Brian Randall Kahn, CEO of Franchise Group, Inc. (RFA, Financial), bought 1.725 million shares of his own company in the past year:

• His frenzy began on July 30, 2020, when he bought 400,000 shares at an average price of $ 23.25 and a total cost of $ 9,300,000.
• On September 2, 2020, he added an additional 175,000 shares at an average price of $ 25.50, for a total cost of $ 4,462,500.
• Two weeks later, on September 15, he bought 149,785 shares at approximately $ 24.99 each, for a total of $ 3,743,130.
• The last installment was on May 21, 2021, when he acquired an additional 1 million shares for approximately $ 36 each.

This type of purchase suggests a long-term approach. Even so, Kahn did very well in the short term. Based on the share price at the close of May 25, he made some big gains.

Given this positive sign from the CEO, should investors follow in Kahn’s footsteps and buy shares in his company? Is Franchise Group the kind of business we would like to buy and own for the next five or 10 years?

What is the franchise group?

Based in Virginia Beach, Virginia, the company claims to own and operate franchise and franchisable businesses. In his 10-K for 2020, he says he adds value by applying his operating and capital allocation philosophies to generate strong cash flow.

Its most well-known franchise is Liberty Tax Service, but it also owns and / or operates American Freight, The Vitamin Shoppe, and Buddy’s Home Furnishings.

In his 10-K, he explained that he uses an asset-based business model designed to generate consistent, recurring revenue and strong operating margins. Each business operates independently, but the parent company provides a shared services platform for economies of scale and efficiency gains.

Much of the business has been acquired over the past two years:

• August 2019: Acquisition of 41 Buddy’s furniture stores.
• September 2019: purchase of 21 other Buddy’s stores.
• October 2019: Purchased Sears Outlet.
• December 2019: Completion of the acquisition of The Vitamin Shoppe.
• February 2020: Purchased American Freight.
• December 2020: Finalization of the purchase of Furniture Factory Ultimate Holding.
• January 2021: Signing of a definitive agreement to purchase Pet Supplies Plus for $ 700 million.

At the end of the Company’s 2020 fiscal year (December 26), the Company operated 4,023 sites in the United States and Canada. Of these locations, 2,743 were franchise locations and 1,280 were company-operated. The majority of those locations, 2,490, were offices of the Liberty Tax Service (it also offers an online do-it-yourself digital tax service in the United States).

However, you can expect that profile to be drastically revised this year if it succeeds in selling Liberty to Canadian company NextPoint Acquisition Corp (NAC.U). The deal is expected to close in the second quarter of 2021 and will earn the franchise group at least $ 243 million in cash and stock. This equates to $ 182 million in cash and $ 61 million in NextPoint shares. The cash proceeds are primarily intended for debt repayment.

Since NextPoint is a new and relatively small company – in fact, it is a PSPC, a blank shell that only exists to make an acquisition with another company – Franchise Group will have what it calls a meaningful participation. NextPoint has a market capitalization of $ 57.21 million; Franchise Group’s $ 61 million stake suggests it could own just over half of NextPoint.

The idea behind the deal is that Liberty’s connection with NextPoint means Liberty will be able to offer a broader set of consumer financial products and services. In turn, this means Liberty’s offices are expected to generate income throughout the year, rather than just during tax season.

Funding

Where did Franchise Group get the capital to make all these purchases? By issuing new shares and taking on heavy debt. Here is a graph showing how the number of shares outstanding has increased:

Interestingly, Kahn was buying even as the company was diluting its stock.

We see a similar picture when we look at a chart of long-term debt and capital lease obligations:

What we found was a company that raised a lot of new capital over the past couple of years and used it to buy a lot of new franchises or franchise type businesses. We will take a closer look at the effects in the sections on financial strength and profitability.

Risk factors

Several risks arise from the many transactions a business enters into, and others are inherent in the types of businesses in which it operates. They include:

• The effective integration of the many parts into a synergistic whole; this must also include the deduction of the Liberty Tax from the set.
• Be able to repay any new debt incurred.
• The Covid-19 pandemic has had a negative effect on its business and may continue to be so in the future.
• Maintain good relations with franchisees.
• Concentration of Ownership: As of February 1, 2021, Vintage Capital Management, LLC and B. Riley Financial, Inc. held shares representing approximately 19.0% and 11.3% of the outstanding shares, respectively.

Competition

Competition from Franchise Group is segment by segment:

• Vitamin Shoppe competes with its peers in the nutritional supplement retail industry in the United States.
• American Freight competes with discount furniture and mattress retailers, as well as local big box and appliance retailers.
• Liberty Tax competes with local, regional and national tax preparation services, as well as with individuals. This list must include the giant H&R Block (HRB, Financial organization.
• Buddy’s competes with other hire purchase businesses that are both physical and online.

Financial solidity

As noted, this is a company that has taken on a lot of debt over the past two years; this graph shows the situation:

This deluge of debt has led to low ratios including cash debt and interest coverage; both are extremely low.

The Piotroski F-Score and Altman Z-Score appear unstable, but at the moment the company is only beginning to expand and a review at this point would be premature.

Also note that the return on invested capital (ROIC) is much lower than the weighted average cost of capital (WACC). This ratio will have to improve if the company is to be successful.

Profitability

Due to rapid expansion, Franchise Group achieves surprisingly good rankings for a company facing many challenges of profitability.

In 10-K, the company talked about strong margins, but we have little evidence of them:

However, after nearly 10 years of declining margins, the expansion strategy could reverse margins. It certainly generated income:

Ebitda has also skyrocketed:

But the trend did not reach the bottom line, as the (diluted) earnings per share remains low:

All of this information needs to be viewed in light of the larger context, i.e. this company has only a brief history of operating at current levels.

Dividends and share buybacks

This image tells the story of Franchise Group’s dividend payments:

Here’s what the dividend yield looks like in relation to the stock price:

And as we saw above, the company issued new shares rather than buying them back.

Evaluation

For long-time holders, the share price is finally back to where it was in 2014:

Following the GuruFocus value chart, we would be very timid about investing in Franchise Group:

Again, however, we have a score based on a very short set of data. The price-to-earnings ratio of 11.08 is exactly half that of 22.16 in the personal services industry as a whole.

Among the few measures available, the price-to-pound ratio indicates a high valuation at 3.19, while the price-to-sell ratio indicates a low valuation at 0.65.

Based on the data available, it appears that the company is somewhat undervalued. And because the business started transforming two years ago, I would hesitate to call it a value trap, although of course it could be if management intends to milk the business. for cash before heading for the exit, which seems a possibility given the frenzy of sudden acquisitions, rising debt, increasing dividend payments and CEO buying.

Gurus

The gurus started to take an interest in the franchise group last year, but recently they’ve been doing a lot of selling and no buying:

Only two gurus held positions in the company at the end of the first quarter:

• HOTCHKIS & WILEY held 111,500 shares, representing a 0.28% stake in Franchise Group and only 0.01% of its assets under management. During the first quarter of 2021, the fund reduced its stake by 14.46%.

• Jim simons

  Renaissance Technologies (Trades, Portfolio) held 28,100 shares after a 63.51% reduction.

Conclusion

Franchise Group CEO Brian Kahn has certainly benefited from his insider buying in the short term, and it looks likely he will do even better in the future. As we have seen, the business had been flat for many years before it started to rebuild.

Because of the debt used to buy new franchises and assets, it performs poorly on measures of financial strength. However, it is reasonably profitable and should do even better trying to squeeze synergies from its various acquisitions (and now a major divestiture). The evaluation is also difficult due to the brief operating history of the new version.

Value investors will want to avoid the company; he has too much debt and a valuation will depend on guesswork. Growing investors who see this story continue may want to do more due diligence. Income investors may find Franchise Group an attractive prospect, but the business model has yet to be proven in practice.

Disclaimer: I do not own any shares in any of the companies listed in this article and do not plan to purchase any within the next 72 hours.

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