August 28, 2013 - 5:41am EST by
2013 2014
Price: 17.00 EPS $3.43 $3.55
Shares Out. (in M): 17 P/E 5.0x 4.8x
Market Cap (in $M): 282 P/FCF 4.3x 3.5x
Net Debt (in $M): -67 EBIT 95 99
TEV (in $M): 215 TEV/EBIT 2.3x 2.2x

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  • Conglomerate
  • Europe
  • Spin-Off
  • Retail
  • Insider Ownership
  • Discount to Peers


Company Profile

FNAC was founded by André Essel and Max Théret in 1954, with the intention of serving customers well. FNAC is the acronym for Fédération Nationale d’Achats des Cadres (the National Federation for Purchases by Executives). The company has historically had its core in retailing, but has buttressed this with auxiliary cultural services such as a record label, a magazine publication, a ticket sale business, and stores themselves act as venues for concerts, book signings and discussion forums.

FNAC was listed on the Paris Stock Exchange in 1980. A year later, it began to diversify internationally through store openings in Brussels. After Belgium, in 1993, FNAC headed south and established itself in Spain, with a first store in Madrid. FNAC became part of the Kering Group (formerly PPR) in 1994 and was delisted in December 1994.

FNAC was spun-off from Kering in June this year and has been listed as a separate company on the Paris Stock Exchange since, although Artemis, the Pinault family fund which also has a large position in Kering, retains a c. 39% shareholding.

Today, FNAC is one of the best known retailers in France, with a large presence of 103 stores located in city centers, and averaging c. 2,250 square meters each. FNAC also operates 67 stores internationally for a total presence of 170.

The FNAC brand benefits from a strong and long-standing level of consumer awareness, particularly in France, that has allowed the company to position itself as a “premium yet accessible” distributor of entertainment and leisure products. It is unsurprising that Kering acquired the franchise nearly two decades ago.

The country has a strong presence in France, and is a player in Iberia. It also has operations in Switzerland, Belgium and has been in Brazil for nearly a decade but is yet to build critical mass there. The company also has a franchise location in Casablanca, Morocco. 69% of 2012 revenue derived from France while 17% was from Iberia.

FNAC’s performance in France can be characterised based on 2 story lines: French macro economy – remains very difficult; and FNAC itself – outperforming peers. FNAC has performed well in France relative to a very challenging market (FNAC (1.6)% vs. the French consumer electronics and editorial markets c. (3)%). Key to its performance has been the ability to gain market share in these declining industries, which has been aided by the turnaround plan implemented in 2011. To place FNAC’s performance in perspective, its market share in consumer products increased from 12.9% to 13.8% and from 16.4% to 16.9% in editorial products – impressive statistics when faced with Amazon on the internet channel and the large grocers encroaching via discount retailing. The key to France is when the market will recover and what trajectory it will take. FNAC is well positioned for the upturn, when it comes, but faces a difficult interim period here.

We believe FNAC will continue to take market share given its renewed focus, which should stabilize revenue over the next few years in our projections. But the French market recovery will not likely occur until 2014 or later. Given the company’s operational leverage this leads to the potential for significant upside, but one which is deferred and may be gradual.

Pricing across the board will remain tight with internet retailers intent on using their cost advantage to gain market share. Volume growth will likely come at the expense of margin deterioration, a theme we believe will be mirrored in other geographies as well.

Iberia has been, is, and will remain a very difficult economy for the medium-term. FNAC has a relatively small market share at about 5% in Spain with a better position in Portugal (c. 15%), which means the business does not have the scale of its competitors – a key component for purchasing/distribution economies and pricing. Part of the company’s current strategic plan is to centralize purchasing, which should help in this regard. One plus we will note is the location of FNAC’s stores, which are concentrated in Madrid and the Spanish coastline, which are well-located to benefit from tourist footfall, although these higher spenders likely represent a small proportion of sales for what is ultimately a domestic-market business.

The company’s margins in Iberia have declined dramatically from 5.4% to 2.6% based on reduced level of sales. As we know, operating leverage works both ways. Q1/13 witnessed a 7.7% decline in sales as FNAC ceded market share to its competitors, and its difficult to see much recovery in market share from pressured Iberian retailers or internet based competitors – both competing aggressively on price.

We believe FNAC will continue to be faced with a difficult economy in Iberia, although the comps will improve as the market bottoms out. Protecting market share may prove to be an uphill struggle.

FNAC is a retailer of entertainment and leisure goods, and any observer of this industry will know that over the past five short years there has been a revolution in how culture is consumed. Dematerialization has been the theme, leaving retailers of physical books, CDs, and DVDs particularly hard hit. FNAC is no exception.

FNAC boasts a competitive advantage in that the company is known for its expertise. People go to FNAC stores to consult the employees working on the floor on which products to buy – internet pureplays simply cannot compete here. Although some consumers may go FNAC to find out which product to buy only to later buy it cheaper from Amazon, the company’s omni-channel strategy seeks to mitigate this trend. FNAC has been engaged in a turnaround plan designed to address the issue of price-based competition from internet retailers and cement its leading sector position. However the relatively higher cost structure of traditional brick & mortar players like FNAC (rent and personnel expense) and greater frugality of customers during the downturn are headwinds the company must face and address.

Indeed, FNAC has the third largest e-commerce website in France, which is a particular strength of the company. Although we are dubious about the company’s synergies that it will gain from its “omni-channel” offering, the online retail presence is an invaluable asset that we expect to continue to grow as a portion of the company’s total revenue, from 12.1% in 2012.

The Turnaround Plan

In 2011, after three years of declining sales and margin compression, the board instituted a new strategy called FNAC 2015. It was at the beginning of Alexandre Bompard’s term as CEO of FNAC. Mr. Bompard has continued in his role of Chairman and CEO of FNAC post its spin off and separate listing. The plan effectively attempts to stabilize revenues, protect margins, and reduce operating expenses. The main “pillars” of the plan are:

•       Reshape FNAC’s commercial model (introduce new products such as kids toys and home & design, partner with branded goods, increase number of loyalty members)
•       Become more customer-centric (develop better CRM, develop social network presence, expand loyalty program)
•       Grow online and expand omni-channel
•       Densify store presence
•       Improve operational efficiency (simplify logistics, negotiate rent reductions, reshape comp schemes)

We view the most crucial aspect of the plan as the shakeup in product offering (first bullet point). FNAC was clearly too slow in paring its physical music and movie offerings, and the wasted floorspace that has been dedicated to these products only exacerbated the company’s margin deterioration. It has been roughly one year since the new store formats have been in operation, and as of the writing of this note, one-third of the company’s store fleet has been converted into the new format with space that had been dedicated to editorial content now having toys and home & design departments. Management reports that the revenue from these new departments has more than offset the loss of music sales in 2012, despite the products only being present in one-third of the stores. It is still early and hard numbers have not yet been disclosed, but we are excited by the prospects for this new offering and see its roll-out as a key concrete step in the company’s turnaround.

According to the listing prospectus the company is not simply developing a multi-channel distribution network but is transforming into an “omni-channel player”, which offers its customers an integrated and streamlined shopping experience across its distribution channels (in store, online, and on its mobile sites) and on social networks. These seem like steps in the right direction that many public-facing companies should be taking (and especially retailers), but we do not expect too much in the form of synergies. Rather it is a necessary step to merge the increasing presence of e-commerce as a sales channel with the existing physical store portfolio.

Management insists that leveraging the physical store network will drive online sales, so is expanding its footprint via franchises and wholly-owned stores. FNAC believes that it has a competitive advantage with its physical presence and so rather than shutter stores like many retailers have done, FNAC is looking to expand and “densify” its physical store network. According to management the physical stores will raise brand awareness and provide additional “nodes” of access to customers. However, we are more sceptical. Brick and mortar retailers in the U.S., which we view as operating in a more developed marketplace than their counterparts in France, have been attempting to retain share through “click and collect” tactics for some time but this does not seem to have slowed the encroachment of online pureplays such as Amazon. FNAC’s densification strategy is closely mirrored on the successful Casino Group strategy which found synergies in having its Cdiscount purchases delivered to Casino’s supermarket for local collection, saving postage expense for the customer. Here it should be noted that Casino already had local supermarkets to employ this strategy and did not require expansion of its current footprint.

FNAC also has a pay membership scheme which allows customers who pay a set amount a year, typically €6-7 to attain special offers throughout that year. Although boosting the company’s loyalty program is worthwhile, we do not view such a move as a strategic transformation. The loyalty program features prominently in the prospectus and is a focus on conference calls, which we believe is to advertise the company’s loyal customer base. The membership program accounted for 55% of sales in 2012, and the number of members rose 10% in France in 2012, having increased 21% in 2011. Loyalty program customers are better customers by the numbers, which is no surprise, but we believe that there is a natural causality to the equation: people who like FNAC and shop there are natural loyalty program subscribers, whereas luring new people into the program will not necessarily lead to more sales. We will however give due credit to the large percentage of sales derived from this source, which is significantly higher than peers throughout Europe.

The final bullet point, cost reductions, fits into most large corporations’ strategic plans in one form or another, and as shareholders we typically welcome such measures. This is no exception. We are encouraged by the evidence of a reduction in rental expense per square meter as well as the decline in headcount after only one year of implementation – please see the attached model for details. This has resulted in an estimated €80mm so far in annualized cost savings, and management expects to reap another €40mm in savings in each of the next two years.

total operating expenses declined on a nominal basis from 2011 to 2012. We expect operating expenses to continue falling as the company’s cost-cutting measures take hold.

The result of the 2015 plan would be a stabilization of revenues and operating margin expansion to greater than 3%.

Financial Profile

The company’s sales per store has been on a declining trajectory, but the new store openings have slightly offset this. We have assumed partial success of the turnaround story, with the near-stabilization of revenues in the coming years.

Management has stated that the new products carry a higher gross margin than the existing corporate average, and we believe that the mix of new products (toys and home & design) will make up a sufficient amount of total revenue to bolster gross margin at the 30% level.

Furthermore, suppliers are learning that bricks and mortar retailers are important to the success of their products, and so are increasingly offering better sourcing terms to retailers with physical showrooms. Better sourcing is included in the company’s FNAC 2015 strategy, and we believe that the valuable service that FNAC offers to its suppliers in the form of showing new products to consumers in an intelligent and attractive environment should enable the company to extract better terms as compared to the internet pureplays. This manifests in stronger gross margins.

The company’s operating expense line-items consist of personnel, rent, and other (marketing, D&A, IT, travel, insurance). The company has been attacking these expenses since the FNAC 2015 plan was started in mid-2011 and is already producing results. Rent per store declined in 2012. Once again, we expect this trend to continue as more than a quarter of leases are up for renewal in 2013 and the company intends to flex its muscle as anchor tenant at most of its properties.

The company has negligible debt outstanding, and has sufficient cash such that it does not intend to draw on its revolving credit line. So interest expense is expected to be low. Taxes have varied significantly in relation to pre-tax income, but management has guided that the effective rate will be 36% going forward. Also, there are €34mm of deferred tax assets on the balance sheet that are expected to be harvested so cash taxes should be lower than effective taxes in the coming years. FNAC realized one-off non-operating expenses of €130mm in 2012, which distorted net income.

We are forecasting 2015e EPS of over €3.50.

FNAC is a highly seasonal business, with a large portion of sales occurring over the holidays. This causes a cash draw down in the run up to the holidays as inventories are built, and a large cash position at year end after the holiday sales take place but before suppliers are paid. FNAC has good payment terms with its suppliers, with DPO above 90.

Another aspect of FNAC 2015 that we did not touch on before is the company is focusing on rationalizing warehouses and bringing inventory levels down by a targeted 3% per year. The company has been successful thus far. This represents a cash release of c. €10mm per year, and more efficient inventory per store figure, and higher inventory turns per annum.

The company is moving to an asset-light model through franchising rather than outright leasing or purchases of new store locations. This saves the company expending the heightened levels of capex it did in the past to refit and develop newly acquired stores. We have been guided by the company to a €60-70m capex run rate, of which half is maintenance. We have taken a conservative view of capex and decided to use the top-end of this for our financial estimates. Free cash flow is acutely sensitive to changes in holiday sales levels, as this causes large movements in working capital at year end. If sales are particularly strong in one year compared to the prior year it will result in a build up of accounts payable and inflate FCF, for example. So we prefer to examine free cash flow before working capital movements as well.

We are forecasting 2015e FCF per share of roughly €5.

Prior to the spin-off, Kering gave FNAC a sizable equity injection, and placed it in a position to weather at least a few more years of continued economic recession. Liquidity is more than ample, with the net cash and a completely undrawn €250mm revolving credit facility. If conditions remain as they are, management does not intend to draw on its credit line. In any event we do not believe the credit facility’s covenants are restrictive with a minimum €375m required in shareholders equity (which includes the €60mm super subordinated loan) and net debt plus 5.0x rent < 2.85x EBITDAR. The only long term debt that the company has on its balance sheet is a deeply subordinated loan that it issued to Kering that it accounts for as SH equity. We consider it preference shares, so do not, but it is still a welcome source of permanent funding for the company. The loan pays an 8% coupon if dividends are paid to common shareholders, and it is callable if the RCF is repaid.

The company plans to institute a dividend, which would likely be welcomed by the investment community, but we would prefer to see a stabilization of the business before even small portions of the capital base are returned to shareholders.

Artémis (the holding company of Pinault) has indirectly committed to hold on to its entire 38.8% stake until April 2015, and at least 25% of FNAC’s shares until April 2016. We welcome the relatively long lock-up period, but are aware that the holding could act as an overhang as soon as late 2014.

The company does not own its property, so has significant lease obligations. These totalled €468mm, with €134mm coming due within one year. Note that rent expense was €138mm in 2012.


We approach a valuation of FNAC using a number of methods. Given the projected earnings and free cash flow figures on a per share basis, the €15.50 purchase price is a no-brainer. But the story is a bit more nuanced due to the company's high operating leverage from its leases. Although the total operating lease obligations due in the next 12 months is only 3.4x 2012 rent, we have capitalized rent 8x in our calculation of the company’s enterprise value (and our calculation of peers’ EVs as well). This puts FNAC’s EV at €1.3bn.

FNAC is an unseasoned stock, and with only one initiation report out on the name at the time of writing it is difficult to decipher what earnings metrics the company will trade on. The most useful method for comparatively valuing retailers is EV/EBITDAR to equalize companies that own and lease real estate. By examining comps Darty, Dixons and to a lesser extent Home Retail Group, FNAC is trading at a deep discount to peers on this basis and we see no fundamental justification for it. Indeed, given the company’s strong brand name and the fact that it has taken market share over the past couple years we would assume that FNAC would trade at a premium to peers.

The reason we attribute to this discount is that there have been significant forced sellers of the name post the spin-off, and we intend to capitalize on these technicals. We believe that a share price of €25 reflects a fair value of the company at 5x forward EV/EBITDAR. This is still a significant discount to peers, but it represents 14x earnings and 10x EBITDA, which we view as reasonable, so €25 per share is our medium-term price target. Longer term, should the French economic environment stabilize allowing the company to achieve significant margin expansion and our projected earnings to be met, shares could trade up to levels above €70.

But analysis aside, an investment in FNAC at current levels is buying a marquee retail brand and the 3rd-largest e-commerce site in France for under €300mm, which we see as truly a bargain. The company has a strong balance sheet and the current price represents option value only.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


Shares become more seasoned and the company attracts attention from sell-side analysts
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