by Thomas Niel
Innovative Food Holdings (OTC: IVFH), is a micro-cap specialty foods distributor selling at a sharp discount to its peers. This discount is not irrational, as the company has two material risks:
IVFH is dependent on a third-party (US Foods) to distribute its specialty food products to restaurants and other food service customers. This contract is year-to-year, but limits the company’s appeal as a takeover candidate to US Foods’s rivals.
IVFH has made two acquisitions in order to diversify into the e-commerce space. Given IVFH’s lackluster M&A track record, investors assume this current endeavor will not pay off for shareholders.
The investing public have conveyed their displeasure via a large sell off in IVFH shares in the past 18 months. But in the chaos, one activist investor sees opportunity. James Pappas’s JCP Investment Management has acquired more than 10% of outstanding shares.
Will this activist be able to help realize IVFH’s intrinsic value? Is the business truly undervalued, or is the current market discount rational? Are there strategic or financial buyers out there to buy out IVFH, or at least buy its non-core units? Read on to see if IVFH presents a strong opportunity for your portfolio!
Innovative Food Holdings is largely the creation of its CEO, Sam Klepfish. Klepfish previously worked in small-cap investment banking before taking the reins at IVFH in 2006. In the past 13 years, he has built the business via roll-up acquisitions. Some of these deals have worked, while others (The Fresh Diet) have destroyed shareholder value.
Innovative Food Holdings formed in 2004, the result of a reverse merger between public shell Fiber Application Systems Technology and privately-held Innovative Food Holdings. Subsequent to this creation, IFVH acquired Food Innovations in an all-stock deal.
In 2012, IFVH acquired Artisan Specialty Foods for $1.2m, as well as The Haley Group, a brand management company.
In 2014, IFVH merged with The Fresh Diet, Inc. in a $14m all-stock transaction. This deal proved to be a bust, with IVFH selling 90% of the unit to its former founder in 2016.
Since 2014, several bolt-on acquisitions have followed:
2014: Organic Food Brokers
2017: Oasis Sales and Marketing
2018: Mouth Foods
IVFH operates through these several units, covering several areas of the specialty foods industry (distribution, eCommerce, Brand Management).
Distribution (Direct To Chef)
IVFH’s Food Innovations, Inc. business is heavily supported by its logistics partner, US Foods Inc. Via its deal with US Foods, the company is able to source niche food products, then distribute them to end users (restaurants, hotels, casinos, hospitals, and other food service buyers) within 24-72 hours.
The distribution segment focuses on the gourmet side of the niche food business.Through Food Innovations and Artisan Specialty Foods, IFVH distributes over 7,000 perishable and specialty food and food products (including delicacies such as alligator and antelope). This segment produced 79% of revenues in 2018.
Since 2018, IVFH has been growing their e-Commerce (B2C) business. That year, the company made two acquisitions:
iGourmet sells a wide variety of specialty foods to the general public. Think of it as the more European-artsy counter to homespun Hickory Farms.
Along with gift baskets, iGourmet sells food products a la carte. This a la carte selection covers a wide range of food products (meats, desserts, snacks, bread, pasta, coffee, condiments).
iGourmet sells both through its own website, as well as through marketplaces such as Amazon, Jet.com, and Walmart.com.
Mouth.com is a specialty food e-commerce website. Their focus is on monthly subscription boxes, as well as traditional gift baskets. Mouth focuses on small batch specialty foods curated from a variety of sources.
IVFH formed the business when they acquired assets from a Brooklyn-based startup in 2018. Mouth Foods was an expert curator and online retailer of small-batch specialty foods.
IVFH paid $208,000 at closing, plus $100,000 in revenue-based contingent liabilities, as well as 5% of all revenues over $500,000 (through 6/30/20), and $205,000 in additional contingent liabilities.
Based on Q1 2019 figures, the e-Commerce segment makes up ~17% of revenue.
The brand management segments consists of three foodservice consulting firms IVFH has acquired: The Haley Group, Organic Food Brokers, and Oasis Sales and Marketing.
The Haley Group is a foodservice consulting firm. The company advises clients with regards to finding private label manufacturing partners for new food products. The Haley Group also advises on obtaining national distribution for new food products.
Brand management is a very small portion of IVFH’s overall business, and may be a prime candidate for divestiture.
IFVH is best valued using “sum of the parts” for each of three segments:
With the distribution business largely a concession of US Foods, valuing the business piecemeal may give investors a better understanding of its underlying value.
The distribution segment generated $41.7m in revenue in FY18. Assuming the B2C segment is running at breakeven or a loss, the distribution segment has a TTM EBITDA of at least $2.82m.
IVFH currently trades at an EV/EBITDA ratio of 6.12, a sharp discount to its peers:
The Chefs’ Warehouse: 19.43x
Sysco Corporation: 13.22x
US Foods Holding: 10.85x
As seen in prior years, IFVH (without the e-commerce unit) had EBITDA exceeding the current TTM:
Would US Foods want to buy the direct-to-chef segment? Cost synergies are highly likely, and IFVH’s overhead could be eliminated.
This would justify US Foods acquiring IFVH at an EBITDA multiple close to its own (around 10-11x). This would imply an acquisition price ~$30m.
Assuming that US Foods could bring IFVH’s EBITDA back to the $5m mark, this transaction would be highly accretive, and would allow them to bring specialty food sourcing in-house.
But how about other strategic buyers? Would they be willing to pay this amount, given the challenge of moving output from US Foods over to their own platform?
I believe if The Chefs’ Warehouse wanted to buy IFVH, paying 10x EBITDA could still be worthwhile. Moving output from US Foods over to their own platform would have a cost, but cost synergies could outweigh these challenges.
e-Commerce (iGourmet, Mouth)
iGourmet was an unprofitable business when acquired by IVFH in 2018, and likely is still losing money on an operating basis.
Based on the financials released at the time of acquisition, iGourmet had operating losses of $724,000 in 2017. Adding in the $500,000 increase in depreciation between 2017 and 2018 (when the e-Commerce acquisitions occurred), we can assume this segment is generating slight EBITDA losses (-$200,000).
As of 12/31/18, IVFH’s effective purchase price for iGourmet was $4.27m. This amount includes the assessed value of contingent liabilities, which have been written down as iGourmet’s operating results have not improved to levels justifying the earn-outs.
While IVFH has a strategic plan to use the business as a springboard for building their B2C business, IVFH shareholders likely want them to abandon this plan.
A divestiture alone (without a planned sale of the distribution business) could boost the stock price. This would outweigh the short term losses IVFH would experience if they sold iGourmet and Mouth for less than their acquisition price.
Who are likely buyers for the B2C segment?
Strategic acquirers (gift basket purveyors), or perhaps a private equity firm rolling up such businesses, may be interested in acquiring the company.
The iGourmet business generated ~$10m/year in revenue at the time of acquisition. Assuming a buyer could bring EBITDA margins up to 5% ($500,000), paying only $2.5m would present meaningful upside to a potential buyer.
Brand Management (Oasis, Organic Food Brokers, The Haley Group)
IVFH’s Brand Management segment generated ~$2.2m in revenue in 2018.
A carve-out of the Brand Management business may make the most since. Combine Oasis and the Haley Group into one entity, with Haley running the show.
Based on the revenue amounts, let’s assume after manager compensation the unit generates margins similar to the rest of IVFH (5%). Add in a conservative estimate of $200k for manager compensation, and the business may generate ~$300k/year in operating income.
Giving this business a 3x multiple (assuming an owner/operator would acquire it) is reasonable given similar valuations attached to small businesses.
This amount is also close to the aggregate purchase price paid by IVFH for all three businesses (Oasis Sales, Organic Food Brokers, The Haley Group).
The Haley Group’s founder (Lou Haley) came on board after selling out to IVFH. He could easily acquire this unit in a management buyout. The combined Oasis/Organic/Haley Group could scale into a sizable brand consulting operation.
To avoid looking like fools for divesting this unit, IVFH could keep a 20% piece as “schmuck insurance” in case this unit scales up in the future.
Another plus of IVFH is their ownership of their facilities. Both warehouses (in Bonita Springs, FL and Broadview, IL) are owned by the company. While these properties are not “hidden assets” worth a large chunk of intrinsic value, they are a saleable asset in the event of a downturn.
The Bonita Springs building was purchased for ~$792,000. Per the most recent 10-Q, the mortgage balance on the property is ~$218,000.
The Broadview building was purchased for $914,000. The current mortgage balance is $604,333.
This gives us $1.7m gross value for the properties (assuming zero appreciation since purchase), as well as $800,000 in total equity held by IVFH in both properties.
Unlike many other scenarios, where I believe that sale/leasebacks can extract value, the company may be better off keeping ownership of the properties. Keeping them on the books may make it easier to sell strategic buyers on paying a 10x EBITDA multiple for the company.
A buyer could easily move operations to different facilities, sell the properties, and see minimal impact to operating income. For the purposes of my “sum of the parts” valuation, I am excluding both the value of the two buildings, as well as the outstanding mortgage debt.
Investments in Food Startups
Through its operations in both food distribution and brand management, IVFH has made strategic investments in food startups. These investments are on the books using the cost method, and are currently valued at $355,000.
Given the high risk of these investments, as well as their value relative to the rest of IVFH, I am assigning zero value to these holdings. Think of them as a garnish that could add additional value to the company if any of them experience a liquidity event. But do not assume they will move the needle.
Sum of the Parts:
B2C (iGourmet): $2.5m
Brand Management: $0.9m
Non-Real Estate Debt (Term Loan, Promissory Note): ($0.8m)
Total Valuation: $32.6m, or $0.96/share
In the case of IVFH, “activism as catalyst” is no long shot: an activist fund with a solid track record has been accumulating a position since late 2018. While they have yet to disclose their intentions, the continued purchases indicate they have a plan to push for material changes.
JCP Acquires 10.1% Stake
Activist Investor James C. Pappas has quietly built up a position in IVFH. Per his latest 13D/A filing, his fund JCP Investment Management controls 10.1% of outstanding shares.
Interesting but relevant anecdote: James Pappas’s father and uncle control Luby’s Inc, and recently fought off an activist campaign from Bandera Partners (activist fund headed by Dear Chairman author Jeff Gramm).
For more information on the Luby’s proxy fight, as well as further background on James Pappas, check out this Houston Chronicle article. According to the piece, Pappas and Gramm have been friends and business associates going back 10 years.
At that time, Bandera had begun building a stake in Luby’s, and the Pappas family invited Gramm to tour a new restaurant.
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