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Buy Regis Corp (RGS) v2

Doug Bennett

September 9, 2013

sholker [printed: August 29, 2007 8:03 AM] [saved: August 29, 2007 8:19 AM] C:\Documents and Settings\sholker\Desktop\Sholk\Presentation\Sholk Molecular Diagnostics Presentation Final.ppt

1

Thesis

• Turnaround management in charge of the newly restructured Regis Corp. (RGS)

believes the fair market value of RGS common stock is at least $24 per share, or

50% above the current trading price of $15.60

• The $24 minimum fair value can be inferred from language in the FY2013 10-K

outlining the methodology and results of the company’s annual goodwill

impairment tests (and is in line with RGS earning a minimum required ROIC)

• Despite this fair value opinion, the stock price is depressed due to concerns about

continued deterioration in the company’s North American salon operations

• However, new management’s turnaround initiatives - which were mostly

implemented during the most recent quarter (after 9 months of preparation) and are

focused on copying operating best practices of its best internal operators,

franchisees, and external peers, will likely result in the improved operating results

currently envisioned by management and a stock price of at least $24 within 1-2

years


2

RGS management thinks stock is worth at least $24

• In the recently filed FY2013 10-K, the company’s annual goodwill impairment tests

on its North American salon concepts are outlined in enough detail that one can

back into management’s base case fair value for RGS stock of at least $24

• Step 1: Estimate book value of North American assets by concept, excluding

goodwill

• Step 2: Add each concept’s GAAP goodwill (given in the 10-K) to its estimated

book value to find the approximate carrying value of each concept

• Step 3: Mark up the carrying value of each North American concept to the fair

value estimate obtained during the goodwill impairment tests (implied by

language in the 10-K)

• Step 4: Add the estimated values of the international salon and North

American beauty school businesses to estimate management’s base case fair

market value for the RGS enterprise and equity


3

Step 1: Estimate book value of each NA concept

• Though the book value of assets by North American concept is not available

(confirmed with Regis VP of FP&A/IR, Paul Dunn), we can borrow aspects of

management’s method of allocating corporate overhead among concepts by

percentage of company-owned salons when valuing individual concepts to estimate

the book value of each concept’s assets

• “The carrying value of each reporting unit is based on the assets and liabilities associated with the

operations of the reporting unit, including allocation of shared or corporate balances among reporting

units. Allocations are generally based on the number of salons in each reporting unit as a percent of

total company-owned salons.” – Regis Corp. 2013 10-K

Estimated book asset values of North American salon concepts

Total company assets @ June 30, 2013 1,390.5

Less: total goodwill (460.9)

Less: estimated book value of international assets (59.4)

Less: equity investments (43.3)

Total NA assets (excl. goodwill & equity investments) 826.9

NA company-owned salons by concept @ June 30, 2013 Percent of total Total

Regis Salons 12% 862

MasterCuts 8% 532

SmartStyle / Cost Cutters (in WMT) 35% 2,490

SuperCuts 17% 1,210

Promenade 28% 1,990

Total company-owned salons 100% 7,084

Estimated NA assets by concept (excl. goodwill and equity investments) Percent of total Total

Regis Salons 12% 100.6

MasterCuts 8% 62.1

SmartStyle / Cost Cutters (in WMT) 35% 290.6

SuperCuts 17% 141.2

Promenade 28% 232.3

Total NA assets (excl. goodwill and equity investments) 100% 826.9


4

Step 2: Add GAAP goodwill to find carrying value

• Add the GAAP goodwill by concept (given in the 2013 10-K) to each concept’s

estimated GAAP book value

Estimated book asset values of North American salon concepts, including goodwill

GAAP goodwill by concept @ June 30, 2013

Regis Salons 35.0

MasterCuts 4.7

SmartStyle / Cost Cutters (in WMT) 49.3

SuperCuts 129.6

Promenade 242.4

Total GAAP goodwill 460.9

Estimated NA concept value including GAAP goodwill

Regis Salons 135.6

MasterCuts 66.7

SmartStyle / Cost Cutters (in WMT) 339.9

SuperCuts 270.8

Promenade 474.7

Estimated NA concept value including GAAP goodwill 1,287.8


5

Steps 3&4: Add fair value mark-up, value the equity

• Management states in the 10-K that “for the fiscal year 2013 annual impairment

testing of goodwill, the estimated fair value of the Regis salon concept reporting

unit exceeded the carrying value by approximately 9.0 percent” and that “the

respective fair values of the Company's remaining reporting units exceeded

carrying value by greater than 20.0 percent at June 30, 2013”

• Accordingly, I mark up the estimated carrying value of each concept (book asset

value + goodwill) to the minimum fair value estimate implied by the 10-K language

Adjusted Regis enterprise and equity values implied by goodwill impairment tests

Adjusted NA enterprise value implied by goodwill impairment tests Mgmt. minimum markup

Regis Salons +9% 147.8

MasterCuts +20% 80.1

SmartStyle / Cost Cutters (in Wal-Mart) +20% 407.9

SuperCuts +20% 325.0

Promenade +20% 569.6

Implied enterprise value 1,530.4

Add: value of equity investments 45.5

Add: value of international segment 10.0

Less: total debt (assumes convertible notes convert at $15.28) (8.3)

Add: excess cash 88.5

Implied equity value 1,666.1

Shares outstanding 56.6

Shares underlying in-the-money options 0.0

Shares underlying convertible notes 11.3

Fully diluted shares 67.9

Implied equity value per share $24.53

Current price per share $15.60

Potential upside/(downside) 57%


6

Valuation sanity check (salon replacement cost)

• Management’s valuation on a per-salon basis appears to be rational (despite the

company not providing per salon profitability by concept), as the struggling mall-

based concepts (Regis Salons and MasterCuts) are valued below or at the bottom

end of a replacement value range and the better performing, strip-center salons

(SmartStyle/Cost Cutters, SuperCuts, Promenade) with growing franchise

businesses well above replacement value

Salon replacement cost sanity check Fair value Company Implied value per Replacement cost LTM sales per avg.

per concept ($m) salons company-owned salon* per company salon** company salon***

Regis Salons $147.8 862 $171,428 $190,000 - $240,000 $416,127

MasterCuts $80.1 532 $150,562 $150,000 - $200,000 $266,133

SmartStyle / Cost Cutters (in WMT) $407.9 2,490 $163,821 $35,000 - $45,000 $205,718

SuperCuts $325.0 1,210 $268,608 $80,000 - $130,000 $264,877

Promenade $569.6 1,990 $286,230 $75,000 - $125,000 $240,631

Source: Company SEC filings

* Includes value of the franchise business (Cost Cutters, SuperCuts and Promenade)

** Replacement cost equal to the intial capital required to construct and open a new salon (indicated in FY2012 10-K)

*** For reference, excludes LTM franchise revenue of $39.2m; franchise revenue estimated for each concept at $2.3m (Cost Cutters), $20.6m (SuperCuts) and $16.3m (Promenade)

using (concept's franchised salons/total franchised salons) x $39.2m


7

Valuation sanity check (consolidated pre-tax ROIC)

• To further triangulate, the $24 per share equity valuation corresponds to a near

future scenario where Regis’ invested capital would be earning a 10%-12% pre-tax

ROIC, likely just above the pre-tax WACC for a large, stable operator/franchisor in

the increasingly chain-dominated mass value, walk-in hair salon industry (for

reference, the riskier Regis concept was valued in the impairment test using a

13.5% WACC)

• Put differently, management’s valuation is realistic if they think the business might

stabilize and earn its cost of capital in response to recent strategy changes, as the

largest operator/franchisor in a highly competitive, but stable industry

Consolidated pre-tax ROIC sanity check

Adjusted NA enterprise value implied by goodwill impairment tests 1,530.4




Normal range (current RGS multiple = 7.0x) Median forward

Comparable EV/EBITDA multiples* 6.5x 7.0x 8.0x 8.8x

Implied future Regis consolidated EBITDA 244 227 198 179

Less: adjusted LTM depreciation and amortization 84 84 84 84

Implied future consolidated Regis EBIT 160 143 115 96

Regis current invested capital** 1,187 1,187 1,187 1,187

Implied future pre-tax ROIC 13.5% 12.0% 9.7% 8.1%

Source: Bloomberg, company filings

* For current comparable trading multiples, see Appendix I

** Invested capital calculated as total assets less non-interest bearing current liabilities @ 6/30/13


8

Mgmt. believes ~$200m EBITDA possible

• The compensation discussion in the recently filed proxy statement confirms

management believed at FY’13 beginning that Regis could get to such earning

potential (~$200m EBITDA, 10% pre-tax ROIC) but admitted that these goals were

optimistic in retrospect given then newly-hired management team’s later decision to

concentrate three major, temporarily disruptive strategy changes in Q3 and Q4

• The turnaround and march back to a sufficient ROIC hasn’t taken hold just yet, as

LTM adjusted EBITDA of $125m fell far short of targets (3.5% ROIC); the two

estimates available in Bloomberg would suggest no improvement is in sight


9

Stock price implies little to no EBITDA growth

• Regis’ current EV/LTM EBITDA multiple of ~7.0x, near the lower bounds of an

admittedly rich trading range (median 8.6x, average 8.8x, specialty retail buyouts

usually 8.0x-10.0x in last 5 years), suggests market participants are at best pricing

in EBITDA stabilization at the current depressed level (see Appendix I for comps)

• The skepticism is a result of Regis being over a year into an intuitively simple but

extensive operational turnaround (new CEO Dan Hanrahan just hit 1 year) that has

not yet produced desired same-store sales and EBITDA growth

Regis turnaround has not yet taken hold

2006 2007 2008 2009 2010 2011 2012 2013

Consolidated sales (-ex sales of divested Hair Club business) $1,994 $2,166 $2,340 $2,289 $2,217 $2,180 $2,122 $2,019

% growth 8.6% 8.1% -2.2% -3.2% -1.6% -2.7% -4.9%

Adjusted EBITDA (-ex est. Hair Club EBITDA and corp. overhead) $251 $278 $248 $226 $203 $191 $125

% growth 10.6% -10.9% -8.8% -10.0% -5.8% -34.5%

EBITDA margin 11.6% 11.9% 10.8% 10.2% 9.3% 9.0% 6.2%

Same-store sales growth

SmartStyle -1.9% -4.3% -1.1%

Supercuts 0.1% -0.3% -0.7%

MasterCuts -0.7% -3.3% -5.1%

Regis -2.5% -4.2% -3.1%

Promenade -2.6% -2.7% -2.8%

Total North American salons -1.8% -3.2% -2.3%

International salons -3.1% -9.1% -4.3%

Total same-store sales growth -1.9% -3.5% -2.4%

Source: SEC filings, management presentations, analyst estimates (FY2007-FY2011 adjusted EBITDA -ex Hair Club)

FYE 06/30


10

Regis’ mall-based salons are challenged...

• Regis’ mall-based salons (Regis Salons and MasterCuts) continue to struggle and

the company indicates in the 10-K that the fair value for the Regis Salons concept

is “reasonably likely” to decline in future goodwill impairment tests, where

“reasonably likely” refers to an occurrence "that is more than remote but less than

probable in the judgment of the Company”

North American mall salon performance

(all company-owned) 9-30-10 12-31-10 3-31-11 6-30-11 9-30-11 12-31-11 3-31-12 6-30-12 9-30-12 12-31-12 3-31-13 6-30-13

Regis Salons

Total sales 107.5 108.9 109.6 108.2 104.9 104.6 105.5 99.8 96.9 95.4 94.1 91.2

% of total company-owned salon sales 20.2% 20.6% 20.4% 19.9% 20.1% 20.2% 20.1% 19.2% 19.5% 19.2% 19.0% 18.5%

Number of salons 1,050 1,043 1,031 1,023 1,016 1,002 978 953 937 912 882 862

% of co.-owned total salons 14.0% 13.9% 13.7% 13.6% 13.5% 13.3% 13.0% 12.7% 12.5% 12.1% 11.7% 11.5%

Sales per average salon $102,434 $104,088 $105,678 $105,384 $102,860 $103,696 $106,573 $103,314 $102,505 $103,226 $104,899 $104,635

YoY growth 0.4% -0.4% 0.8% -2.0% -0.3% -0.5% -1.6% 1.3%

Same-store sales, service -4.5% -4.9% -6.1% -6.4% -4.2% -2.9% -2.6% -3.0%

Same-store sales, product 1.6% 2.9% 1.1% 1.3% -1.5% -4.6% -3.4% -2.4%

Same-store sales, total -3.5% -3.5% -4.8% -5.1% -3.8% -3.2% -2.7% -2.9%

MasterCuts

Total sales 42.0 41.3 41.8 40.6 40.5 40.3 40.5 38.3 37.9 37.6 36.5 34.5


Number of salons 597 596 593 588 590 587 578 569 566 556 541 532


Sales per average salon 70,242 69,229 70,288 68,769 68,691 68,467 69,612 66,828 66,839 67,030 66,540 64,257

YoY growth -2.2% -1.1% -1.0% -2.8% -2.7% -2.1% -4.4% -3.8%


Same-store sales, product -1.0% 3.1% 4.3% 2.9% -1.6% -4.8% -11.7% -5.6%


Quarter ending


11

…but RGS upside exists assuming $0 mall salon value

• Put differently, a newly installed, high-caliber management team thinks there is a

~10%-50% chance the Regis concept will be worth less than the $150m value

ascribed to it at June 30, 2013

• That said, even assuming the mall salon concepts are immediately marked to $0

value, RGS stock is still worth ~$20 per share (+35%) if management’s valuations

on the North American strip center concepts are credible

Adjusted Regis enterprise and equity values implied by goodwill impairment tests

Adjusted NA enterprise value implied by goodwill impairment tests Mgmt. minimum markup

Regis Salons +9% 0.0

MasterCuts +20% 0.0

SmartStyle / Cost Cutters (in WMT) +20% 407.9

SuperCuts +20% 325.0

Promenade +20% 569.6




Less: total debt (assumes convertible notes convert at $15.28) (8.3)

Add: excess cash 88.5

Implied equity value 1,438.2

Shares outstanding 56.6

Shares underlying in-the-money options 0.0

Shares underlying convertible notes 11.3

Fully diluted shares 67.9

Implied equity value per share $21.18

Current price per share $15.78

Potential upside/(downside) 34%


12

RGS-owned strip center/Wal-Mart salons struggling…

• Sales at North American company-owned salons in strip centers and Wal-Mart

(72% LTM sales) had apparently begun to stabilize over the last year until the most

recent quarter, leading to renewed pessimism about management’s ability to drive

the SSS growth required for RGS to once again earn a competitive ROIC (full sales

statistics for these salons can be found in Appendix II)

• However, of the -3.1% consolidated same-store service sales decline recorded in

the most recent quarter, management attributes -0.7% to a shift in Easter from Q4

to Q3 in FY2013 and “much of the remaining decline” to temporary but material

disruptions caused by a complete field reorganization and company-wide

implementation of a new POS system and salon workstations during Q4’13


13

…but copying best operators is likely to work

• These initiatives - along with implementation of a simplified inventory plan-o-gram

requiring markdown sales of dropped SKU’s and a revised product reset in all North

American company-owned salons, which disrupted product sales - were required to

bring company-owned salons’ operating practices in line with those of Regis’ best-

performing internal operators, franchisees and well-operated external peers

• These initiatives were largely completed at quarter end June 30, 2013 and

management suggested in late August 2013 that “FY2014 (July ‘13 – June ‘14) will

be our year of transition and execution”


14

Best operator arbitrage has worked before

• Copying best practices of industry’s best operators (internal and external) to bring

up performance in struggling stores in a multi-unit retail operation is a tried and true

turnaround strategy and should lead in time to Regis earning a competitive ROIC

• Regis’ strategy is similar to that used in the successful turnaround of El Pollo Loco

(and later Red Robin Gourmet Burgers) under CEO Steve Carley

• “Start focusing your team on benchmarks that reflect the best-in-class performance…One way to do that is to look for

people both inside and outside the organization, or even the industry, who reflect the absolute highest level of

performance. Then you can track your performance against theirs…Carley says this holds your employees to a higher

standard, and it has helped El Pollo Loco reach new highs in guest service and satisfaction…So once you’ve created

straightforward metrics that establish the standard for success, from both a customer and employee standpoint…“You

need to take operating information and convert it into information that you can’t ignore,” Carley says. “So you create a

set of metrics based on what you are trying to accomplish, so that it’s clear to the casual observer who is achieving or

overachieving and who is not, and in a way that they can’t ignore it…At El Pollo Loco, that information conversion is so

simple that if you understand how a traffic light works, you’ll know if a particular store is a top performer. Restaurants

that are hitting the benchmarks get to hoist a green flag in their stores with pride. Restaurants that are just a bit below

their target metrics post a yellow flag, and the stores with significant work to do operate under a red flag. The relevant

information is dissected on a monthly basis, ranked for that month, and then publicly reviewed by management. The

key is getting the metrics and benchmarks right and then tracking them closely and publish their performance under a

harsh spotlight for everybody to see,” Carley says. “Your best employees will respond to that and step up, and your

marginal ones will either improve or leave.”

(http://www.sbnonline.com/index.php?option=com_k2&view=item&id=17565)

• Per RGS CEO Hanrahan, “We have a scoreboard we use to monitor improvements

in sales performance. In July, 15% of our districts were positive, or green as we

refer to it, and as of yesterday our August total increased to 26%.”

http://www.sbnonline.com/index.php?option=com_k2&view=item&id=17565

http://www.sbnonline.com/index.php?option=com_k2&view=item&id=17565


15

Improved operator effect on RGS EBITDA

• Annual sales per avg. company-owned salon were $250k-$280k across the

Promenade and SuperCuts concepts vs. $280k-$340k for Regis franchised salons

and an estimated avg. $300k-$320k for competitors Great Clips and Sports Clips

• Accordingly, in the event Regis’ turnaround strategies worked, same-store sales

would likely rise 10%-15% from the current level to reach those realized by best-in-

class internal and external peers

• Since a 1% rise in company-wide same-store sales equates to $8m-$9m

incremental RGS EBITDA, 10%-15% SSS growth would equate to $80m-$135m

incremental EBITDA and the Regis enterprise earning a realistic, competitive pre-

tax ROIC of 10%-15%

EBITDA and ROIC potential of a best-in-class operated Regis

LTM adjusted EBITDA 125.4

Same-store sales growth due to best-in-class arbitrage 10% 15%

Incremental EBITDA on 1% SSS growth 8.0 9.0

Incremental EBITDA on best-in-class arbitrage 80.0 135.0

Future Regis EBITDA 205.4 260.4

Less: adjusted LTM depreciation and amortization 84 84

Future Regis EBIT 121.8 176.8

Regis current invested capital* 1,187 1,187

Implied future pre-tax ROIC 10.3% 14.9%

* Invested capital calculated as total assets less non-interest bearing current liabilities @ 6/30/13


16

Probability-weighted upside/downside

• In this realistic turnaround scenario, the RGS stock price likely rises 50%-100%

• The equity downside for an uncompetitive retailer that doesn’t own its properties is

$0 given a highly-levered, lease-based business model, but a strategy based on

copying best operators in a stable industry should work

• That said, the evidence suggests it won’t be anything close to a $0 in the bear case

as there are pockets of well-operated company-owned salons that should remain

viable, Regis just renegotiated a 5 year credit line of $400m (excluding a +$200m

option) and the company’s ~$40m franchise revenue stream is growing

Upside in a Regis turnaround scenario

Future EBITDA 205 260

EV/EBITDA multiples* 6.5x 7.0x 8.0x 8.8x 6.5x 7.0x 8.0x 8.8x

Future enterprise value 1,335 1,438 1,643 1,807 1,692 1,823 2,083 2,291

Add: value of equity investments 45.5 45.5

Add: value of international segment 10.0 10.0

Less: total debt (assumes convertible notes convert at $15.28) (8.3) (8.3)

Add: excess cash 88.5 88.5

Implied equity value 1,471 1,573 1,779 1,943 1,828 1,958 2,219 2,427

Shares outstanding 56.6 56.6

Shares underlying in-the-money options 0.0 0.0

Shares underlying convertible notes 11.3 11.3

Fully diluted shares 67.9 67.9

Implied equity value per share $21.65 $23.16 $26.19 $28.61 $26.92 $28.83 $32.67 $35.73

Current price per share $15.78 $15.78

Potential upside/(downside) 37% 47% 66% 81% 71% 83% 107% 126%

* For current comparable trading multiples, see Appendix I

Appendix


18

Appendix I: Comparable trading multiples @ 9/2/13

Comparable company Enterprise Value ($b) LTM EBITDA ($b) Fwd EBITDA ($b) EV/EBITDA (LTM) EV/EBITDA (Fwd)

Coinstar (Outerwall Inc.) $2.0 $0.436 $0.496 4.5x 4.0x

Advance Auto Parts $5.9 $0.865 $0.889 6.8x 6.7x

Fred's Inc. $0.6 $0.083 $0.090 6.9x 6.3x

Regis Corp. $0.9 $0.125 $0.112 7.0x 7.9x

Jack in the Box $1.7 $0.233 $0.233 7.3x 7.3x

Revlon Inc. $2.3 $0.296 $0.281 7.8x 8.2x

Brinker International $3.3 $0.389 $0.436 8.4x 7.5x

H&R Block $7.6 $0.883 $0.910 8.6x 8.4x

Penn National Gaming $6.4 $0.727 $0.817 8.8x 7.8x

The Cheesecake Factory $2.1 $0.233 $0.245 9.1x 8.6x

Service Corporation International $5.6 $0.614 $0.608 9.1x 9.2x

Cracker Barrel Old Country Store $2.7 $0.272 $0.272 9.8x 9.9x

Sally Beauty Holdings $6.0 $0.571 $0.603 10.4x 9.9x

DineEquity $2.6 $0.238 $0.259 10.8x 10.0x

Fossil Inc. $6.6 $0.593 $0.624 11.1x 10.6x

Panera Bread Co. $4.5 $0.400 $0.428 11.2x 10.5x

Boyd Gaming $5.9 $0.483 $0.657 12.2x 9.0x

Green Mountain Coffee Roasters $13.0 $0.962 $1.006 13.5x 12.9x

Ulta Salon Inc. $6.0 $0.382 $0.453 15.8x 13.3x

Source: Bloomberg, company fi l ings/mgmt. presentations

Median 9.1x 8.6x

Average 9.4x 8.8x


19

Appendix II: NA strip center salon sales (RGS-owned)

North American strip-center

salon performance (company-owned) 9/30/10 12/31/10 3/31/11 6/30/11 9/30/11 12/31/11 3/31/12 6/30/12 9/30/12 12/31/12 3/31/13 6/30/13

SmartStyle / Cost Cutters (in Wal-Mart)

Total sales, -ex estimated franchise sales 132.0 129.1 136.5 131.2 127.9 125.4 133.1 125.3 122.4 126.8 132.0 126.0


Number of salons 2,392 2,413 2,385 2,393 2,407 2,423 2,432 2,441 2,453 2,470 2,484 2,490



YoY growth -3.8% -3.4% -3.6% -6.4% -6.1% -0.8% -2.8% -1.5%

Same-store sales, service -3.6% -3.7% -6.2% -6.3% -4.5% 0.8% 2.6% 0.6%

Same-store sales, product -4.3% -3.7% -2.9% -1.2% -3.4% -0.2% -4.2% -4.4%

Same-store sales, total -3.8% -3.7% -5.1% -4.6% -4.2% 0.5% 0.3% -1.1%

Promenade*



Number of salons 2,381 2,372 2,356 2,335 2,307 2,258 2,192 2,147 2,120 2,081 2,043 2,010



YoY growth -0.5% -0.4% 3.8% 0.0% -0.3% 1.7% -0.5% 1.0%


Same-store sales, product -5.7% -2.8% -1.0% -3.0% -4.1% -5.6% -3.4% 4.0%


SuperCuts



Number of salons 1,096 1,099 1,121 1,147 1,170 1,197 1,214 1,222 1,227 1,226 1,226 1,218


Sales per average salon 67,961 67,041 67,250 69,158 67,333 67,153 67,301 68,268 66,886 65,313 65,771 65,813

YoY growth -0.9% 0.2% 0.1% -1.3% -0.7% -2.7% -2.3% -3.6%

Same-store sales, service 0.0% -1.1% -0.3% 0.5% 1.4% 0.5% 1.3% -4.9%

Same-store sales, product -4.3% -3.0% 2.3% 0.4% -0.5% -1.2% -3.7% -4.0%

Same-store sales, total -0.5% -1.3% 0.0% 0.5% 1.2% 0.3% 0.7% -4.8%

Source: SEC filings, company presentations

* Promenade Salons operate under the primary concepts of Hair Masters, Cool Cuts for Kids, Style America, First Choice Haircutters,

Famous Hair, Cost Cutters, BoRics, Magicuts, Holiday Hair, Fiesta Salons, TGF and others

Quarter ended