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There is something very strange about Apollo Global (NYSE: APO) making a $1.34 billion roll-up offer for The Fresh Market (NYSE: TFM). Sure, Fresh Market shareholders are dancing in the aisles because of the 25% premium added on to their shares overnight. Yet the Fresh Market buyout seems a little mystifying when we look at the numbers involved.
The Fresh Market had 12-month trailing profit of $63 million. So Apollo paid 20.9 times earnings for this company. Now, if we assume that a stock trades at a value that reflects its future cash flow, why would Apollo pay twice the expected growth rate for The Fresh Market? Analysts think the company will have 10% annualized earnings growth going forward, and that’s only after it escapes the next two years during which earnings are expected to be near zero.
A Fat Price for a Laggard
Nor does the deal make much sense when it comes to cash flow. Normally, we might expect food stores to go out at 5 to 6 times cash flow. Yet The Fresh Market only enjoyed $149 million in cash flow over the past 12 months, and a mere $43 million of free cash flow. That means Apollo paid about 8.9 times cash flow and something like 29 times free cash flow.
What catches my attention is that Apollo paid an awful lot of money for a chain that, compared to juggernaut Whole Foods Market (NASDAQ: WFM), is rather far behind.
The Fresh Market has 177 stores to Whole Foods’ 435. So you might expect that with 40% of the store base, its metrics would be proportional. They aren’t. Whole Foods has $15.5 billion in revenue over the past 12 months. The Fresh Market has $1.8 billion, when we’d expect it to have $6.2 billion.
Gross margins for the Fresh Market in fiscal year 2015 were 33.2%, operating margins were 3.85%, and net margins were 2.3%. For Whole Foods, gross margins were 34%, operating margins were 5.21%, and net margins were 3.25%. This tells us that, while cost of revenues are equal on a proportional basis, Whole Foods runs a far more efficient operation. This is particularly significant considering The Fresh Market has 13% of Whole Foods’ workforce despite having 40% of its store base.
A Makeover to Boost Margins?
What this tells us is that Apollo may believe it can wring more efficiencies out of The Fresh Market, as is often the case with private equity companies. Firms like Apollo will buy out a company and then institute a top-to-bottom reworking of operations to increase margins and cash flow. Once the business has been optimized, private equity will often exit the deal by putting the company out via an IPO again.
I think this may be why Apollo jumped into this business. Another tip-off is that George Golleher, the former chief executive officer of grocery chain Smart & Final (NYSE: SFS) is a co-investor in the deal with Apollo.
This is an interesting partnership, and Golleher is obviously experienced in this area. While I think Apollo overpaid for The Fresh Market, it is telling that it paid the same relative valuation as Whole Foods is worth. That suggests that Apollo management thinks the market should value The Fresh Market at an equivalent valuation. Considering competitor Sprouts Farmers Market (NYSE: SFM) trades at 32 times earnings, Apollo may even think it could be worth even more, which is why it did the deal.
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