2023-03-21 02:22:51 ET
Summary
- Regis is in the final stages of converting to a franchisee business model that should provide a highly valued stable stream of earnings and free cash flow.
- The company’s franchise transformation has been obfuscated by the lockdowns and labor shortages associated with COVID-19 that should abate.
- I estimate the company can generate $33MM of EBITDA for FY 6/25, valuing the company just under $5 per share excluding valuable tax shields and potential debt refinancing savings.
- RGS has over $43MM of liquidity, no covenants until 12/31/23, and is cash flow positive with variable debt that could price lower as the Fed's tightening cycle ends.
Company Overview
Regis Corporation (RGS) “the company” is one of the largest hair salons in the country with over 5,400 salons. The salons operate in the value segment of the market under the brands Supercuts, SmartStyle, Cost Cutters, First Choice Haircutters, and Roosters. RGS is a small capitalization stock that trades on the NYSE. The company’s turnaround is in process and could accelerate as marketing initiatives are executed and remaining company owned stores are closed.
Thesis
RGS’ value proposition is providing a low-risk business opportunity to hair stylists. The brand creates consistent customer traffic, and the stylists receive a salary, productivity bonuses and tips; versus a more entrepreneurial hair stylist route of renting a chair at a salon or independently operating a salon.
RGS is a highly levered company in process of turning around operations. If successful, the company should be able to improve EBITDA and paydown debt before its maturity in August 2025. The report below will try to lay out the path to increasing revenue and cash flow that could enable value realization.
Situation Analysis
In 2018, Regis started to sell its store base to franchisees. The company sold its stores to local entrepreneurs through an auction process. The franchisee model allows the local entrepreneur to run the stores versus a company store manager. The company also outsourced product sales to Sally Beauty ticker: SBH eliminating working capital investment and warehousing costs. The franchisee model also eliminates company capex as owners are responsible for those expenditures. The Company has a $150MM (NOL) that will shield tax expenses for several years.
From the franchisee’s perspective, they get to operate a branded salon with consistent traffic along with marketing and operational support from Regis. The company also provides the franchisees with a ((POS)) system, stylist recruitment, retention, and education initiatives.
Investors typically pay large multiples for franchisors as they receive royalty based off of the franchisee’s stores revenue, so profitable, break-even or money losing stores have the same economics to the franchisor. The only expenses the company must pay is its interest and G&A expenses.
The company received a 3-year debt extension from Bank of America in August 2022. The new debt carries high variable interest around 11.75% rising to above 12.75% in the next year and requires the company to paydown debt with any excess cash flow. The loan extension gives the company time to implement its strategy.
The most important element of a turnaround is time and liquidity. The company has over $43.7MM of liquidity and has no covenants until 12/31/23 with its debt maturing in August 2025.
Understanding the Financials
The company sold most of its store units to franchisees, but some of its worse locations could not be sold. The 75 remaining company owned stores out of 5,400 stores produce small losses and are being shut down as leases expire and/or are broken this year. The company breaks out franchisee performance to show how the business will appear after the company owned locations are closed.
The model below attempts to eliminate non-cash or offsetting revenue and expenses. The cash revenue number is the royalty number, which is calculated by system-wide revenue multiplied by about 5.5%. The model reduces G&A in relation to lower franchisee revenue amortization and product fees in the coming quarters and years.
Quarterly Model Going-Forward
Source: Created by the Author based on company filings
Annual Model
Source: Created by the Author based on company filings
Revenue and EBITDA Drivers
My base case is royalty revenue increase approximately 15% from FY 23 to FY 25, producing EBITDA of $33MM in 2.5 years. Management is key to any turnaround and Matt Doctor, CEO has unique experience as an investment banker at JP Morgan and working experience as both a franchisee and franchisor before joining RGS. Please listen to the two attached recent conferences for better insight into his vision .
Last Quarter EBITDA – the company produced $7.5MM of EBITDA in the second quarter of FY 2023, annualizing that number you arrive at an annual EBITDA of $30MM. Management stated on their last earnings call that the 2nd quarter of FY 23 was not a high-water mark for the company, but the next two quarters would be lower as they spend money on new marketing initiatives to grow future revenue. My low case of $29MM EBITDA is a no growth case from annualizing the most recent 2nd quarter FY 23 EBITDA.
Same Store Sales Growth - For the first six months of FY 2023, the company has same store sales growth of 4.5% year over year. If the company maintains that level of growth revenue should increase 12% cumulatively in 2.5 years. I'm assuming slightly higher growth due to the company education, sales and retention programs.
New concepts – The real value of a franchisee model is for franchisees to use their capital to grow units. RGS is now a platform that could grow by franchisees investment, roll-ups of regional brands or a creation of new unique brands. I am not including any potential growth in the model due to conservatism.
G&A Drivers
G&A has steadily been declining and should decline as franchisee fees and product fees decline through time. I believe G&A will decline from $55MM to $48MM in two years. The company guided to $54MM of G&A this year and you can back out through their guidance on the call that guidance included about $3MM to $4MM of growth G&A for the launch new initiatives.
Earnings vs Free Cash Flow
I use a 26% estimated tax rate for earnings, but the FCF does not include taxes as the company will not pay taxes for years. The company has a tax shield of approximately $150MM, which has a value of approximately $45MM or $1 per share.
Catalysts
Debt Repayment
The Company is highly levered, and repayment of debt significantly increases earnings and value to shareholders. Aside from operational FCF, according to the company they should receive $19MM from the rollout of their POS system Zenoti that should occur in the next 18 months.
Sell-side Coverage
Jefferies previously covered RGS and has been asking questions on their recent earnings calls. If the company’s turnaround gains traction, Jefferies and/or other investment banks could take coverage increasing share liquidity and value to shareholders.
Risks
Debt and Interest
The company has variable rate debt at SOFR plus 6.25% moving to SOFR plus debt 7.25% in a year. The company’s debt facility has an effective interest rate above 11.75% moving to above 12.75% in a year. The company will paydown debt reducing interest expense with the $19MM of Zenoti proceeds and FCF over the next couple of years. If EBITDA can reach $33MM or greater the company should be able to refinance its debt at lower rate as it would be levered less than 4x.
Due to recent bank failures and collapsing economic leading indicators, it seems the Fed tightening cycle is over and lower interest rates in the future will greatly benefit RGS to repay its debt.
BofA and Bloomberg
University of Michigan Leading Economic Indicators
Delisting
RGS must keep their stock price above $1.00 and market cap above $50MM for 30 days or face potential delisting from the NYSE. As of their last earnings call, the company was not in violation of this requirement, but recent stock price volatility allows this risk to resurface. A delisting could prevent some institutions to own the stock, thereby reducing trading volume.
Scenario Outcomes
Downside Case – $0 per share if the company’s revenues decline to the point where cash flows do not cover interest payments and debt balances grow, forcing banks to limit exposure, ultimately forcing a bankruptcy.
Base Case - $5 in this scenario the company grows royalty revenue 15% over 2 years and reduces G&A, which produces approximately $33MM of EBITDA with no capex or taxes. A high EBITDA multiple of 10x would be justified.
Conclusion
An investment in RGS stock is a high-risk speculative investment given the company’s high leverage. However, reasonable improvements in revenue goes straight to the bottom line. Given the company’s NOLs and little capital expenditures the company could significantly reduce debt accreting directly to shareholder value.
For further details see:
Regis Corp: Deep Value Levered Turnaround Poised For Rebound