You can’t invest in one of the best businesses in the world – Bloomberg L.P. They are impossible to negotiate with (I tried and failed miserably). They don’t want to hear anyone’s sad story about how they need to watch their budget; they want $20,000 per terminal. They have over 325,000 subscribers around the world and each one can run the same stock screens. The problem is that this wonderful business has utterly commoditized screening and has helped price in valuation discrepancies. That has relegated our firm to seek out opportunities that don’t screen well, frequently due to some historical transaction that created a misleading dataset.
You can invest in one of the best dividend growth opportunities for 2020 – Franchise Group Inc. (FRG). This company, at least in its current iteration, is so new that Seeking Alpha doesn’t even have the correct share price listed. Another popular stock discussion forum has no discussion of FRG other than an unrelated company called Furr’s Restaurant Group which declared bankruptcy in 2003. On the company’s website, the most recent investor presentation is from June 2017. There is no sell side research or other aids to point potential investors in the right direction. You have to do your own work by hand. We have. This is what we found.
The CEO is Brian Kahn, a smart, successful value investor with a multi-decade record of consistently strong returns. He is expert at preserving capital, managing risk, exploiting structural advantages, and unlocking value for shareholders. There is no one who I would prefer to invest alongside. Time after time, he has found opportunities that the public markets have missed, frequently because of agency problems in which incumbent managements have failed to maximize shareholder value.
In this case, he started with Liberty Tax (nee TAXA on the over the counter pink sheets), the number three tax preparer. His firm, Vintage Capital, started with a 15% stake and, along with a few other fellow shareholders, took control of the company. Despite scandals and mismanagement, the business was doing okay; with easily implemented improvements, it could do great. Before implementing any changes, the business was worth between $15 per share (based on its free cash flow relative to H&R Block’s (HRB) and Jackson Hewitt’s) and $19 (based on EBITDA). But that number is closer to the downside than the upside opportunity. With the kind of cost controls and margin improvements that the new CEO has been able to achieve many times before, the shares are worth within a few dollars of $27 per share.
When it comes to quickly improving Liberty’s value, there is a lot of low hanging fruit. The lowest hanging fruit is Liberty Tax’s corporate stores, which should/could/probably will/possibly already have been sold to franchisees. They are outsourcing their tax software which will both save a lot of money and improve their service to customers. They are also filling in non-tax season with revenue streams such as installment loans. In aggregate, such changes push the share value into the upper $20s.
Kahn’s plan was to build a platform by buying companies with corporate stores that can be easily sold to franchisees in order to get back most or all of our acquisition costs. He changed the name to “Franchise Group” and changed the ticker from TAXA to FRG, which is now listed on the Nasdaq (NDAQ). The business was initially combined with Buddy’s Home Furnishings with a plan to keep adding additional businesses that would be attractive franchises. Shortly thereafter, the company bought The Vitamin Shoppe (nee VSI), another undervalued and undermanaged business that had been practically left for dead by the equity markets. The company operates over 750 stores that should be sold to franchisees in short order to recoup much or all of the takeover premium. Next, the company added Sears Hometown and Outlet Stores (nee SHOS). They operate 126 locations including only eight franchises. The rest can all be flipped to franchises, too. Most recently, they bought Revolution Finance, a tuck in deal that will allow Liberty Tax to offer year-round consumer loans and credit products.
All existing Liberty Tax shareholders were offered $12 per share in a self-tender offer. This offer was for approximately half of the shares’ value. However, the shareholder base was left over from the company’s previous incarnation. The shares had dipped beneath $10 a dozen times or so over the past few years. Many people wanted out and were not particularly interested in learning the details of the company’s new direction. Almost four million shares were tendered in a transaction that was extremely accretive to the value of non-tendered shares.
As for the dividend, the company’s objective is to distribute a significant amount of its excess cash flow. It is going to start at $0.25 per share per quarter in January, but my sense is that is the lowest it will ever be. Even today, that is over a 5% dividend yield, but management will be on the prowl for more opportunities to buy companies, sell franchises, and pump out an increasing amount of cash to shareholders. If you are an investor looking for steadily increasing regular distributions, you won’t find it by looking at FRG’s past, but you probably will find it in its future. Meanwhile, the public markets have not yet seen this company’s value comprehensively presented.
Today, shares that cost less than $20 per share are worth about 50% more taking into account the value of Liberty Tax, the accretive self-tender, and subsequent acquisitions. Whether you are interested in a steadily increasing dividend or a chance to underpay for a value investment run by a great value investor, you will find it in FRG. None of this is clear as we head into 2020. But by the time we get to 2021, anyone with a Bloomberg terminal will be easily able to see a NASDAQ stock worth within a few dollars of $30 per share. All 325,000 terminals will show a growing company that distributes its growing free cash flow in steadily increasing dividends. It will probably be a reasonable investment, but not as good as it is today, before all of that becomes clear. Longer term, FRG’s market cap will probably grow from less than half a billion dollars today to ten or twenty times that within the next decade. Along the way, you will be able to collect much more in growing dividends then you pay for today’s stock.
Merry Christmas and Happy New Year.
Please contact me with any questions or interest in Sifting the World.
It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it – who look and sift the world for a mispriced bet – that they can occasionally find one.
— Charlie Munger
