Fairway Group Holdings Corp.
Jared Ziment, Max Lipscomb
January 11, 2015
2
Table of Contents
I. Sourcing & Investment Thesis
II. Company Overview
III. Valuation
IV. Conclusion
V. Appendix
I. Sourcing & Investment Thesis
4
Early History of Fairway Market
Source: Company Presentation and Filings
HISTORICAL OVERVIEW
1933
1990
2007
2013
Nathan Glickberg opens a small market in Manhattan’s Upper West Side neighborhood. For much of it’s history, Fairway operates as a single, family-owned market.
Nathan’s grandson Howie expands the original location and builds a new store in Harlem.
Westport, CT based private equity firm Sterling Investment Partners purchased a majority stake in the business, valuing it at $150mm. Fairway had opened 3 stores.
Fairway IPO’s at $13 per share, raising $177mm at a total valuation of around $400mm. Fairway had opened 12 stores.
5
Headlines Galore
Sources: New York Times, Dealbook, Wall Street Journal, Bloomberg
6
All Was Going Well …
Source: Bloomberg
$15
$20
$25
$30
Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13
IMMEDIATE PRICE PERFORMANCE FOLLOWING IPO
High: $28.31
$25.46
7
… Until
Source: Bloomberg
$0
$10
$20
$30
Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15
PRICE DECLINE SINCE OCT. ‘13
Jan. 9$3.47
Earnings Miss
Earnings Miss
Earnings Miss
8
So What Happened?
Private equity-fueled management became increasingly aggressive with growth plans. At the time of the IPO in April, 2013, fairway told investors it expected to expand at a rate of “3 to 4 stores per year.”
1
To meet growth expectations, management invested in an industrial scale distribution center and focused on store openings. Costs began to spiral out of control and bottom line suffered despite strong top-line growth.
2
With a cost structure designed for a 30 store operation and only 14 stores opened, consistent earnings misses and downward guidance revisions destroyed positive investor sentiment.
3
The stock currently trades in the $2-4 range (~0.2x sales), indicating that investors are seriously concerned about the possibility of bankruptcy and/or further dilution.
4
We believe overly negative investor sentiment has exaggerated the possibility of bankruptcy and ignored FWM’s $50MM in liquidity along with the possibility of a
secondary equity raise. This presents us with an investment opportunity at below the security’s intrinsic value.
9
Fairway Group Holdings Corp. (NASDAQ:FWM)As of January 9, 2015
Recommendation: Buy Current Price: $3.47 2 Yr. Price Target: $6.67
Fairway Market has proven its ability to successfully deliver a unique product met by strong consumer demand.
Mismanagement and overly ambitious expansion plans have nearly derailed the company, but a newly installed veteran
management team create an undervalued turnaround opportunity.
Newly appointed CEO Jack Murphy has experience building two nearly identical businesses
Fairway’s product is proven to be differentiated and desirable; fixing cost structure and store
management issues will lead to bottom-line increases and multiple expansion
Immediate price catalyst – Jack Murphy is presenting at the ICR Xchange Conference on Jan. 13th;
presentation is likely to cover new plans for growth and expansion
CATALYSTS
RISKS
High probability of a secondary equity raise in the next year
Bankruptcy is a legitimate possibility for this company in the event of a liquidity crunch; FCF has
been negative for 7 of the past 8 quarters
Fairway’s market and industry are both highly competitive
II. Company Overview
11
Unique Position within the Evolving Grocer Industry
Source: S-1 Filing
Specialty / Fresh / Convenience
Natural / Organic
Conventional Grocery
Fairway Market is a grocer based in New York City, NY which provides a highly differentiated one-stop shopping
experience “Like No Other Market.”
12
Differentiated Product Offering in a Growing Market Segment
1. Nutrition Business Journal, USDA
2. IRI, Morgan Stanley Research
$695 $716 $738 $760 $783 $806 $830 $855 $881
$51 $54 $59 $64 $69 $76 $83 $91 $100
$0
$200
$400
$600
$800
$1,000
2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E
Total Food at Home Natural / Organic
8.4% 8.7%
10.5%11.8% 12.2%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
2010 2011 2012 2013 2014E
FOOD INDUSTRY SALES (1)
Y/Y GROWTH IN ORGANIC PACKAGED FOOD SALES (2)
13
Stable Top-line Growth Follows Leading Capacity Utilization
Source: Company Filings, I-Club Research, Morgan Stanley Research
5 5
7
9
12
14
0
200
400
600
800
1,000
1,200
1,400
1,600
0
2
4
6
8
10
12
14
16
2009 2010 2011 2012 2013 2014
Store Count Sales Per Square Foot Peer Sales Per Square Foot
Top Line Performance Summary (FY ‘09 – FY‘14)
Operating Metrics Summary(FY ‘09 – FY‘14)
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
2009 2010 2011 2012 2013 2014
Revenue Gross Margin SSS
14
Cost Structure Issues Arise From Inexperienced Management Team
Source: Company Filings, I-Club Research, Morgan Stanley Research
Margin Analysis Summary (FY‘11 – 1H‘15)
22.62%
25.07%
8.24%
9.14%
6.03%
3.43%
13.80%
0%
5%
10%
15%
20%
25%
30%
Direct Store Expenses G&A Expenses
Adj. EBITDA Margin Average Peer EBITDA Margin
($12,352.9)
($35,000)
($30,000)
($25,000)
($20,000)
($15,000)
($10,000)
($5,000)
0
$5,000
$10,000
Quartely Free Cash Flow($ Millions, CFO - Capex)
Free Cash Flow Average FCF Burn
Jack Murphy – Chief Executive Officer (CEO)
30+ years of experience in retail businesses
Started Fresh Fields, a grocer in the DC area; grew from 0 to 25 stores before selling to
Whole Foods
Managing partner tasked with investment in 24 Hour Fitness; helped grow company from
30 to 400+ locations
Most recently CEO of Earth Fare, a North Carolina grocer; grew from 10 to 30 stores and
sold business to Oak Hill Capital
Dorothy Carlow – Chief Merchandising Officer (CMO)
Media and Community Relations manager at The Fresh Market (2005-2007)
Worked at Earth Fare under Murphy (2009-2014)
Was promoted four times, eventually becoming the Chief Merchandising Officer
Responsible for Earth Fare’s same store sales growth, new store openings,
profitability, cost controls, shrink management, and rebranding for 32 locations
across 9 states
15
Newly Installed Veteran Management Team
Source: Company Website, Earnings Transcripts, LinkedIn
“We are very pleased by the growth and financial performance of Earth Fare, which has more than quadrupled run-rate EBITDA since we acquired the company in 2006. This has translated into a very successful investment for our firm.”
Charlie Yoon, Partner at Monitor Clipper(1)
III. Valuation
17
Comparable Universe
Source: Bloomberg, Company Filings, Morgan Stanley Research
3.7x
13.8x
15.2x
0
5
10
15
20
25
30
CQ2 2013 CQ3 2013 CQ4 2013 CQ1 2014 CQ2 2014 CQ3 2014
FWM Peer Group Average Russell 2000
EV/LTM EBITDA EV/ LTM Sales EV/LTM FCF Stores SSS Growth (%)Sales per Square
Foot (FY '14)
Sprouts Farmers Market (SFM) 19.46x 1.66x 78.16x 191 9 608
The Fresh Market (TFM) 12.23x 0.98x 42.29x 164 3.3 515
Whole Foods (WFM) 9.84x 0.91x 34.11x 399 3.1 985
Mean 13.84x 1.18x 51.52x 251 5.13 702.67
Fairway Markets (FWM) 3.73x 0.20x -7.11x 15 -3.9 996
EV / LTM EBITDA
18
Notes on Valuation
When looking into Fairway Market’s valuation, we made the following observations:
1. This is an extremely risk-laden investment with high leverage, implying that we should seek
LBO-like returns to compensate
2. The investment is characterized by several years of expected negative free cash flows
3. There is a high possibility for a secondary equity issuance to raise additional capital and
ensure maintenance of loan covenants
Leading us to conclude…
The Venture Capital Method of valuation is an appropriate measure for this stock’s intrinsic value. It
allows us to account for the necessity of high returns, short-term unprofitability, and likely equity
dilution.
Basic concept is to assume future sale of the company, discount the expected proceeds, and assume a
certain amount of dilution.
19
Venture Capital Valuation Method
Source: Venture Capital & Private Equity: A Casebook, by Josh Lerner, Felda Hardymon, and Ann Leamon
Terminal Year Discounting
Required Rate of Return: 20%
Years to Sale of Investment: 6.25
2014 EBITDA 48,797
Terminal Estimated EBITDA 195,188
EBITDA Multiple 8.5x
Terminal Firm Value 1,659,098
Discount Factor 32.0%
Present Firm Value 530,871
Required Ownership Percentage
Current Shares Outstanding (MM) 29.3
IPO Shares 13.6
New Shares Issued 6.8
Price Per Share $3.00
Amt. Raised 20.4
Total Shares 36.1
Retained Ownership % 81.2%
Dilution Factor: 18.8%
Required Ownership Percentage: 84.1%
Intrinsic Firm Present Value 446,724
Net Debt 216,614
Intrinsic Mkt Cap - With Dilution 230,110
Intrinsic Mkt Cap - No Dilution 314,257
Mkt Cap as of 1/7/2015 153,400
VALUATION ASSUMPTIONS
1. Assume required 20%+ required IRR
2. Sale of company in 6.25 yrs
3. Jack Murphy is able to replicate his success at Earth
Fare, quadrupling run-rate EBITDA in 6 years (not
unreasonable given inefficient cost structure and
previous poor management)
4. Company is sold at 8.5x EBITDA, the low-end of the
peer range
5. Equity is raised to address near-term liquidity issues –
6.8mm shares issued at $3.00 per share; current
shareholders retain ~80% ownership
RESULTS
We are easily able to hit our 20% IRR breakeven point with
these relatively conservative assumptions. Even with
significant equity dilution, the investment is a homerun in
the event of a successful turnaround.
20
Price Target and Sensitivity AnalysisAs of January 9, 2015
With Dilution
EBITDA Multiple
230,110 8 9 10 11 12
Term
inal
EB
ITD
A($
00
0's
)
100,000 ($1,208) $25,717 $52,643 $79,569 $106,494
125,000 $52,643 $86,300 $119,957 $153,614 $187,272
150,000 $106,494 $146,883 $187,272 $227,660 $268,049
175,000 $160,346 $207,466 $254,586 $301,706 $348,826
200,000 $214,197 $268,049 $321,900 $375,752 $429,603
No Dilution
EBITDA Multiple
314,257 8 9 10 11 12
Term
inal
EB
ITD
A($
00
0's
)
100,000 $39,367 $71,364 $103,362 $135,359 $167,357
125,000 $103,362 $143,359 $183,356 $223,353 $263,350
150,000 $167,357 $215,353 $263,350 $311,346 $359,343
175,000 $231,352 $287,348 $343,344 $399,340 $455,335
200,000 $295,347 $359,343 $423,338 $487,333 $551,328
SENSITIVITY ANALYSIS
PRICE TARGET
80% Venture Capital Method
(20% IRR over 2 years)
= $5.00
20% Comparables
(8.0x EBITDA Multiple)
= $13.37
+ =Price Target:
$6.67 / share
Compared against
1/9/2015 $153mm MCAP for breakeven
IV. Conclusion
22
Closing Thoughts
After significant research into Fairway Group Holdings Corp (NASDAQ:FWM), we believe that Fairway is currently
plagued by a series of very fixable problems
The firm’s stable top-line revenue, differentiated product, and incoming senior management present an overall
investment picture better than the apparent market consensus
Given a willingness to maintain a long-term investment horizon, we believe this investment provides a favorable risk-
adjusted return
Primary Risks:
Risk of bankruptcy, while exaggerated, is a legitimate possibility for Fairway
At current burn rate, management has roughly 1 year of runway remaining ($50mm in liquidity, average of
$12mm burned per quarter)
If current short-term funding is exhausted we find a secondary issuance to be likely in the $20-30mm range
We believe Murphy will be able to reduce the burn rate substantially given current operational inefficiencies
Taken together, these facts imply a high likelihood of refinancing capability for FWM’s 2018 loan maturity of
$250mm
Fairway operates in a highly competitive industry
To further this concern, New York’s metropolitan area is one of the most saturated in the world for high-
end/luxury grocers
That said, Fairway has proven its ability to compete for customer dollars in NYC and the surrounding area
POST-DILIGENCE OPINION
V. Appendix
24
Financial Model
Source: I-Club Estimates, Company Filings
Fiscal Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
($ in thousands) FY FY FY FY FY FY FY FY FY FY FY FY FY
Net Sales $343,106.0 $401,167.0 $485,712.0 $554,858.0 $661,244.0 $775,986.0 $873,837.7 $1,033,360.9 $1,219,365.9 $1,438,851.7 $1,697,845.1 $2,003,457.2 $2,364,079.5
COGS $230,912.0 $271,599.0 $326,207.0 $368,728.0 $445,379.0 524,659.0 $591,763.7 682,018.2 804,781.5 949,642.1 1,120,577.7 1,322,281.7 1,560,292.4
Gross profit 112,194.0 129,568.0 159,505.0 186,130.0 215,865.0 251,327.0 282,073.9 351,342.7 414,584.4 489,209.6 577,267.3 681,175.4 803,787.0
Operating Expenses 102,435.0 124,465.0 159,911.0 189,465.0 233,960.0 285,337.0 282,975.1 308,512.9 350,567.7 410,072.7 479,641.2 563,973.2 656,032.0
Operating Income (EBIT) 9,759.0 5,103.0 (406.0) (3,335.0) (18,095.0) (34,010.0) (901.2) 42,829.8 64,016.7 79,136.8 97,626.1 117,202.2 147,755.0
D&A 7,175.0 10,233.0 14,588.0 19,202.0 22,093.0 27,056.0 31,174.3 38,234.4 24,387.3 28,777.0 33,956.9 40,069.1 47,281.6
Non Reoccurring Items 4,851.0 8,538.0 15,127.0 19,908.0 43,366.0 55,751.0 – – – – – – –
Adjusted EBITDA 21,785.0 23,874.0 29,309.0 35,775.0 47,364.0 48,797.0 49,182.5 81,064.2 88,404.0 107,913.9 131,583.0 157,271.4 195,036.6
25
Financial Model – Key Assumptions
Source: I-Club Estimates, Company Filings
Fiscal Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
y/y sales growth NA 16.92% 21.07% 14.24% 19.17% 17.35% 12.61% 18.26% 18.00% 18.00% 18.00% 18.00% 18.00%
y/y Adj. EBITDA growth NA 9.59% 22.77% 22.06% 32.39% 3.03% 0.79% 64.82% 9.05% 22.07% 21.93% 19.52% 24.01%
Gross Margin 32.70% 32.30% 32.84% 33.55% 32.65% 32.39% 34.00% 34.00% 34.00% 34.00% 34.00% 34.00% 34.00%
Operating Margin 2.84% 1.27% -0.08% -0.60% -2.74% -4.38% -0.10% 4.14% 5.25% 5.50% 5.75% 5.85% 6.25%
Adjusted EBITDA Margin 6.35% 5.95% 6.03% 6.45% 7.16% 6.29% 5.63% 7.84% 7.25% 7.50% 7.75% 7.85% 8.25%
D&A / Sales 2.09% 2.55% 3.00% 3.46% 3.34% 3.49% 3.57% 3.70% 2.00% 2.00% 2.00% 2.00% 2.00%
COGS/ Sales 67.30% 67.70% 67.16% 66.45% 67.35% 67.61% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00% 66.00%
Operating Expenses / Sales 29.86% 31.03% 32.92% 34.15% 35.38% 36.77% 32.38% 29.00% 28.75% 28.50% 28.25% 28.15% 27.75%