $4.4mm paid by Schmitt against $10mm in revenue. This values Ample Hills at an EV/sales of just 0.44x – extraordinarily cheap for a high-growth, high-margin business that ought to be quickly turned around, especially post-COVID. If Zapata can get it back to just 10% EBITDA margins, which is quite likely given his work in turnarounds, Ample Hills will have been bought at 4x EBITDA.
Ample Hills is a business that has grown at an >80% annualized rate in 2019, and well into the triple-digits in prior years. With proper management and a reasonable capital structure, this could quickly be turned into a wonderful business at a fantastic price – every investor’s dream. Zapata is not held back by emotions the way that an original founder necessarily would be, and has his work cut out for him after all employees were laid off already.
What this Means for Schmitt
I believe that this acquisition is a fantastic deal for Schmitt and its shareholders, and Mr. Zapata will be hard at work turning it around. It could easily add quite a bit to Schmitt’s bottom and top lines, since Schmitt only does about $4mm in annualized revenue after selling their SBS business, so adding $10mm (likely less though – business interruptions and right-sizing will probably drive down sales) would more than triple Schmitt’s total revenue.
As follows, I do not plan to participate in Schmitt’s Dutch tender offer. I believe that even $3.25 is far too cheap for SMIT shares and this transaction further solidifies my stance, as it both demonstrates CEO Zapata’s commitment to finding great deals for investors and creates massive upside potential for SMIT stock.
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