June 15, 2010 - 11:56pm EST by
2010 2011
Price: 17.55 EPS $1.34 $1.40
Shares Out. (in M): 57 P/E 13.1x 12.5x
Market Cap (in $M): 1,007 P/FCF 9.0x 9.7x
Net Debt (in $M): 300 EBIT 141 151
TEV ($): 1,307 TEV/EBIT 9.3x 8.7x

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Regis is the global leader in owning and operating hair salons.  It does about $2.4 billion in revenue and trades at 5X EBITDA.  Due to the economy and perhaps some management misteps, I believe earnings have troughed and the shares trade at a compelling value at these levels.  In addition, due to the recession resistant nature of the industry, the large footprint of the Regis salons across the world, and the monetizable non-core assets, I believe that Regis has potential to be a takeover candidate.
Quick Summary
Regis has 12,700 worldwide salon locations under various brands (such as Supercuts) with locations primarily in North America.  It also owns 95 hair restoration centers operating under the Hair Club for Men and Women brand.  It also has minority interests in Europe's largest salon operator and the US's largest beauty and cosmetology school (both of which very profitable and non-core to operations and worth about $150mm).  Regis makes money by primarily cutting hair and selling hair care products.  The key to this business customer visits and price increases.  While Regis has been regularly increasing prices over the past few years, its customer visits have trended negative in FY 2009 and thus far in FY 2010, yet are now starting to rebound a little bit.  Most of the weakness in customer traffic (and thus earnings) came from their higher-end salons, not their "value" salons.  Regis has an 88 year history, and these are the only 2 years that comps (comparable store sales) trended negative primarily due to clients waiting longer between haircuts.  Eventually these negative comps will annualize and growth will begin to occur.  There are a few public comps that trade at about 7-8X EBITDA which I believe RGS should trade at eventually, and at these depressed EBITDA levels that comes out to about $26-31/share.  Management, though experienced, has made a number of misteps in my opinion over the years and still was not able to destroy the company.  And to be fair, they have also done a few things rights although investors may be getting impatient.  Right now management is being proactive in improving sales trends but so far there has been only modest improvement.  For these reasons, I believe that either comps will show improvement over the next few quarters and the stock will go up, or investors will get impatient and this might draw attention from an activist to bring in new management.
Hair Salon Industry Overview
The hair salon industry is about $165 billion worldwide and about $55 billion in the US.  As you can imagine, the sales growth in the industry follows population and economic growth.  The industry is extremely fragmented with most of the players being sole proprietorships and small chains.  Regis, the industry leader only has about 2% of the worldwide market and 4% in North America.  In the US, there are about 300,000 salons and while most are small and scattered through the country there has been trend for more chains to develop.  Chains provide smaller salon operators an exit strategy.  The benefits of becoming a part of a larger chain is leveraging purchasing in products, inventory and overhead expense.  The barriers to enty to open a single salon is not great, and competition is abundant.  However to open a chain of salons, with a strong brand that leverages resources is much harder to do.  There are a few larger chains in the US that compete with Regis 9,500 salons.  One of which is called the Ratner Companies.  They operate about 900 salons in various states across the midwest and the East Coast.  Their brands include Hair Cutterly and Bubbles.  Ulta Salon (Nasdaq--ULTA) operates about 340 salons in the US as well as being a larger reseller of beauty products.  Ulta Salons are larger averaging about 9,000 square feet and include a big portion of retail space to sell products.  Their locations are primarily in off-mall locations and their clientele consists primarily of women.

Regis Company Overview
It is a simple business.  Regis owns salons that cut hair and sell hair products.  They also own hair restoration centers.  The sales of haircare products usually occur when someone gets a haircut but this is not exclusive.  But if customers are not going in for haircuts the sales of haircare products are affected as well.
Locations:  Regis is the largest owner/operator and franchisor of hair salons in the world.  The company has 12,700 locations.  8000 are company owned, 2000 are franchised and 2700 are affiliated.  The Company's locations consisted of 9,555 North American salons (located in the United States, Canada and Puerto Rico), 416 international salons, 95 hair restoration centers and approximately 2,700 locations in which the Company maintains an ownership interest (to be discussed later). 
Revenue Breakdown:  The company does about $2.4 billion in revenues with 87% of it coming from North America and about 13% coming from the UK.  80% of the revenue is derived from services and the other 20% is derived from sales of hair care products.  The company's hair restoration business (which has remained very steady) represents about $140mm of sales.  The North American business operates under 5 primary brands or "concepts": Supercuts, Promenade, MasterCuts, SmartStyle and Regis .  It is important to note that 85% of the salons for Regis are value-focused meaning that they do not cater to high end haircuts but rather to more value focused clients who want to pay $16-25 dollars for a haircut.  75% of the revenues that Regis derives from the US salons are from the "value" concepts are have experienced a more modest decrease in client visits.  The higher end salons that Regis operates is under the Regis name and has haircuts in the $40 range.  The Regis concept has seen the biggest dropoff in visits.
Regis Corp. "Concepts" or Brands
In North America, the company has about 9,500 salons (about 2000 are franchised) under the brand names Supercuts, Promenade, MasterCuts, SmartStyle and Regis.
Regis Salons.    Regis Salons are primarily mall based, full service salons providing complete hair care and beauty services aimed at moderate to upscale, fashion conscious consumers. In recent years, the Company has expanded its Regis Salons into strip centers.  The customer mix at Regis Salons is approximately 78 percent women and both appointments and walk-in customers are common. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care products. Service revenues represent approximately 84 percent of the concept's total revenues. The average ticket is approximately $40. Regis Salons compete in their existing markets primarily by emphasizing the high quality of the services provided. Included within the Regis Salons concept are various other trade names, including Carlton Hair, Sassoon, Mia & Maxx Hair Studios, Hair by Stewarts and Heidi's.  The average initial capital investment required for a new Regis Salon is approximately $150,000 to $200,000, excluding average opening inventory costs of approximately $18,000. Average annual salon revenues in a Regis Salon which has been open five years or more are approximately $431,000.  The Regis concept represents about $475mm of sales to the company and during FY 2009 and FY 2010 it was the standout weak performer seeing comp store revenues drop nearly 12% before stabilizing and coming back to being only down 5.6% in the quarter ended March.  The company blames much of the decline in the Regis concept due to its higher price point and location in malls where foot traffice has been low. However, the company believes that its other mall competitors are hurting more and are taking market share.  In addition the company has been testing marketing campaigns to convert more mall visitors to customers.  
MasterCuts.    MasterCuts is a full service, mall based salon group which focuses on the walk-in consumer (no appointment necessary) that demands moderately priced hair care services. MasterCuts salons emphasize quality hair care services, affordable prices and time saving services for the entire family. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care products. The customer mix at MasterCuts is split relatively evenly between men and women. Service revenues compose approximately 82 percent of the concept's total revenues. The average ticket is approximately $19.  The average initial capital investment required for a new MasterCuts salon is approximately $150,000 to $200,000, excluding average opening inventory costs of approximately $13,600. Average annual salon revenues in a MasterCuts salon which has been open five years or more are approximately $290,000.  MasterCuts represents just $170mm in revenue and saw about a 2.5% decline is same store sales at its worst and now is running flat.
SmartStyle.    The SmartStyle salons share many operating characteristics of the Company's other salon concepts; however, they are located exclusively in Wal-Mart Supercenters. SmartStyle has a walk-in customer base, pricing is promotional and services are focused on the family. These salons offer a full range of custom styling, cutting, hair coloring and waving services as well as professional hair care products. The customer mix at SmartStyle Salons is approximately 76 percent women. Professional retail product sales contribute considerably to overall revenues at approximately 33 percent. Additionally, the Company has 122 franchise salons located in Wal-Mart Supercenters. The average ticket is approximately $19.  The average initial capital investment required for a new SmartStyle salon is approximately $35,000 to $45,000, excluding average opening inventory costs of approximately $14,000. Average annual salon revenues in a SmartStyle salon which has been open five years or more are approximately $271,000.  SmartStyle represents about $530mm in revenues or 22% of total revenues.  It is important to know this since it is directly tied to WalMart foot traffic.  SmartStyle saw minimal decline is comp sales of about 2.5% and is now comping positive.
Supercuts.    This is another budget choice.  The Supercuts concept provides hair care services and professional products to its customers at convenient times and locations and at a reasonable price. This concept appeals to men, women and children, although male customers account for approximately 66 percent of the customer mix. Service revenues represent approximately 89 percent of total company-owned strip center revenues. The average ticket is approximately $16.  The average initial capital investment required for a new Supercuts salon is approximately $110,000 to $120,000, excluding average opening inventory costs of approximately $8,300. Average annual salon revenues in a company-owned Supercuts salon which has been open five years or more are approximately $269,000.  Supercuts represents about $310mm in sales.  It saw virtually no decline in comp sales and is comping positively.
Promenade Salons.    Promenade Salons are made up of successful regional company-owned salon groups acquired over the past several years operating under the primary concepts of Hair Masters, Cool Cuts for Kids, Style America, First Choice Haircutters, Famous Hair, Cost Cutters, BoRics, Magicuts, Holiday Hair and TGF, as well as other concept names. Most concepts offer a full range of custom hairstyling, cutting, coloring and waving, as well as hair care products. Hair Masters offers moderately-priced services to a predominately female demographic, while the other concepts primarily cater to time-pressed, value-oriented families. The customer mix is split relatively evenly between men and women at most concepts. Service revenues represent approximately 89 percent of total company-owned strip center revenues. The average ticket is approximately $18.  The average initial capital investment required for a new Promenade Salon is approximately $80,000 to $90,000, excluding average opening inventory costs of approximately $8,000. Average annual salon revenues in a Promenade Salon which has been open five years or more are approximately $245,000.  Promenade represents about 1/4 of Regis' sales at $600mm.  Promenade comp sales dropped down as low as 4.8% but in the last quarter they were down only 1.9%.
In summary, during the downturn, the higher priced service offerings got hit the hardest, with product sales getting hit along with it.  In most cases, product sales dropped off more than haircut sales because even if you got a haircut, you did not go ahead and buy the haircare products.
Hair Club For Men and Women
A brief commentary on this business is that it is very annuity like and is a solid business.  It represents just 6% of company revenues but generates 13% of EBITDA, with EBITDA margins over 25%.  Hair Club is the industry leader with in the domestic $4Bln market.  From its traditional non-surgical hair replacement systems, to hair transplants, hair therapies and hair care products and services, Hair Club offers a solution for anyone experiencing or anticipating hair loss. The Company's operations consist of 95 locations (33 franchise locations) in the United States and Canada.   Revenues grew in the mid-single digits throughout the downturn in the other businesses and continues to grow.  They will do about $142mm in the year ended June 30, 2010.
Hair Product Sales
Hair product sales represent about 20% of total company revenue or about $540mm in revenue.  They tend to track customer visits but not exclusively.   The Company's salons sell nationally recognized hair care and beauty products as well as a complete line of private label products sold under the Regis, MasterCuts and Cost Cutters labels. The retail products offered by the Company are intended to be sold only through professional salons. The top selling brands include Paul Mitchell, Biolage, Redken, Nioxin, Tigi Bedhead, Kenra, Tigi Catwalk, American Crew, Big Sexy Hair and the Company's various private label brands.  The Company has s comprehensive assortment of retail products. Although the Company constantly strives to carry an optimal level of inventory in relation to consumer demand, it is more economical for the Company to have a higher amount of inventory on hand than to run the risk of being under stocked should demand prove higher than expected. The extended shelf life and lack of seasonality related to the beauty products allows the cost of carrying inventory to be relatively low and lessens the importance of inventory turnover ratios. The Company's primary goal is to maximize revenues rather than inventory turns.  The retail portion of the Company's business complements its salon services business. The Company's stylists and beauty consultants are compensated and regularly trained to sell hair care and beauty products to their customers. Additionally, customers are enticed to purchase products after a stylist demonstrates its effect by using it in the styling of the customer's hair.
Growth is the Issue to Valuation---How does Regis Grow?
Comp Store Growth---I am focused primarily on this.  It is a function of price increases and client visits.  So far in 2010I truly believe that the core business is fine and growth will resume as it has the past 88 years.  I believe this because Regis has been consistently raising prices about 3.5% while visits have been dropped as much as 7% for a comp decline of about 4%.  In the third quarter ended March however, the average customer count decreased about 5% for a comp decline of only 1.8%.  At some point in time people have to settle in on the length of time between haircuts.  Once they do this, client count will stop declining and pricing will kick in.   Client visits will track the population growth and the economy etc.  I am also a believer that this is the key since it requires nothing from management.  I'd rather have management not do anything too stupid to screw up the businesses.    The leverage that the company earns from comp store increases can be significant.  For every 1% increase in comps means about $10mm in EBITDA. and $.08 in EPS.  To breakeven, comps have to stay flat to up 1%.  Management is guiding for comps to be down 1% to up 2% for  FY 2011 ended in June, from being down 2.5% in FY ended 2010.  A lot of the growth will come naturally from more regular client visits but also management is trying to improve customer acquisition at its worst peforming high end business.  I encourage to look at their latest presentation which provides a graphical depiction of the weakness in the higher end Regis concept which the lower end concepts saw a much lower decline.  It also shows that comps are bouncing nicely as of the March 2010 quarter.
Newbuilds/Acquisitions--  This has been a biggest part of the business driver over the years.  Regis has typically added 700 to 1000 salons per year in its system either through franchise or owned.  About half are built and the rest are acquired.  Regis has bought about $1.6 billion in revenues through acquisiitons since inception with salon integration being the most important part.  They look to buy business for their location, not because they have a flashy popular barber or stylist.  Currently there are about 50,000 salons that meet the acquisition requirement for Regis representing about 15% of the market.   A typical acquisition consists of sales of $2.5mm and operating cashflow of $400k.  The company believes it can create an additional $100k of synergies over the next 3 years and ends up paying 3-4X cashflow for the business.  Payback is about 3-4 years.  Newbuilds and acquisitions have been very light in FY 2010 but management has indicated that they would put to work about $25mm in FY 2011 if the opportunities are available which would translate into about $6mm in EBITDA on a go forward basis. The company also plans to construct another 160 salons.   Looking at newbuilds, new salons generate average cash flows of about $55k after five years with an initial investment of roughly $76k.    For salons open over 5 years, salons generate an average sales per store of $262k with cashflow of $70k  (26% margin).  The average initial investment was about $80k.   Of course not all Supercuts make it 5 years but the ones that do have seen a nice return on investment.
Cost Reductions in FY 2010 Helped Perhaps some more in 2011
It is worth noting that managment did a pretty good job maintaining both service margins and product margins in FY2010 which shows their flexibility to act in the downturn.  Service margins were actually up 20 basis points while product margins were up a full percentage point.  They were able to do this by restructuring salon payrolls and adjusting commissions rates on products.  There are other potential cost saving that can be had including bigger discounts on product costs and lower rents as rents roll over.
Partner Investments--A potential Source of Value and a Liquidity Event
Management has made a number of bad investments over the years but these could be a source of value.  Could be worth $150mm.
Beauty Schools-Empire Education group-- RGS owns 55% of the Empire Education Group which owns and operates  95 cosmetology schools.  It was spun out of the company in 2007.  It does about $170mm in Revenue and $27mm in EBITDA.  It is growing topline 12% and bottomline 24%.  Management carries the investment on the books for $100mm and modestly contributes to "other income" on the income statement.  It is a non-core assets and can/will be sold at multiple greater than Regis.  I think
Provalliance---  Another spinout.  On January 31, 2008, the Company merged its continental European franchise salon operations with the operations of the Franck Provost Salon Group in exchange for a 30.0 percent equity interest in the newly formed Provalliance entity (Provalliance). The merger with the operations of the Franck Provost Salon Group which are also located in continental Europe, created Europe's largest salon operator with approximately 2,500 company-owned and franchise salons as of March 31, 2010.   It will do revenues of $270 to $285mm and EBITDA of $37mm to $41mm representing topline growth of 3% and bottomline growth of 18%.
Clearly these two investments are doing quite well yet not much value is being acknowledged in the value of RGS.  Interestingly, businesses seem to do better when they are spun out of RGS....Hmmm.  In any event, they are valued at $180mm on the balance sheet, so I am discounting them to $150mm to be conservative, but perhaps they are worth more.
Management Commentary
I wish I could say that RGS is a great business doing great financially with great management.  Unfortunatley, the business is in a rough patch and management in my view has made a few mistakes over the years that definite cause an investor to be concerned.  Management is a reason why the stock is at a discount.  Without going into specific details on capital outlay mistakes they have made, let me just say that there have been a few including leveraging up the balance sheet and buying back so much stock in 2006 and 2007.  In addition, while management touts that they have made good organic investments in the past, they are still closing a lot of stores which may have not been open in the first place.  Perhaps better site selection is in order.  Fortunately for investors right now, the company did a costly equity offering last year and the liquidity is much better with $170mm in cash and $300mm in a line of credit.  One also has to wonder why margins haven't improved during the big growth phase over the past several year.  I translate this into management perhaps not having a lot of vision and seeming to be more reactive than proactive.  The CEO Paul Finkelstein is 67 and perhaps not totally interested in improving shareholder value.  He is a bit promotional, but I haven't noticed him buying stock.  
I am not an activist but I believe new management could really liven up the company through starting some loyalty programs, and gathering better data on customers.

-Economy Double Dip
-Poor Managment Initiatives to drive growth
-Market Share loss due to competition
-Continued weak mall traffic

For FY ended June 2010 they will do about $2.375 Billion in Revenues and $252mm in EBITDA.  Interest for 2010 came out to about $45mm and capex will be about $70mm with cash taxes about $25mm generating $112mm in FCF. This comes out to about $1.34 in adjusted EPS
For FY 2011, I am modeling $2.395 Billion in revenues and $260mm in EBITDA.  Interest will be much lower at about $28mm and capex will be much higher at about $120mm with cash taxes of about $48mm.  FCF of about $65mm.  These assumption are on the lower end of managements guidance.  This comes out to about $1.40 adjusted EPS
It is worth noting that Maintenance capex for the business runs about $65mm.  So when I calculate Adjusted free cash flow for FY 2010 and FY 2011 they are actually higher numbers.  Adj FCF should be $117 in 2010, and should be $120mm in FY 2010.
For FY 2011, the company is spending an extra $15mm in a POS/IT roll out which is making the capex number look large.  The balance of the increase in capex will come from growth capex and/or acquisitions which may or may not fully materialize depending on opportunities.
Cash    $170mm
Debt and capitalized leases $470mm, including $150mm book value of a 5% convertible at $15/share.
Net Debt $300mm.
 TEV 1307mm
Key Multiples
TEV/2011 June EBITDA             =5X
P/FCF adjusted 2011 FCF         =8.4



Comparable store increases
Activist Investor putting the fire under managment
Buyout by private equity who recognizes the consistent cashflow
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