Wednesday, January 12, 2011

Crumbs Cupcake Bakery Reverse-Merger IPO: I Take a Bite So You Don't Have To

The news on Monday was that Crumbs Bake Shop was going public via a reverse merger with a SPAC. Several other consumer businesses have gone public via SPACs, and the track record is not exactly great. JMBA, Jamba Juice, was at $12 in '06 after the merger, currently at $2.30. SMBL, Smart Balance, reached $13 in '07, and is now at $4.50. APP, American Apparel, a company I have written extensively about (be it defaults, illegal alien employment, or the CEO's "idiosyncrasies" ), was a $15 stock in early '08, and $1.50 now. May be fourth time is a charm.

I glanced through the materials, and my view is that the growth that will undoubtedly come is priced too aggressively. I have some other considerations as well.

The strong sides of the business are: good growth, excellent sales per sq ft/good store-level economics, broad appeal, NO onsite baking.

Valuation: as proposed, Crumbs is valued at 16x 2011 EBITDA vs. 11x for their sel-selected peer group (SBUX CMG PNRA JMBA RMCF CBOU BAGL etc). Setting aside the "sausage" (aka adjusted EBITDA) forecast for next year, this multiple is very aggressive. More on the EBITDA later.

Dilution/overhang: it is not just the SPAC warrants. There is a large contingent share issuance to management that will kick in 2013. Large grants like that might depress the per share value even if the underlying business is doing well.

Sales composition: this is a big one for me. 78% of the sales come from cupcakes, 12% from other baked goods, and only 9% from beverages. This is a BIG problem in three ways. One, cupcakes are trendy (some may say, past their prime). This is a risk. Two, the cost of the ingredients has been marching up (flour, sugar, oil). What is the pricing power of a cup cake? Zero. Third, only 9% of the sales are from beverages. Beverages is where the money is made in the vast majority of food service establishments, and these guys really should have a good, solid coffee program by now. They don't. I would have liked to see a more balanced sales mix. We have seen a number of consumer companies overly dependent on one product or trend crash and burn: Jamba, Crox, Heelys, Atkins, Krispy Kreme.

Average check: the company says that its $20 average check is a good thing. It might be, but it might also be too much of a good thing. It means that customers do not visit the store on a regular basis so the purchase is completely discretionary (also 2-6 pm is the biggest sales period). This is a less robust model. High average check places are more susceptible. For example, high-average check restaurants like RUTH went from $20 to $1, MRT from $20 to $2 and MSSR from $30 to $2 when things really went downhill in 08-09. Low-average check place did much better during the period, MCD gyrated around $60 and YUM went from $40 to $25 at the very bottom. There are easier, less painful ways to add beta if you need it.

Aggressive growth: this is a part of the story. The company currently has 34 stores, and targets 200 stores by 2014. Here's a little secret. Stores are not as easily scalable as iPhone apps. There are operational problems, and then there is the capital required. The company says that it costs them $300k to open a store. This is $50 mm for the 166 stores they need to open for '11,'12,'13 and '14, assuming, bravely, no inflation. The company's "adjusted pro-forma EBITDA target" for '11-'14 is $5mm+$12.3mm+$17.5mm+$25 mm, or $60 mm total. Sounds like all the money will be going for expansion capex. Call your inner Warren Buffett on this one.

With that, good luck to the new shareholders, and enjoy your cupcakes. I am watching both my waistline and my wallet.

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