When researching new investment ideas, some of the criteria or qualities I try to seek out include, among other things:
Simple business model
Clean balance sheet
Experienced management team who is properly incentivized to create shareholder value (high insider ownership)
Growing revenues (bonus for recurring) with limited execution risk for continued growth
The ability of a company to dominate a niche in the market, or control part of the industry
Some macro or industry tailwinds driving that growth
Underappreciated growth with a valuation that is not pricing in long term fundamentals
Strong free cash flow yield (or path to achieve it) and margin of safety in purchase price
Well, when I came across The Joint Corp. (NASDAQ: JYNT), just about all of those criteria were met. In addition, the company was being almost completely ignored by the market due to it’s small size (EV of less than $75mm when I started researching), the fact that it was under-followed by analysts, there was no sell-side research, and until recently was trading near 52-week lows. This invisibility persisted despite the company’s significant progress in improving operations, growing it’s competitive position, and heading toward profitability.
To put it simply, The Joint fell squarely into the wheelhouse of the type of investment that I’d want to add to Greystone’s portfolio.
While shares have appreciated nearly 60% from when I first starting researching the business, I still see plenty of room to run, and view shares as undervalued given the company’s addressable market, operational excellence, and attractive business model. It’s still early, but management has done a terrific job thus far, and I feel great about partnering with CEO Peter Holt and company to deliver solid shareholder returns far into the future.
Description of the Business
The Joint Chiropractic was developed 17 years ago with a vision of making chiropractic care more convenient, friendly and affordable. The convenience and affordability of The Joint clinics make it an attractive option for patients, which means greater volume and a faster return on investment for franchisees.
The company’s business model is simple and straightforward. They manage and operate chiropractic clinics in a small-box retail format (located in strip malls, shopping centers) that caters to patients looking for convenient, affordable way to receive spinal adjustments. The company operates a cash-based model, with no appointments required, and visit pricing ranging from single visit to membership packages. The company’s primary goal is to sell franchise licenses, build new clinics, and open company owned or managed stores.
The company operates in two main segments; franchise and company-owned or managed clinics. There are currently 47 company-owned or managed clinics, and 359 franchised locations around the US.
The company earns revenue in a variety of ways (outside of franchise royalties and company-owned sales), including:
Franchise fees and royalties – there is a non-refundable franchise fee paid during the execution of a franchise agreement for $39k – $40k. In addition, the company collects royalties equal to 7% of gross franchise sales, and a marketing/advertising fee royalty of 2% of gross sales.
Regional developer fees – the regional developer program was established by the company in 2011. Each regional developer pays a licensing fee somewhere in the range of $7,250 to 25% of the then current franchise fee, for each franchise they receive the right to develop. Upon the development of each franchise, regional developers receive a 3% royalty of sales generated by franchises in their region, as well as $14k – $20k upon the sale of franchises
Revenues and management fees from company owned clinics – this one is pretty straightforward, revenues from company owned clinics that provide chiropractic services. There is one catch however. In some states, law requires the chiropractic practice to be owned by a licensed chiropractor. In that case, the company will enter into an agreement with the doctor’s PC. Under the management agreement, the company provides administrative and management services to the doctor’s PC in return for a monthly management fee.
IT Related Income and Software Fees – the company collects a monthly computer software fee for the use of proprietary chiropractic software, computer support, and IT services support.
Segment breakdown looks like this:
Total Revenues (Y/E 2017): $24.9mm
Revenues and management fees from company owned clinics: 42% of sales
Royalty and franchise fees: 40% of sales
Advertising fund revenue: 9.2% of sales
IT related income and software fees: 4.5% of sales
Regional developer fees: 3.0% of sales
Other revenues: 1.3% of sales
What attracted me to the business was the simple, convenient, modern, affordable care, that provides the nearly 40 million adults who seek chiropractic are with a private pay, cash-based model that requires short site visits, at a price lower than most competitors pricing for similar services. Industry data reveals that Americans spend around $90 billion dollars on back pain each year, of which $15 billion is dedicated to chiropractic services (and oddly enough, back pain is tough to diagnose, and is still just called ‘back pain’ in most doctor’s offices).
What made the initial valuation and opportunity attractive was that shares declined from a 2016 high of around $12 to below $5.00/share today. During the ramp up of the company’s growth, former management (no longer with the company) got a little too aggressive with their expansion targets, aiming to double the number of clinics being opened each year. Meaning 100% growth every year. With ambitions like that, you’re going to run into some hiccups, which is exactly what happened. Following an announcement of reduced clinic growth and a large cash burn (the company closed 14 clinics in Chicago and burned $13mm in cash in one year) the shares were hammered all the way down to around $2/share. Shares traded below the IPO price for some time, despite during this same time period, the company had grown their clinic footprint, slowed the cash burn, shuttered unprofitable stores, and same store sales growth (the growth of stores that are already open) remained in the double digits. Yet, the share price was still depressed.
The company has grown rapidly in both system wide sales and opening of new clinics, going from 8 clinics in 2010 to 400 as of last month. The expansion hasn’t been without hiccups (described above) however, and the company has since slowed their growth expectations to 40-50 new franchised clinic openings per year (still 20% growth per year), and the halting of company owned store acquisitions, in order to preserve cash and systematically grow the business in a sustainable way. Previous management (guys from Starbucks and with retail franchise experience) guided for a doubling of new clinic openings each year, which place enormous growth expectations on the company. Old management was also focused on building out company owned stores, which have higher EBITDA margins at maturity than franchised operations, yet higher upfront investment/capital costs.
Both company owned and franchised units are a key part of the company’s strategic objectives moving forward. Increased sales from both models results in high operating leverage by clustering clinics and lowering operational and marketing costs. Franchise model generates predictable, recurring revenue from royalties and licensing fees.
Unit Economics
Unit economics for individual clinics are phenomenal, with the company having lowered clinic breakeven time from around 24 months, to nearly one year for the 2017 new clinic class.
Per the company presentation it cost roughly $264,000 to build a unit and for the working capital to break even. Average monthly gross sales has been in the range of $25k for new clinics, with operating margins as high as 21% at maturity (open for 48 months).
$25k * 12 = $300k average yearly revenues, at 21% margins yields $63,000 operating income or 23% cash on cash yield given a franchisees’ initial investment. Not too bad. On top of that, same store sales growth is in the low double digit range for clinics open at least 48 months. The Joint expects its franchisees can see a return in less than two years. The capital investment is not outrageous and each clinic has the ability to scale fairly quickly. The Joint clinics average about 1,600 patient visits per month at maturity, which industry data says is about three to four times the number a general practice doctor might have.
For the franchisee, franchising a clinic costs an upfront licensing fee of $39,900, in addition to the 7% royalty on gross sales. For franchisees interested in opening a second location, there are cost savings of $10K/clinic less, or $29,900. If a regional developer is involved, the regional developer receives a 50% commission on the license fee. Also, the regional developer gets a 3% royalty on gross sales and The Joint keeps 4% of the royalty on gross sales. They also collect a national marketing fee of 2% on gross sales for all franchised locations.
In terms of economics for the business, The Joint receives $39,900 in royalties for a franchised location (4/7 of that if the company utilizes a regional developer). Unit economics for company owned clinics are attractive, with the average clinic turning cash flow positive within 12-18 months, and generating EBITDA margins in the neighborhood of 25%- 35%.
What I’m really looking forward to is the potential for massive operating leverage as the company expands their clinic footprint, and sales grow faster than G&A expenses. The Joint outlines this as one of their key strategies, and management points to being able to drive greater efficiencies across operations, development and marketing programs as the clinic base grows. Corporate costs will decline, and as the clinic base matures and the number of patient visits increases we will see margins drive higher and costs lower.
Management
Following the 2016 issues the company was facing, there have been major shifts in the management team, with a new CEO now in place who has 30 years of small-box franchise experience. In addition, the company is majority owned by a group of experienced, patient investors (John Leonesio, the founder of Massage Envy and a number of other franchises across the US, owns 6% of the company).
CEO Peter Holt has extensive experience managing and growing franchise businesses, having been involved with D-Lite, Planet Smoothie, the UPS Store and others.
Since his start as CEO, Holt has worked his magic on the company, growing the clinic base, shuttering unprofitable stores, repairing damaged relationships with franchisees, and preserving cash on the balance sheet. In conversations I’ve had with him, as well as listening to him give interviews, you get the sense that he is knowledgeable, experienced, and building something right up his alley in terms of his operational experience.
Compensation appears very fair (Holt brought in around $500k in total comp for 2016), and there is nothing I’ve seen that would indicate management is interested in taking shortcuts or doing things not in line with shareholder interests over the long term.
My biggest gripe with management comp or the share structure would be the CEO and CFO owning less than 1% of shares. With that said, to date, management has been rational, conservative, and transparent about most issues facing the business, so lack of alignment in terms of equity ownership hasn’t yet presented a cause for concern.
I may also be able to chalk up the low % of shares ownership to the fact that Peter Holt was a replacement of former management and had been with the company at the VP level, where he may not have had an opportunity to acquire or be gifted shares. The board has stock ownership guidelines in place (not superb, but it’s a start) that may cause the % of equity ownership to increase over time. Holt is not a founding owner/operator, which of course I would prefer, but to date his performance has been very solid, having to dig the company out of the mess it got itself in during 2015-2016. His continued focus on lowering the cash burn, focusing on the franchise segment growth, and further building out the regional developer network are why I feel good about partnering with him as my CEO.
Driving Further Upside
I believe The Joint offers a value prop far and above traditional chiropractic care offered for back pain, and is miles ahead of it’s nearest competitor in terms of size, scale, brand offering, and customer awareness. I’ve been able to speak to management, employees and customers, as well as read hundreds of reviews via Yelp, Glassdoor and various other forums. The company seems to be loved by customers and employees alike, and the ‘spa-like’ setting of the clinics feels much more intimate and relaxing than a typical doctor-office adjustment. The industry is highly fragmented as well, with nearly 40,000 providers of chiropractic care across the US, and with the top 5 providers contributing to less than 10% of industry revenues. Aside from two competitors who operate just 12 clinics with a model similar to JYNT, nobody is operating at the scale or size of what the Joint is currently doing.
What will drive further increases in the share price include reaching profitability by year end 2018, increased system wide sales, increased patient visits, growth in recurring annual revenue, further operating leverage, the opening of new clinics (including the ramp back up of company owned stores) and the continued build out of the regional developer network.
As it stands now, the rapid growth in the demand for chiropractic care across the US, the asset light, recurring revenue nature of the model, and the potential operating leverage as new clinics are built and old ones mature, provide for a really attractive set up to step in front of. The company isn’t currently GAAP profitable (management guides for 2018 breakeven, although the franchise segment is profitable). but that will change in the very near term, with the business hitting on all cylinders and the cost structure being well managed.
The company has projected their addressable market being able to sustain around 1,700 clinics (currently at 400) across the US, so I see plenty of runway for continued expansion, as JYNT provides an affordable, effective solution to a real problem for many people.
Valuation
I see the company eventually being able to reach (being conservative) EBITDA of $8-$10mm and free cash flow targets of around $6-$8mm by 2020, at which point I feel the business has the ability to generate a greater than 10% free cash flow yield and continued operating leverage (despite growth, SG&A has remained flat or declined each of the last 6 quarters).
I believe the margin of safety lies in the positive industry tailwinds, solid management team in place, multi-year share price decline (from around $12 to under $5, pricing in some pessimism, despite business results rolling along), clean balance sheet with no debt (excl. small operating lease expenses) and an improving cash position. Mature franchise businesses with much smaller growth rates trade at around 13x – 16x EV/EBITDA. JYNT’s strong balance sheet and experienced management make me very comfortable holding for the long term.
In addition, I did a back-of-the-napkin estimate of financials assuming a full build-out of US locations in order to get an idea of the opportunity. While the math below will almost certainly end up being wrong, they are meant to demonstrate the potential opportunity in front of the company, and should be digested with a long term view kept in mind.
*Note that the calculations below assume nothing in the way of international sales.
Assumptions
1700 stores (1300 franchised/400 company owned or managed)
$39K in royalty/franchise for direct franchise or $21K if franchised with a regional developer
60% franchised through a regional developer
$18M in corporate overhead (not including overhead for store locations)
$160K in income/company owned or managed store at maturity
Tax rate of 25%
20M shares outstanding
No up front licensing fees included in model because this is when the system is fully built out in the US although they still may have some due to accounting and churn
EPS =
(1300 * 0.4 * $39K)
+ (1300 * 0.6 * $21K)
+ (400 * 160K) – $18M)
* 0.75/20M shares
= $3.10/share
Applying a 10-15x multiple to EPS of around $3.00/share (about average for mature franchise businesses) would get us to a share price range of $30-45.
This type of growth in locations, revenue, EPS is going to take decades to accomplish, but looking at the unit economics, runway for expansion and opportunity set, one can see the company being worth multiples of the current share price when adopting a long-term approach.
Long JYNT and still buying.
Comments