Burger Fuel has announced preliminary results to 30 September 2007. The full financial results have yet to be released but the point of interest from the summary provided is the costs associated with Burger Fuel’s initial public offering (IPO). Valuecruncher estimated the cost of the IPO at approximately $810,000. This estimate was based on information provided in the prospectus scaled to account for the low level of subscriptions. Based on the NZX announcement Burger Fuel incurred IPO expenses of $1.321 million. This represents 16.5% of the $8 million raised. This is high when compared to similar sized capital raisings on the NZX by companies such as Xero (7.3%) and 42 Below (7.7%). The cost of the IPO as a percentage is even uglier when calculated as a function of the $5.25 million raised from the public (Burger Fuel founders contributed $2.75 million to ensure the offering reached the minimum $8 million required). The IPO costs represented 25% of the capital raised from the public.

An IPO was always going to be a risky approach to raising capital for Burger Fuel. The strategy specifically focused on customers and young first-time investors. It would have been very difficult to estimate the uptake prior to the IPO. In hindsight the IPO was clearly not the best strategy. The offer period was extended and the founders were required to inject $2.75 million to ensure the offer reached the minimum requirement.

Burger Fuel IPO Summary 

Winners

• Advisers and Advertising Agencies

Losers

• Burger Fuel
• Founding Shareholders
• ~2,400 Public Investors

Valuecruncher analysis of the operating performance will follow the release of Burger Fuel’s full financials.

The recent successful Xero initial public offering (IPO) and the current BurgerFuel IPO have drawn comparisons to the 42 Below listing in 2003. The common characteristics of these 3 IPOs are that the companies involved all had minimal or negative earnings, valuations that implied significant growth and a global strategy. The products, markets and business models of the 3 companies are completely different. Commentators have cited the returns provided to investors in 42 Below, “Shareholders made a lot of money out of it” (at approximately 2 min 20 sec), as a guide to the potential returns available from growth companies. Valuecruncher has posted previously on both the Xero and BurgerFuel IPOs. Given the comparisons Valuecruncher has decided to review the return provided to investors in the 42 Below IPO.

42 Below undertook an IPO in September 2003 issuing 31 million shares at $0.50 raising $15.5 million (every 3 shares purchased in the IPO was accompanied by 1 warrant with an exercise price of $0.50 available for exercise during October 2005). The issue price of $0.50 implied a post-money valuation of $60.5 million. At the time of listing 42 Below had negative earnings.

Post the IPO 42 Below traded significantly below the IPO price of $0.50 and remained below $0.50 for the majority of the first year it was listed. In the year ending 31 March 2004 42 Below had operating revenues of $4.41 million and an operating deficit of $1.125 million. This is to be expected from a company such as 42 Below that is developing products, expanding into new markets and building a brand.

42 Below continued to grow sales and in the 2005 financial year had operating revenues of $12.58 million producing an operating deficit of $5.22 million. A key driver of revenue growth in the 2005 year was increased sales in the U.S.. During the 2005 calendar year 42 Below consistently traded above $0.50 and at times over $0.80. In 2005 42 Below engaged Macquarie to advise on strategic issues surrounding development of international opportunities, the Bacardi offer arose as a result of this process.

In the 2006 financial year 42 Below continued to exhibit strong revenue growth increasing operating revenue to $17.0 million and improving the operating deficit to $2.8 million. A key contributor to these improved results was a foreign exchange gain of approximately $1.2 million.

After being listed for 2 1/2 years and nearly 4 full years of financial reporting 42 Below had grown revenues to approximately $17 million, established a strong brand in the New Zealand market for premium spirits and had grown sales in the U.S. to over $6 million in 2006. Despite this 42 Below was still not profitable. Although 42 Below were growing revenues, these revenues were spread across geographical segments (primarily New Zealand and the United States). Based on management forecasts for the 2007 financial year 42 Below was expecting trading revenues to grow to $18.2 and EBIT of ($4.9) million [compared to ($3.7) million in 2006].

On 27 September 2006 Bacardi made a full takeover offer for 42 Below at a price of $0.77. The day prior to the offer 42 Below closed at $0.57 and had traded at a volume weighted average price of $0.55 in the 6 months prior to the offer. Valuecruncher has discussed the framework required to evaluate the Bacardi offer in a previous post.

The offer from Bacardi represents a 54% return for an investor in the IPO, this represents an annualised return of 15.5%. Based on the $0.57 price the day before the offer the gross return would have been 14% or 4.5% annualised. In Valuecruncher’s opinion the Bacardi offer represented an excellent opportunity for investors to realise value from a company that had done a great job building a brand and penetrating the tough U.S. market but was showing no signs of reaching profitability.

A professional early stage investor (i.e. a venture capitalist) targets a 10x return on investment over a period of 5-7 years. The 42 Below return for IPO investors (even with the sale to Bacardi) is well below this targeted level.

Although the 15.5% annualised return realised via the Bacardi offer was a significant improvement on the pre-offer price it can hardly be described as a “home run” return for investors in a startup IPO. Citing the 42 Below result as validation for investing in early stage growth companies on the NZX is misleading. Each investment should be considered on it’s merits. Companies such as Xero have the ability to develop into global players and have significant upside potential but investors should not be relying on a 42 Below style exit to realise their return. If these growth companies achieve a significant global presence investors should expect a return well in excess of 15% per annum (of course any return is a function of the price paid).

Note: This analysis focuses on the return to an investor in the 42 Below IPO who adopted a buy and hold strategy and does not incorporate potential returns from any warrants exercised. 

Last week Valuecruncher commented on the BurgerFuel IPO. The post focused on the post IPO valuation of $60 million and carried out some high-level and subjective analysis of what that valuation implied in terms of BurgerFuel stores in 5 years. This analysis was restricted by the limited information provided in the prospectus. The BurgerFuel Team has responded (via a comment in the previous post) to the analysis and highlighted alternative assumptions for a couple of the key variables in our analysis. Valuecruncher is surprised that BurgerFuel are commenting during the IPO process and would like to reiterate BurgerFuel’s point that “responses do not constitute prospective or forecast financial information”.

The two key assumptions queried by BurgerFuel were:

• Revenue in year 5 from franchise setup fees.
• Growth in average sales per store.

In the original post Valuecruncher did not explicitly account for the revenues from franchise setup fees, we stated approximately 700 stores would be required to generate the $76.6 million expected in year 5 (based on our analysis). At $1 million sales per store 700 stores was a conservative approximation that incorporated an allowance for franchise setup fees. It is difficult to estimate the the setup fee figure because you don’t know how many franchises will be sold to franchisees in that year.

Valuecruncher assumed that average store sales were $1 million (based on information contained in the prospectus). BurgerFuel raise the valid point that this number could increase over time and suggest an 8% pa growth rate. Although the prospectus contains historic store numbers and system sales they have not included a historic same store sales growth figure, this information would be useful to any investor evaluating the opportunity and Valuecruncher can see no reason why it wasn’t included. The average store sales of $1 million dollars reflects the performance of the current NZ operations, we have no idea what level of sales will be achieved in other markets (Lance Wiggs provides an overview of the competitive landscape) or what level of sales stores will experience as they open but find it hard to justify an abitrary assumption of 8% pa growth. 

Based on the revised assumptions provided by BurgerFuel the 5-year target drops from Valuecruncher’s figure 700 stores to 350 stores (350 stores represents opening an average of 1.3 stores per week every week for the next 5 years). Valuecruncher stands by the original assumptions used but the response highlights the uncertainty involved and how sensitive the analysis is to your assumptions. 

The return generated by an investment is a function of the price paid and Valuecruncher believes the current valuation does not reflect the risk and uncertainty associated with the BurgerFuel opportunity. BurgerFuel and their advisors should have conducted detailed analysis of the opportunity when determining the IPO price, it would have been nice if they could have shared some of their assumptions and expectations with potential investors in the prospectus.

New Zealand gourmet burger chain Burger Fuel has announced it’s intention to list on the NZAX. The IPO is to raise $15 million at $1.00 per share and values the company at $60 million. According to the Burger Fuel Prospectus proceeds of the IPO will be used to fund expansion into the Australian market. The expansion will involve Burger Fuel setting up and operating restaurants before on selling them to franchisees. Burger Fuel currently has 19 stores in New Zealand and 1 in Australia.

Burger Fuel is a growth company that has potential to expand both within New Zealand and overseas but a valuation today of $60 million is crazy. The absence of any projections (operating or financial) and detailed financials in the prospectus makes it difficult to value the company. Valuecruncher has conducted some high-level analysis of the $60 million valuation implied by the IPO issue price. The analysis draws on information contained in the Burger Fuel prospectus and operating and valuation data associated with Burger King.

Assumptions

Valuation Today: $60 million (Based on IPO issue price)

Cost of Capital: 20% (Based on risks associated with investment)

EV/EBITDA Valuation Multiple: 13 (Based on established burger chain Burger King)

EBITDA Margin: 15% (Based on established burger chain Burger King)

Burger Fuel Royalty: 10% of total system sales (6% revenue royalty + 4% marketing levy)

Average Sales per Store: $1 million per annum (Based on information contained in the prospectus)

Horizon: 5 years

Dilution: Any future capital raising would not dilute the value of shares issued in IPO.

Based on these assumptions Burger Fuel’s $60 million valuation today implies expected revenues of $76.6 million in 5 years, based on 100% of the stores being franchisee owned and revenue + marketing royalties of 10% this equates to approximately 700 stores and approximately $700 million of total system sales. Burger Fuel currently has 20 stores and had $16.5 million of total system sales in the 2007 financial year. These assumptions are very subjective but highlight the magnitude of growth implied by the $60 million IPO valuation.

Valuecruncher believes that based on the high-level analysis, current status of Burger Fuel’s operations and the extremely competitive nature of the market the IPO valuation cannot be justified and question why Burger Fuel is undertaking an IPO at this stage. These issues are compounded by no substantial explanation of how the funds from the IPO will be used and the absence of any financial projections in the prospectus.