We generally avoid public sales processes but believe the valuation of PFSW is sufficiently discounted to protect downside if a sale does not occur – and believe there is material upside should the company find a buyer. Part of the reason for posting this idea is to solicit feedback as to why this business would be worth such a material discount in a no-deal situation. We have yet to find a sufficient answer to that question.
For a 30-second overview, PFSW previously owned PFS and LiveArea, before LiveArea was sold in 2021 for 3x sales. PFS provides e-commerce order fulfillment services largely for consumer branded manufacturers. The most similar competitor across product offerings is Radial, the former GSI Commerce, which was sold to BPost in 2017 for 12x EBITDA/0.8x sales. The most representative public comp is the much larger GXO, which trades for 12.6x ’23 EBITDA, 0.9x sales. PFSW trades for 4.9x the midpoint of their ’23 EBITDA guide including public costs, or 3.8x excluding them, and 0.3x ’23 sales. After selling LiveArea, a Strategic Process for PFS began, but for reasons we will discuss later the business still has not been sold. The exhaustion of the process is likely what is presenting the opportunity, but we believe there are valid reasons why it stalled and that the time is now right to conclude the process.
The PFS segment is structurally sounder versus recent years and performing at a higher level. We would expect small downside in a failed process, and this downside may even be temporary if the business keeps growing and the large cash balance is used for share repurchase. In the event of a sale, there would be material upside even at the low-end of precedent transactions and public comps. We believe 8x-12x EBITDA (implies $8-$13 per share) is a realistic possibility given prior transactions in the space as well as valuation of peers. We particularly highlight GXO, whose financial metrics look quite similar to PFSW in almost all respects other than size.
Recent PFS Performance
PFS has certainly had its fits and starts; high profile customer losses (Starbucks, TJ Maxx, Columbia Sportswear etc.), bankruptcies (Charlotte Russe, Charming Charlie’s in 2019) and changes in focus have all held back progress over the ~25-year history of the business. However, we think the current positioning largely centered on Health and Beauty, Jewelry, Collectibles and Fashion creates a defensible niche positioning, better category exposures and should deserve a higher, not lower multiple than the past. The long story short is that lowest cost doesn’t always win when the client is most focused on a branded packaging experience, allowing for PFSW to punch above its weight in these categories. We believe that PFS has more than held its own since the 2019 setbacks, and its relative performance as evidenced by record bookings in 2022 has inflected positively.
Health & Beauty now represents the largest vertical for PFS, anchored by a >20-year relationship with L’Oreal, which has renewed several times, as well as Shiseido more recently. According to McKinsey’s recent “State of Fashion: Beauty” report, the Beauty category represented $427 billion of sales in 2022, grew at a 5% CAGR from 2015-2022, and is forecasted to grow at a 6% CAGR through 2027. E-commerce still represents just 21% of the category, up from 8% in 2015, and is forecasted to grow at a 12% CAGR through ’27, increasing penetration to 26%. L’Oreal has added new brands to the relationship over time, and we’d note that the Shiseido relationship is also multi-brand. This land and expand strategy, along with the ability to win upstarts like Kendra Scott and Anastasia are likely a large part of the reason why PFSW projects fulfillment revenue growing at a 15% CAGR through 2026, outpacing the category growth and under-pinning corporate revenue growth of 8-12%.
2022 bookings performance should have been an aha moment that shifted investor perception more positively, yet the exact opposite has happened; a business that averaged ~8x EBITDA for the past decade can now be had for ~4x. The company signed 31 new deals in the year for $45M, up 67% versus 2021. We would expect these bookings to turn to revenue in FY’23 and need to model record churn to get within management guidance of 5-10% revenue growth. For context, if the $45M of 2022 bookings layered in to ’23 revenue, and the company lost $30M via churn, 2023 revenue would shake out at $215M, i.e. 7.5% growth, right in the middle of company guidance. The average differential since 2019 has been far lower, however – we show an average churn around $9M over these four years, with a range of UP $1M in 2020 (Covid benefit) to down $21M in 2019 (multiple customer bankruptcies). At $15M of churn, the company would beat the high-end of guidance and deliver $230M of revenue, up 15%. 2023 seems to be shaping up as quite a different year than 2019, however – that year saw Charlotte Russe and Charming Charlie’s filing for bankruptcy; contrast this with management quoting 16% market growth for the beauty category in its 1Q’23 results, as well as maintaining a bullish posture towards future bookings.
**We use the shorthand ‘churn’ but this is basically a catch-all for all revenue change unexplained by bookings addition. It would include churn, FX, business performance, pricing etc..
We provide this detail on ’23 not to obsess over the short-term, but rather to rule out the potential that there is something wrong in the business which is holding up a sale. If anything, we would expect that the current guide may be under-stated, not over-stated.
As a quick sanity check, we asked ourselves whether PFS’ financial metrics are substantially worse than GXO, which sports a 12x ’23 EBITDA multiple. We found the answer to be a definitive ‘no’.
2023 revenue growth
9% for GXO vs 5-10% guide for PFSW with management indicating they expect the upper end of this range in their 1st quarter earnings call.
7.5% for GXO vs 8-10% for PFSW excluding 2% for public company costs.
44% for GXO vs 46% for PFSW
1.8x for GXO vs -1.8x for PFSW
LT revenue growth aspiration
8-12% organic for GXO over the next 6 years, vs 8-12% for PFSW from 2024-2026, inclusive of a Contact Center revenue headwind.
Obviously, these are completely different size businesses, but we do find the striking similarities in so many metrics to be at odds with the EBITDA multiple disparity. We would also pushback on size being a huge issue because as we saw with GXO’s Clipper purchase, there is a decent chance that smaller size is a benefit to synergies, further advancing the probability of a deal. As a reminder, Clipper synergies were estimated to amount to 75% of going-in EBITDA at the time of the deal, or approximately 4-5% of revenue. Further, the same range on PFSW would be ~$8M-$10M and we already know the first $4M are public company costs.
We intentionally discussed the business first, as the asymmetry is largely anchored by a stock that is not carrying a deal premium. Public comps and precedent transaction suggest an 8x-12x EBITDA range is entirely reasonable, and this would result in a share price between $8-$13
Below we list some valuation considerations vs PSFW at 3.6x/4.6x EBITDA at the midpoint of ’23 guidance (including/excluding public company costs) and 0.3x EV/Sales.
Public Comps (none are perfect – ’23 financials)
A very reasonable pushback is the following: This business has been in a process since the sale of Live Area over 2 years ago. How is a company ever going to sell if a process has run that long?
To be clear, this is a concerning fact pattern and causes us to reduce our expected odds of a sale occurring. However, we do have one plausible hypothesis based on public commentary since July of ’21. First, the company had substantial difficulties filing their financials after the Live Area transaction was completed in August ’21. Financials did not become fully current until June of 2022. Even at this point, PFSW still had not executed on its cost reduction to right-size overhead. We believe both of these would have represented major hurdles to a sales process. Another consideration*: it is extremely important for e-commerce fulfillment companies to nail the holiday season, and thus the ability for management to focus on a strategic process likely dies in the fourth quarter. Long story short, we highly doubt that a transaction was feasible until financials were current, ’22 holiday season had past, and corporate restructuring was completed. This is now the current reality, and we believe the holiday constraint works in your favor this year – i.e. there is a real imperative to get a deal done well in advance of the 4th quarter.
*We suspect there is long institutional memory on this topic. Refer back to the Q2’14 transcript as management discussed a challenging 2011 holiday causing customer churn. They were still talking about it 3 years later.
Below is a sensitivity table we have created. The EBITDA range represents the low-end of management guidance and subtracts public company costs. This should be a good bear case if the company cannot sell itself – it would no longer make sense to ignore public company costs. The high-end assumes a slight beat to the ’23 guide (i.e. current high end of guide is $220M revenue/10% margin for $22M)
What Happens in a No-Deal Scenario?
Our best bet is that the multiple stays in the 4x-6x range, the market shifts to using fully burdened EBITDA (2% margin headwind from public company costs) and the company trades like any other stock at stabilization. A big fear to address is the event-driven nature of the shareholders list. We believe this presents management with an interesting decision. It is quite fair to assume that there would be substantial selling pressure should a deal not come to fruition. However, with $40M of cash on the balance sheet against $100M of market cap, we think it would be wise for management to initiate a substantial tender. There seems to be no great reason to hold excess cash, especially since the company just closed on a $25M 5-year credit facility secured by Accounts Receivable (see 8-K filed June 21st).
Contact center represents 16% of revenue and management has guided that this segment will be flat to shrinking over time. Perhaps it falls off even faster than expected (AI risk).
Customer concentration – the company has 2 12% customers. We presume L’Oreal is the first and feel strongly that this longstanding relationship will persist. We are not 100% sure which customer is the 2nd with that level of revenue.
Timing – we believe a process would need to be wrapped up before the holiday, otherwise it needs to be pushed into next year.