June 08, 2012 - 10:47am EST by
2012 2013
Price: 34.90 EPS $0.82 $0.99
Shares Out. (in M): 18 P/E 43x 35x
Market Cap (in $M): 624 P/FCF NA NA
Net Debt (in $M): 2 EBIT 24 29
TEV (in $M): 626 TEV/EBIT 26x 21x
Borrow Cost: NA

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  • Food Manufacturer
  • Recent IPO
  • Private Equity (PE)



This will be a fairly straightforward summary given the simplicity of the idea.  It is admittedly a valuation short, but with a decent understanding of why it has reached its current heights, and a business simple and predictable enough that it seems unlikely to surprise fundamentally by a wide margin, despite its potential for growth. 


Annie’s Inc. (BNNY) is fairly well-known to anyone with children, and many others, for their organic Mac & Cheese in a box (organic Kraft) and Cheddar Bunny and Bunny Fruit snacks.  The bull case is that they will transition their product placement from the organic section of supermarkets to the “normal food” aisle, and that they will “innovate” by introducing new categories.  I see ample similarity to Smart Balance, which has tried to leverage its brand’s initial success in margarine/spread to compete in other categories including milk, peanut butter, etc.  SMBL was always supposed to get bought, but with a fairly demanding public market valuation, it hasn’t happened, and instead has become an acquirer. 


BNNY went public a few days before April Fool’s Day, 2012.  The company originally filed to offer 5m shares with a $14 to $16 range, subsequently raised to $16 to $18, and finally priced at $19.  The stock then proceeded to rise by 89% its first day of trading, and it remains in this general vicinity (+84%), making it 2012’s hottest IPO by this measure.  How underwriters could mis-price a company this simple, by this much, seems absurd.  In this case, I do not believe the underwriters mis-priced the deal at all. 


Solera Capital, a middle market private equity firm run by Molly Ashby, has been around since 1999 and according to its website, “is driven by our belief in the power of business to shape the world and inspire solutions. We are guided by a set of core values that include diversity, honesty, collaboration and mentorship.”  Ashby is a veteran of JP Morgan’s private equity arm and seems generally well regarded.  Her firm is staffed with over 50% women, rare in private equity, and many of her investments have been in companies with minority or women founders or management.  Otherwise, it seems like most middle-market private equity firms in terms of objectives and approach.


Solera invested in Annie’s in 2002, and at the time of the IPO, owned over 90% of the company at an effective cost of under $6 per share.  In the IPO, 5.75m shares were sold, of which less than 1m were primary shares.  Net of offering fees, the company raised only about $11 million for itself in the deal – this was clearly a liquidity event for Solera.  Solera sold 4.4m shares for net proceeds of $78 million, which added to its previously earned dividends and management fees of about $30 million, resulted in the recoupment of more than 100% of its cumulative investment in the company (around $80m).  At today’s price, Solera still has approximately $340m on paper of unrealized gains through its ownership of 9.8 million shares, making the investment a home run by any metric. 


Some BNNY numbers:


BNNY Equity   $34.90                  
Basic Shares   16.6                  
Dil Shrs from Warrant 0.1                  
Dil Shrs from Options 1.2                  
  Diluted Shares   17.9                  
Market Cap   623.9                  
Debt     2.5                  
Cash     (0.6)                  
  TEV     625.8                  
      Historical FYE 3/31   Projected FYE 3/31
      2007 2008 2009 2010 2011 2012   2013 2014 2015
Sales     65.6 76.8 93.6 96.0 117.6 141.3   166.0 195.1 229.2
  growth       17.1% 22.0% 2.5% 22.5% 20.1%   17.5% 17.5% 17.5%
Gross Profit   20.9 25.5 28.8 32.9 45.8 55.4   65.5 77.5 91.6
  Gross Margin   31.9% 33.3% 30.7% 34.3% 39.0% 39.2%   39.5% 39.7% 40.0%
SG&A     24.7 23.9 25.6 24.9 30.3 35.6   41.4 48.2 56.0
  % of Sales   37.6% 31.1% 27.3% 26.0% 25.7% 25.2%   24.9% 24.7% 24.4%
EBIT     (3.7) 1.7 3.2 8.0 15.5 19.8   24.1 29.3 35.6
  Margin     (5.7%) 2.2% 3.4% 8.3% 13.2% 14.0%   14.5% 15.0% 15.5%
Adj EBITDA   (3.0) 2.7 4.4 9.3 16.6 21.2   26.8 32.3 38.9
Less: Stock-based Comp 0.3 0.7 0.8 0.9 0.4 0.5   1.0 1.0 1.0
Real Adj EBITDA   (3.3) 2.0 3.6 8.4 16.2 20.7   25.8 31.3 37.9
  Margin     (5.1%) 2.7% 3.8% 8.7% 13.8% 14.6%   15.5% 16.0% 16.5%
Normalized Taxes 40% (1.5) 0.7 1.3 3.2 6.1 7.8   9.5 11.6 14.1
Adj Net Income (unlevered) (2.3) 1.0 2.0 4.8 9.4 12.0   14.6 17.7 21.5
Adj EPS (current share count) ($0.13) $0.06 $0.11 $0.27 $0.53 $0.67   $0.82 $0.99 $1.21
P/E             66x 52x   43x 35x 29x
EV/Sales             5.32x 4.43x   3.77x 3.21x 2.73x
EV/EBITDA           38.7x 30.3x   24.3x 20.0x 16.5x



What is BNNY worth? 

BNNY currently trades for 4.4x LTM Sales (3.9x calendar 2012), 30x LTM EBITDA (26x calendar 2012), and a whopping 52x LTM EPS (45x calendar 2012).  In my view, the company is worth less than $20 per share (2.5x LTM sales, 17x LTM EBITDA) to an acquirer.  This reflects over 1.5x Sales and 9x EBITDA on a generous forecast for FYE March 2015, assuming uninterrupted high teens revenue growth as well as operating margin expansion to 15.5% from 14.0%.


BNNY is growing, but it also is showing signs of its core products being tapped out.  After promoting mac & cheese last year, presenting a tough comp this year, they seem to be pinning their hopes for growth more on frozen pizza.  Smart Balance just bought Udi’s, a gluten-free specialist also active in frozen pizza, for 1.7x Sales ($103m net purchase price for $60.9m sales).  Udi’s doubled sales last year, so this is at least as juicy a growth story coming off a lower base, vs. BNNY’s LTM sales of $141m.  1.7x Sales implies just $14 for BNNY… which corroborates the initial filing range.  Smart Balance also recently bought Glutino for 1.2x Sales, which would imply just a $10 stock price for BNNY.  At 8x LTM EBITDA for BNNY, I’ll call $10 too cheap, but it’s not crazy either.  SMBL itself recently attracted a 13D filing from Gabelli and rose considerably, so call it “half in play”… and it is valued at < 1.7x Sales (pro forma for Glutino and Udi’s).  Even if SMBL stock doubles from here, and we use the implied sales multiple of 2.8x, we get $22 for BNNY.  Now SMBL has lower margins, but using consensus estimates (and conservatively assuming they include Udi’s, which they probably don’t), it seems SMBL trades for 14x 2012 and 12x 2013 EBITDA… implying a $20-$21 stock for BNNY.  Enough playing with numbers, but it’s pretty clear that the current price is crazy when we look at recent, relevant private and public market valuations.  Or we could step back and think about BNNY on the basis of absolute valuation – if you managed a traditional food producer with flagging revenue growth and desperately wanted to augment your position in the organic segment, would you buy Annie’s, and if so, for what price? 


What is wrong with Annie’s? 

Here is the weakest part of my thesis.  I posted DMND as a short in spring 2010 because I thought something was very wrong.  I don’t claim to have done anywhere near as much ground research into BNNY, nor would I expect to come up with anything remotely as interesting if I did.  The business seems fine for what and where it is in its lifecycle… but not without challenges.  The following come from a first cut.  I will plan to post an update if I find anything incremental/material/contradictory (but I am not promising anything). 


First, everyone I speak to says organic sourcing is currently a pain and limits revenue and profit growth.  Maybe the organic food supply will catch up, but in the near term, this presents execution risk for BNNY.  One CEO of a ~$2 billion food company told me they would have no interest in a company like BNNY or in aggressively pursuing the organic category … “just not worth the hassle.” 


Second, Annie’s is only a couple of steps removed from a start-up.  They have under 80 employees, and they just installed ERP systems.  They plan to hire everywhere (marketing, supply chain, finance, accounting), capping any hopes for meaningful margin expansion.  Maybe it will all go off without a hitch.  It better. 


Third, they are “capital light”, meaning they completely outsource their manufacturing.  Sounds great until your contract manufacturers drop the ball and can’t meet shipment deadlines, or get greedy on price during commodity fluctuations, or go lax on food safety, etc. etc. etc.  If you’re making a “premium” product, it seems you would want to control the process.  Again, they might be ok here, but this presents another way for them to disappoint.  The stock price doesn’t allow for disappointment. 


Fourth, their products really aren’t good for you – this seems to be in extreme contrast to the corporate purpose “to cultivate a healthier, happier world by spreading goodness through nourishing foods, honest words and conduct that is considerate and forever kind to the planet.”  Never mind all the other fun we could have with that one.  I conducted the following nutritional steel cage matches:


- Annie’s Mac & Cheese vs. Kraft Original (KFT)

- Annie’s Cheddar Bunnies vs. Pepperidge Farm Goldfish (CPB)


Surprisingly, the products are almost identical in standardized nutritional content, with Annie’s actually slightly worse for you by several key metrics.  So for the extra money, you are getting "organic"… but not healthy.  Before adding butter/milk, the mac n cheese has a quarter of your daily sodium (and that’s if you only eat a “serving” of 40% of the box).  50 Cheddar Bunnies have 6-7g of fat, vs. 5g of fat in a serving of 55 Goldfish.  Also, the fact that the numbers are so close across the board suggests to me that the ingredients/recipes/formulas are very close… is Annie’s essentially swapping regular flour/cheese/milk for organic, slapping a cute bunny on the box, and calling it a much more differentiated product than it really is? 


Fifth, I don’t fully buy into their policy of “honest words”.  Small examples include the following:


They disclose that once prepared, their mac n cheese has no more fat, sodium or other bad stuff than the box contents, whereas Kraft admits their offering balloons in fat content (5% to 29% RDA) once you add the recommended butter and milk.  I guess you could make Annie’s with water… sounds delicious. 


On a different front, they went out of their way to disclose in their IPO prospectus that their revolver balance had declined from $13.3m at 12/31/11 to $11.2m at 3/22/12, and even adjusted for this in their Pro Forma Capitalization table.  Yet they reported Q4 (3/31/12) earnings on June 6, and the 3/31/12 revolver balance was back up to 12.8m.  Small potatoes, but was that favorable 2.1m adjustment really necessary, when 1.6m of it came back in the course of the next nine days?  I call that a little cheesy, and not necessarily "honest conduct". 


Splitting hairs, but on the earnings call they guided to 17.8m average shares outstanding this year.  Using the treasury method and current share price, I get 17.9m.  But I do get their number if the stock falls into the high $20’s… maybe that’s the difference :)  And this is before new stock compensation, which they warn will ramp up this year. 


So, no smoking guns here, but clearly some yellow flags that both suggest the potential for mis-steps, as well as question the company's credibility aroud the margins with both its customers and new shareholders. 


Why Does BNNY Trade Where it Does?

I think it’s important to try and understand why a mis-pricing exists, rather than assume we aren’t missing anything.  In this case, there are some general aspects which are obvious – an attractive growth story on the surface, easy to understand, familiar products, a small float, a hot IPO market for consumer brands – these factors all helped get the ball rolling.  But two widely distributed media outlets – CNBC and the WSJ – perpetuated the momentum with some really bad math. 


First, Jim Cramer adopted BNNY out of the gates.  On April 2, he claimed the company had notched “150% EPS growth last year” and traded for "23x earnings, cheaper than HAIN at 25x".  His recommendation to buy despite the post-IPO run-up was fairly intense, complete with product placement (did the company supply the goods, and if so, are they complicit in endorsing his “honest words”?)


I wrote him the following morning on Bloomberg to let him in on a little secret…


The company recognized a significant tax reversal in fiscal 2011 (ended 3/31/11), adding $5.7m to pre-tax income.  This is plainly disclosed in the IPO prospectus.  They have also disclosed that their effective tax rate is normally 39.5%.  So, instead of adding $5.7m to their 2011 pre-tax income, we should actually be subtracting $6.1m.  I have also added back Solera’s discontinued management fee and interest expense on since-retired debt, to be fair.  After these adjustments, net income wasn’t $20m – far from it, it was $9.4m.  And as for P/E, it was in the 50's, more than double that of HAIN.  


He didn’t respond directly, but the next night he did backtrack pretty heavily on his show (ostensibly caused by the $4 gain in the stock, not by any newfound appreciation for that annoying concept called accuracy).  He admitted that BNNY wasn't as attractive at $38 as it was at $34 in a fairly protracted retracement of the prior evening’s endorsement:


And by May 12, he affirmed he liked HAIN better, although I doubt anyone was listening any more:


So I’m not sure if this explains why the stock stays in the $30’s, but I think it helps explain how it held up initially, sheds light on the constituency of some of BNNY’s newer shareholders, and reflects the poor analysis and “who cares – it’s going up, baby” outlook buttressing the silly valuation. 


The WSJ had some problems with the numbers as well.  On April 13, they wrote in a piece called “The Buyout Brain Behind Annie's IPO”: “Profit climbed to $20.2 million in 2011, up from $6 million in 2010”.  Really?  This wasn’t a quick blurb, but a full feature article.  I contacted the journalist, and their response implied they were not focused on the stock, “certainly didn't intend any endorsement of the stock”, but were focused instead on Solera in what was “merely a personality profile” of Molly Ashby.  Fair enough.  Solera seems to have great PR – witness recent follow-up, a June 6 update titled “Annie’s First Quarter as Public Company a Beat” which keeps the drum beating, but neglects to opine as to why the stock traded down 3% into earnings, and another 3% following earnings, as the market rose.  Some “beat”.  I guess my biggest issue here is really that the company seems to have allowed this gross exaggeration to subsist in multiple venues.  I can’t imagine Solera wants to disabuse any prospective purchasers of the stock of the notion that BNNY is growing EPS triple digits, at least not while they have $340m wrapped up in the stock and are counting the days until they can sell more in late September 2012.  





Some massive food producer with flagging revenue growth desperately overpays for BNNY in a few years after BNNY has managed to more or less execute on their growth plans (but do we even lose money from here in this scenario?)


It’s a somewhat obvious short without a huge float… but today it only costs around 1-2% to borrow, with 7% of the float sold short… and I can’t imagine this writeup of a short idea with no “hard catalyst” is going to change that :) 



Molly Ashby is proven right after telling the WSJ about BNNY: "Every once in a while a company comes around that changes things."  IBM, MSFT, INTC, Ford, Boeing… move over (and grab yourself a frozen pizza with organic dough… just not one of the competitors’... for a taste of true innovation!) 






There aren’t any, but if I must…


Solera is almost certain to sell its shares if they trade anywhere near here.  They couldn’t wait to sell at $19.  They were ready to sell as low as $14.  They continue to hold about 59% of the basic shares outstanding.  The lock-up expires late September 2012. 


The share count will creep up… people are probably working off the reported 3/31/12 quarter’s number of 16.4m or the prospectus number of 16.6m, but warrants and options add another 1.23m shares and should bring the total to about 17.9m diluted shares over this June quarter, up from the 16.4m number disclosed for the March 2012 quarter.  Bloomberg seems to have 16.6m, which is the pro forma basic number from the prospectus.  Also, there are 867k shares reserved for incentives, and they said on the earnings call there would be an increase in stock-based comp this year, so I expect some additional creep as well.  


As of this week, we now have EPS guidance for FY 2013 of 78-82c.  The math just got a lot easier for the WSJ, CNBC et al.  Maybe BNNY “beats and raises” every quarter and ends up closer to $0.90-$1.00 this year, but even if they do, I think we’re ok from here. 



Lock-up expires late September 2012. 

 Share count will creep up.  

 P/E math just got a lot easier for the media. 

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