Card Factory: Be Greedy When Others Are Fearful

Disclaimer: We are shareholders of Card Factory.

How would you like to invest in a UK greeting cards retailer with its entire store base closed because of COVID? Yes, you have read that sentence correctly. And no, we have not gone mad. Pinch your nose and let us introduce you to Card Factory.

Elevator Pitch

Card Factory is Britain’s leading specialist retailer of greeting cards, dressings and gifts, with an estate of over 1,000 operated stores. It was set-up in 1997 to provide a lower cost, higher quality card  alternative to incumbent chains. Key to this formula was to vertically integrate the supply chain in order to lower production costs, shorten lead times and get more relevant card designs. These efficiencies were then passed onto the customer and allowed Card Factory to undercut competitors on prices by 50% to 70%. The business model was successfully rolled-out across the UK and the company went on to capture 33% of the market by volume (20% by value) in less than 25 years. Speaking of the market, it is important to understand that there is an ingrained culture of sending cards in the UK, with approximately 87% of adults purchasing cards and each person sending on average 20 of them per  year[1]. It is a macro-resilient industry, as demonstrated by its growth throughout the GFC[2], and volumes have been rather stable despite increased online communications (down only 5% since 2012). Online penetration so far is low at 14% and is essentially focused on categories unavailable in stores. Given the highly experiential component of a card purchase (touching and comparing) as well as the c.£5 average basket value, we expect it to stay low in the longer-term. We therefore believe that Card Factory’s business should come back to near historical levels post-COVID and potentially better (two of its biggest competitors are in administration and plan to significantly reduce their footprints). Do not mistake us, Card Factory is far from being a good business, it has flat to slightly negative like-for-like sales while costs creep up by 2-3% per year, meaning constant margin pressure. On the other hand, everything has a price and despite its challenges, the company should generate c.£45-£50m of free cash flow in the medium-term (for a £110m market capitalization). Mr. Market however hates uncertainty and is so focused on the group’s near-term cash burn and debt load that no matter the price, it is simply unwilling to buy the business. Unsurprisingly, Card Factory trades at 2x normalized earnings. Our work on cash burn indicates that the business has enough liquidity to last until end of May with its stores closed while our analysis of COVID new cases, hospital ventilator beds occupancy and vaccinations indicates that the UK lockdown should be lifted by early/mid-April (an announcement is expected in the week of the 22^nd of February). We believe that this is a typical case of ‘time-horizon arbitrage’, where high uncertainty is mistaken for high risk. This set-up provides one of the best risk/reward we have ever seen, with immediate and tangible catalysts that could propel the shares significantly higher: If we are right, we believe the stock can quadruple and trade at 8x normalized earnings (Card Factory traded at 11x-12x earnings in 2018 and 2019) for a 12% free cash flow yield. If we are wrong, the business will need to raise up to £40m (c.35% dilution at current prices) to make it to the other side of the lockdown. At a similar 8x P/E, the shares would still end up being a 2.5 bagger.

2MX Organic: A "free look" at a transaction carried out by France's best retail operator in the organic food space (Disclosure: Yes, it's a SPAC!)

Disclaimer: We are shareholders of 2MX Organic. 

At DK Value we like a good old low risk, high reward set-up. Usually, it takes the form of high-quality companies with good growth potential trading at significant discount to intrinsic value. However, when we have lots of cash sitting around, it can look like 2MX Organic, a French SPAC listed in December 2020 with the purpose of acquiring a leading distributor or a consumer goods player benefiting from the shift to more organic and sustainable food.

Yes, we know that between dilution, bad incentives and record-high business valuations, SPACs are a usually a terrible value proposition. However, when the SPAC’s CEO, Moez-Alexandre Zouari, in addition to its founder shares, buys 10% of the company for EUR30m at the IPO price (EUR 10), we take notice and dig deeper. 

Enlabs: Why shares are worth at least SEK60, 50% above Entain’s public offer

Disclaimer: We own 0.1% of Enlabs’ capital. You can find our initial investment case (28 July 2020) on this blog as well. 

We originally intended to use this platform to 1) share our point-by-point rebuttal to the 6 arguments laid out by Enlabs’ Independent Bid Committee’s (“IBC”) in favor of Entain’s SEK40 public offer [1] and 2) ask Enlabs’ shareholders not to tender their shares during the acceptance period (21 January – 18 February 2021). Then news came out yesterday that Hans Isoz, Enlabs’ 6^th biggest shareholder, had rallied enough shareholders to block the transaction, which is conditional to a 90% acceptance rate [2]. This is a very welcomed development, and we commend Mr. Isoz for stepping up for all Enlabs’ shareholders.

We hope with the following to provide a framework as to the extent to which Entain’s offer undervalues Enlabs. Importantly, we show why Enlabs is worth at least SEK60 per share (50% higher that Entain’s bid), even under the IBC’s flawed valuation methodology.

Enlabs - high tech, high growth, low price

Disclaimer: We are shareholders of Enlabs AB.

NB: Enlabs is listed in Sweden while its financial reporting is in Euro and under IFRS 16. All operational figures are therefore stated in Euros (EUR) and share prices are stated in Swedish Krona (SEK). The same applies for Global Gaming 555, mentioned later. The EUR/SEK exchange rate used in this write-up is 10.31.

Summary

Enlabs is the biggest gambling operator in the Baltics with a market capitalization of SEK1.39bn. It derives 94% of its EUR40m revenues from online operations where it has a 25%+ regional market share. Online penetration in the region is still low, in the high-teens range (vs. 40%+ in some Western European countries) but growing +15% per year thanks to excellent broadband and 4G coverage. We believe the company can disproportionately benefit from this secular tailwind thanks to its unique proprietary technological platform and the local restrictions on gambling advertising favoring incumbents’ brands. This moat currently translates into 30% EBITDA margins, little need for capital reinvestment and therefore a 90% ROIC ex-goodwill. 

A true asset light compounder, we think the company has a clear path to an 18% FCF CAGR, reaching EUR19m in 2024. Applying an 8% FCF to EV yield in 2024 leads to an intrinsic value of SEK48 per share, or a 21.5% IRR on capital invested from current levels (SEK22 per share). This does not include the optionality of entering neighboring markets (such as Finland, Belarus or Sweden), where we think the company is very well positioned. This could add north of SEK10 of intrinsic value per share. Lastly, insider ownership is high with the Chairman owning 21% of the company. He has significant knowledge and experience growing gambling operations in the Baltics and is involved in the day to day operations of the business.