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“ The best business is a royalty on the growth of others, requiring little capital itself.” — Warren Buffett, 1978

I was six years old when I first started to learn the wisdom of these words (Eugene here). My parents had just decided to pursue the American dream of owning their own business. My father was making a modest living as an entry-level engi-neer at Mobil (before it became ExxonMobil), and my mother taught math at the local community college.

They had immigrated to the United States from China for their graduate studies, and over the years had scrimped and saved every dollar they possibly could. So in 1982 they took their entire life savings of $150,000 and opened a small electronics retail store in the local shopping mall called Team Electronics.

Team Electronics operated as a franchise model. My parents were the “franchisees,” the owner/operators of their own indi-vidual unit store. This means that they took their own capital and built and operated the store. Team Electronics the parent company was the “franchisor” and provided the business tem-plate to my parents: training, suppliers, advertising, etc.

In return for these services, Team Electronics the parent company would get paid a royalty fee of 6% of all sales. In return for their hard work, my parents would earn a profit of whatever’s remaining after this royalty fee and all other operating expenses were deducted.

And what hard work it was. Every waking hour of every day was spent dealing with retail customers, managing employees, escalating rents, learning accounting, tracking inventory, etc. On weekends I would earn 25 cents for

Exponential Compounding on the Back of Healthy Living

Portfolio OpsAbove Average Odds Investing’s

Portfolio Ops — Jamba Juice (JMBA) March 4, 2013

Action to take: Buy Jamba Juice (JMBA) up to $3.00 per share.

Target: $8.00–10.00 per share over 3 to 5 years

Risk: Low

Synopsis: Jamba juice presents an opportunity to purchase a high quality owner operated compound-ing machine at a mid single digit multiple of YE 2013 owner earnings. With a current enterprise value of only ~$180m investors can purchase the company’s owned store base at a sizable discount to true value and get a bevy of high margin, annuity-like recurring revenue streams from their franchise and royalty segments for free.

March 2013 Issue 001

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cleaning the store toilet. On a Friday night after working until 4 a.m. my parents were too exhausted to safely make the drive home, so we stayed at the La Quinta motel across the street. The next morning we had to be back at the store at 9 a.m. to open. After many years of extremely hard work, my parents eventually parlayed this rocky start into a suc-cessful business and realized their American dream.

It didn’t take me long to realize that it was a much better busi-ness proposition to be the franchisor than the franchisee. For example, in the early years our store might have annual sales of $500,000. After paying all the expenses, my parents were lucky to take home $20,000. Based on their initial investment of $150,000, they were earning a 13% return, which doesn’t sound too horrible. But remember, that’s after risking their entire life savings, both working over 100+ hours per week, taking on all the risk of purchasing inventory and long-term lease obligations, not to mention the stress and headaches of running your own business.

As the franchisor, Team Electronics the parent company would earn about $30,000 (6% of annual sales of $500,000) from my parents’ store. What did they risk to earn this $30,000? Almost nothing. They had already developed the business model tem-plate, so all they had to do was provide a few weeks training to my parents and some occasional support.

What if my parents’ store had a bad year and only sold $400,000 of electronics? My parents would pray to break even, but Team Electronics the franchisor would still earn $24,000. In other words, to earn this perpetual income stream of $24,000 to $30,000, Team Electronics the fran-chisor undertook no risk, and invested almost no capital.

Warren Buffett captured a powerful insight in just a few words: “The best business is a royalty on the growth of others, requir-ing little capital itself.” Indeed! It would be almost 25 years later when I first read this nugget of wisdom by Buffett. But then again I didn’t really need to, because it was already firmly etched into my mind from cleaning toilets.

Framing the Opportunity: The Power of the McDonald’s

Franchise Model

Imagine for a moment that you could go back in time and buy a piece of one of the all-time great businesses in the

world: McDonald’s (MCD). Imagine that you could go back to 1968 when it had less than 1000 restaurant loca-tions, before it’s explosive growth to over 33,000 units today. What makes McDonald’s such a great business?

It has an extremely strong brand and mind-share across the globe. Three times a day at every meal is an opportunity for McDonalds to generate income from almost the entire world’s population.

An equally important reason for McDonald’s business success is its franchise business model.

McDonald’s gets a continuously recurring stream of income from every single item of food consumed in each of its 33,000 restaurants around the world, 365 days a year. From every Coca-Cola that you buy for $1.80, McDonald’s (the franchisor parent company) receives over 20 cents (McDonald’s royalty is 12% of sales). It’s a business model that is superior even to Coca-Cola itself.

McDonalds’s is truly one of the greatest perpetual annuity income streams in the world. It is a very low risk, capital-light business model generating income from the sales of each franchisee. This franchise model virtually ensures that McDonald’s will always generate a profit, regardless of the economy or fluctuating food sales. In some ways, it’s more akin to a utility in the stability and predictability of its cash flow generation, versus the ups and downs you would find in a typical restaurant business.

Let’s examine a critical phrase from Buffett’s quote, “… requir-ing little capital itself.”

Given the nature of the franchise model, the vast majority of McDonald’s profits can flow down to the benefit of the share-holders (via dividends, buybacks, or reinvested for growth), without impairing it’s competitive position or future earnings capacity. This is because the franchisees, like my parents, are on the hook for all of the negative aspects of the business: escalating expenses with inflation, large capital expenditures required just to maintain the physical assets, etc.

All of these negatives consume capital, reduce profits, and make it difficult to grow the business. Not only do the franchisees bear the weight of having to continually reinvest capital back into the business just to keep it running, but they must also invest all of the capital required to open additional locations.

On the other hand, McDonald’s the franchisor is a much

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more attractive business because it is not required to expend its capital on these negatives. It may choose, however, to rein-vest a small portion of its profits towards creating a stronger brand. By doing so, McDonald’s can increase sales at existing locations and encourage growth through franchisees opening new locations. Thus, the franchise business model creates a strong virtuous cycle of an ever-growing royalty stream of cash, requiring little capital itself.

Another important element of the franchise model is the lack of negative operating leverage. Negative operating leverage is bad: if sales drop by a few percent, then profits will drop by a much greater percentage. This is usually due to the burden of large fixed costs required just to stay open for business.

For an example, let’s return to my parents’ small retail electron-ics store. In an average year, the store would generate $500,000 in sales, with a gross profit of $200,000 (i.e. 60% cost of goods sold, or a 40% gross margin). Their fixed costs such as rent, util-ities, and employees would be about $180,000. So, they would be left with a net profit of only $20,000. Heaven forbid if they had a bad year with sales declining 20% down to $400,000. The 40% gross margin would then yield a gross profit of only $160,000. But their fixed costs would remain about the same at $180,000, wiping out all their efforts and resulting in a net loss of $-20,000. That’s negative operating leverage at work.

Conversely, the franchisor parent company does not suffer from this business problem. Because it always gets its 6% roy-alty of sales, it doesn’t matter whether sales were $500,000 or $400,000. At worst, the franchisor would still generate a profit of $24,000

One last salient point we want to highlight about the superior-ity of the franchise model is the divergent effect of inflation on the franchisee versus the franchisor. Buffett alluded to this dur-ing the 2011 Berkshire Hathaway annual meeting: “Ideally to protect against inflation, you want a royalty on someone else’s sales so you don’t have to invest any more capital… you make money as their volume grows.”

Rising food costs from inflation generally hurts the franchisees operating the restaurants because it crimps the profit margins. Soon, inflation will force the franchisee to raise prices simply to maintain the same nominal level of profitability. However, in a perverse twist of economics, what is the franchisee’s pain ultimately becomes the franchisor’s gain. Because the franchi-sor receives a fixed percentage of the top line food sales, these

price increases will fall directly to the bottom line resulting in higher profits. In other words, inflationary forces will provide a perpetual tailwind of rising profits, instead of a continuous headwind depressing profits.

What if my parents had invested their $150,000 life savings, not by becoming a franchisee of Team Electronics, but instead by buying stock in the franchisor McDonald’s? What if they could have bought it in 1968 when McDonald’s had just opened its 1,000th store?

In many ways, this would have been a very low risk invest-ment. By then McDonald’s franchise business model was already perfected by Ray Kroc, was geographically diverse, and was very profitable. It did not require any unusual cre-ative foresight to see the potential runway of growth. Indeed, the potential should have been self-evident if only they had fully understood the power of the franchise business model at that time.

Well, it pains me to say that my parents would now be worth over $35 million, and I wouldn’t have had to clean any toilets.

So the question some of you may be asking is: if McDonald’s is so great, why not buy McDonald’s stock now? Well, it’s already a $100 billion company. While there’s always some room for growth, the tailwind is not nearly as great as it was 40 years ago. Also, the stock is not an extremely cheap value, trading at about 18x earnings.

What we want to find is the McDonald’s of 1968: a wonder-ful business with similarly attractive economic characteristics, set to ride a tidal wave of growth over the coming decade, trad-ing at a very cheap price today that does not factor in any of its enormous potential. And that, dear readers, brings us to this issue’s recommendation: Jamba Juice (JMBA).

The Jamba Juice Turnaround

Flying low under the radar of Wall Street, Jamba Juice has executed a remarkable transfor-mation over the last four years to become the ideal franchise business model. Today it is on the cusp of becoming a huge global brand riding the tailwind

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growth trend towards healthy active living.

Despite relatively few stores (780 units) and low geographic market penetration, Jamba enjoys extremely strong brand recognition, consistently ranking high in association with a healthy active lifestyle, similar to brands such as Whole Foods and Chipotle. The nearest Jamba Juice to my home is several hours away, yet all of my neighbors have heard of the brand and associate it with healthy fruit smoothies, even though they’ve never actually been to one of the stores.

While many people recognize the Jamba brand, the stock has been completely ignored. It is a microcap with a market cap of only $200 million. As a publicly traded company, Jamba has had a poor showing for much of its history.

Jamba became public in 2006 as the leading concept store selling fresh fruit smoothies with ambitious plans for growth. However, its business model at that time was your typical capital-intensive fixed-cost restaurant. Over 70% of the locations were company owned and operated, and less than 30% were franchised. In a misguided attempt to grow 30% annually, many operational problems immediately began to surface. Profit margins at the company-owned units declined from 20% down to below 10%. Rather than grow, the sales at each store actually declined 8%. Soon, the company post-ed losses of $150 million (a lesson in the perils of negative operative leverage). Within two short years, the stock imploded from $12 to pennies.

In late 2008, Jamba Juice began one of the most remarkable corporate turnarounds we’ve ever witnessed. First, to avert terminal cardiac arrest the company raised $32 million of

cash through a preferred stock issue, bring-ing some much needed financial stability. Second, in December 2008 they brought on board one of the best CEO’s we’ve ever seen: James White.

Previously, White worked with one of the greatest executives in the corporate turn-around game, Jim Kilts who orchestrated Gillette’s spectacular success. Later, White became a brand builder by developing the consumer-packaged goods (CPG) business within Safeway, responsible for brand strat-egy, innovation, manufacturing, and sales.

Jamba hired White for his skills both as a corporate turnaround specialist for the near-term, and as a brand builder to help drive growth for the long-term. White is a CEO who is not flashy and does not oversell. He intensely focuses on the “Plan,” and more importantly, the solid execution of the plan. Since 2009, this management team has literally made all the right strategic moves, and exe-cuted them with remarkable speed and effectiveness. Let’s take a closer look at some of them.

White’s first order of business was to restore the business to profitability. If a business is not profitable, over time it will bleed cash and eventually go under. White had to make the difficult decision, as CEO of a newly public company, to give up on growing revenues for the sake of improving profitabili-ty. Wall Street hates declining sales, and while obviously the correct long-term decision, it can be a painful transition in the short-term. White’s game plan was to gradually transform Jamba to become a franchisor, because he recognized it was such a vastly superior business model.

To make this transformation, Jamba Juice started to sell many of their poorly performing company-owned stores to franchisees. These poorly performing Jamba Juice units gen-erate less than $500,000 in sales (the better performing stores which Jamba kept generally average more than $700,000 in sales). By refranchising this store, Jamba would give up these “revenues,” but in return it would get $30,000 (6% royalty fee) each year.

As a franchisor parent company, this $30,000 would be the new number that Jamba would report to Wall Street as reve-nue. While much lower, the important point is that this is

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nearly all profit. In the process of this conversion, Jamba would sell these units to a franchisee for an average of about $215,000. With this kind of transaction, White simultane-ously killed two birds with one stone: convert a money losing asset into a cash generating machine, and immediately raise some cash to help keep the company afloat.

For the franchisees, they would be getting a Jamba unit a great price. On average, it takes about $500,000 to build a new Jamba unit from scratch. So by purchasing this existing unit from Jamba for $215,000, the franchisee got a great deal and is off to a good start. It’s a mutually beneficial transaction. It is also encouraging to see that many of these franchisees that bought the units from Jamba were already current Jamba franchisees — signaling that they believed in the strength of the brand and the turnaround efforts.

White’s goal is to eventually make the transformation so that about 80% to 90% of its stores are franchised, and 10% to 20% would remain company-owned (as of today, almost 60% are franchised). In the depths of 2009, however, over 70% were company owned. Therefore, White also had to simulta-neously focus on restoring profitability at the company owned units. Within a short period of time, White improved same-store sales, reduced the cost expense of food supplies, reduced the cost of labor, and dramatically improved profit margins.

If all that wasn’t enough, Jamba also desperately needed to diversify away from smoothies. Selling only smoothies car-ried many drawbacks. It concentrated the majority of sales within a narrow window in the afternoon, which caused operational and throughput inefficiencies. So, the strategy was to create high-quality food offerings that would help drive sales throughout the entire day. Jamba’s first offering

was an award winning steel-cut oatmeal, which was a great success. Jamba soon expanded to offering wraps, flatbreads, and kid’s menu items.

Growing the Brand Beyond Just Juice

Within three short years, Jamba has transformed its core business from an unprofitable one-trick pony, into a com-plete quick service restaurant alternative with an extremely strong niche brand associated with healthy active living. The company has also converted to a highly profitable low-risk capital-light franchise business model. And the really great news is that Jamba has barely gotten started. Its goal is to become the leading health and wellness brand in the world. With the turnaround completed, Jamba can now focus on growing its brand. Let’s look at some of their strategies and initiatives to illustrate why your editors are so excited about the company’s plans and long-term potential.

Consumer-Packaged Goods: Jamba is extending their brand into every Wal-Mart, Costco, grocery, and convenience store near you. They are partnering with other companies to develop products such as smoothie kits for home, frozen yogurt bars, trail mix, and energy drinks. These deals are very favorable for Jamba in that they are similar to the franchise royalty model. Jamba gets paid a licensing fee of 3% to 5% of every sale.

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Jamba offers their brand name and helps develop the product and marketing. The partnering companies will be responsible for all the heavy lifting including production, packaging, and distribution. In other words, the other companies will carry the burdens of fixed-costs, capital investments, and manageri-al responsibilities. Jamba simply sits back and collects checks. Jamba’s expenses for developing and growing this operation are very low — basically just a handful of employees.

Sales growth within this nascent segment has been phenome-nal. Jamba started with home smoothie kits, and sales in 2010 were only a few million dollars. This grew to $50 million in 2011, and is estimated to be $150 million for 2012. Within a couple more years, this should easily be a $500 million to $1 billion business. Remember that Jamba will get at least 3% to 5% of every sale, and this revenue stream will be almost entire-ly pure profit. With a market cap of only $200 million, to say the math is extremely compelling is quite the understatement.

JambaGo: There is a movement afoot to ban sugary soda like Coke and Pepsi from schools. It is also a public health concern that kids aren’t getting enough fruits and vegetables, and they certainly don’t like eating what the school cafeteria cooks up. So who are the tens of thousands of schools across the nation going to turn to for a solution? Why Jamba, of course! In fact, Jamba has developed a standalone unit called JambaGo specifically to be installed in schools. These units blend fresh fruit and non-fat milk to create a healthy but tasty option that kids will actually eat.

The growth has been stunning. JambaGo is a hugely value-add product that sits squarely at the center of an emerging and growing secular trend. Jamba started with a few schools in 2011, and grew to over 400 schools by end of 2012.

Management’s stated goal is to have JambaGo in over 1500 schools in 2013. The potential growth runway for this con-cept alone is mind-boggling. Jamba has not penetrated even a fraction of a fraction of the addressable market.

In the United States alone, there are over 100,000 K-12 schools, over 100,000 convenience stores, and over 5000 colleges and universities. We estimate that each JambaGo unit can earn about $2,000 to $3,000 per year for Jamba. The economics are very favorable, again, because JambaGo does not require any capital investment from Jamba. The schools pay for and operate the units. So virtually all of this revenue will be pure profit.

Even more compelling than the economics, is the branding and goodwill that JambaGo can build for Jamba. Imagine being in front of every kid every day for lunch, and providing the best-tasting menu option available in the cafeteria. No amount of advertising dollars can buy this kind of brand awareness.

Jamba has many other promising initiatives in development as well. Management is being highly selective about the loca-tion of new store units. Prime locations will be in airports, universities, and business areas like convention centers. Each store will then have the highest impact and exposure to the broadest population.

Jamba is developing a smaller format “Smoothie Station” store unit for convenience stores and entertainment venues. The company has also expanded their product offerings into energy drinks by partnering with Nestle, and into premium hot teas by acquiring Talbot Teas. Jamba is starting to offer fresh squeezed juice at their stores to capitalize on the juicing craze. (By the way, this juice bar upgrade has been extremely impressive: for an investment cost of $50,000, this upgrade has generated same-store sales growth of 50% to 100% per store!)

At several locations, Jamba is starting to add drive-thru’s in order to provide faster service and convenience, which will

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especially help drive growth in geographic areas that aren’t blessed with California weather year-round. Jamba is also actively engaging the community, such as developing a rela-tionship with the school PTA, to promote health and wellness.

The Jockey

This remarkable transformation is why we say say that James White is hands down one of the best CEO’s ever. Years from now we believe that case studies will be written in business schools about how White orchestrated Jamba’s turnaround and laid the foundation to build an enduring global brand. This is the kind of management team that you want to partner with for years to come. Within three short years, they took a one-dimensional smoothie shop with $150 million in losses, transitioned this core business to profitability, and simultane-ously developed multiple new lines of low-risk, capital-light, high-growth initiatives.

When evaluating management, I usually consider two things. First, did they do what they said they would do? Check out this extended video from three years ago when White first started at Jamba. In clear simple English, he laid out his entire plan and future strategy. It’s almost an hour long, but very well worth it, as you will come away with a deeper understanding of the com-pany and how White operates.

So we can now verify that White did indeed execute his plan in brilliant fashion. Here we have a CEO who ends all of his presentations with the mantra “Promises made will be kept!” How refreshing! Rarely have we seen this level of accountabili-

ty and execution from a CEO before. Here’s an episode from Bloomberg Television where White is a mentor to another business owner. Notice at the end, his advice boils down to “It’s all about the plan.”

http://www.bloomberg.com/video/65330968- bloomberg-the-mentor-james-white-guides-drybar.html

Second, does management have any skin in the game? Do they own a lot of stock options or restricted stock? Better yet, did they take their own cash and buy shares in the open market?

When White joined Jamba in Dec 2008 as CEO, he was granted a special package of 1.5 million stock options. Ad- ditional options have been granted over the last three years as incentive compensation and bonuses. More importantly, White has invested over $250,000 of his own cash buying stock in the open market at periodic intervals between $1.02 and $2.01 per share. While this may not seem like a lot of money if you’re a Wall Street bank executive, it is a very sig-nificant purchase relative to White’s after-tax income (annual salary: $550,000).

How Huge is the Potential Growth?

Let’s take a moment to recap here. We have an opportunity to buy shares of Jamba Juice, one of the strongest brands in the country riding on the growing trend towards healthier eating and living. Jamba has recently completed a remark-able transformation into one of the greatest business models of all time: royalty fees from franchising and licensing. The business possesses highly attractive economics with its diver-sified set of sticky, stable, high-margin revenue streams. In addition, future growth requires very little capital invest-ment, and thus carries little risk. Most importantly, this is a low risk investment because, unlike other turnaround stories, we can buy this turnaround after it has already been completed. Plus, Jamba now has $30 million in cash (over 40 cents per share), zero debt, is cash flow positive, and is headed by an exceptional CEO and management team.

Now let’s consider the future. Jamba is starting from a low base of 780 store units, and management plans to open about 50–70 new franchise units per year. Management has stated in presentations that it believes the potential number of store units is 3,700 globally. We believe that this is vastly understated.

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This is the same estimate they used five years ago, and the Jamba brand has certainly grown stronger since. Of the 3,700 units, about 1,000 are suppose to be international stores. This is certainly underestimated, as there are plans for 200 units within South Korea alone.

We don’t know exactly how many units the future will hold, but we are highly confident it is well above 3,700. For frame of reference, McDonald’s has 33,000 locations, Starbucks has 20,000, Burger King has 12,000, and Wendy’s and Dairy Queen each have about 6,000 locations.

While Jamba will never have as many locations as McDonald’s or Starbucks, we think that 5,000 to 6,000 units are definitely possible. That is more than 6x the current footprint. Add to that, the royalty fees from the consumer-packaged goods business with multibillion dollar potential, and exponentially growing revenues from JambaGo that will soon be in thou-sands of schools, and it should start to become very clear that the estimates don’t even scratch the surface of Jamba’s ultimate growth potential.

The great thing about Jamba’s growth runway is that its huge potential is not just theoretical. It has been demonstrated and proven over the last three years.

Why is it Mispriced?

And the best part of all? Wall Street has not taken any notice… yet. This microcap with a checkered past has historically report-ed losses, and its transformation has been under Wall Street’s radar. As it’s been working through the turnaround, these losses have been rapidly declining.

The primary reason why Jamba’s underlying highly attractive economic characteristics have remained hidden is that the cor-porate level general and administration expenses are relatively high ($38 million) for such a small company. This has been a deliberate decision because White wants to maintain a strong platform that can easily scale and accommodate the anticipated future growth. In addition, this was used to lay the founda-tion for developing the consumer-packaged goods and JambaGo businesses.

Your editors love situations like this where the stock’s value is obscured from cursory screens, and some extra effort is required to peel back the layers to uncover the gem. On this point, we

will quote from the always fantastic letters of East Coast Asset Management’s Chris Begg:

“… The market is less efficient in its ability to look around the corners for businesses that are not yet great, but emerging toward greatness… we are focused on seeking knowledge of the causes that will produce a meaningful inflection point of change on the economics of the businesses.” (Christopher Begg, East Coast Asset Management, Fourth Quarter 2012 Update)

Exactly! Jamba is rapidly nearing its inflection point. With Jamba’s expansion and growing cash flows, it will soon achieve enough scale where the corporate level expenses become a much smaller component and no longer mask the underlying favorable economics of this business. Stay tuned for future issues where we will examine in-depth the power of this hidden fulcrum and how it will soon flow through the underlying business into financial statements.

We expect that when Jamba reports its financials for 2012, it will likely report a profit for the first time. This will start to attract attention from the institutions. With the turnaround recently completed, White has been doing more CNBC inter-views and emphasizing the company’s plans for growth. Your editors believe that 2013 will be the year when everyone starts to take notice of Jamba’s remarkable business.

Just How Cheap is This Stock?

Today, you can buy all of Jamba’s stores, transformation, brand name, and future growth for an enterprise value of $180 million at $2.70 per share (enterprise value means the price to acquire the entire business: market cap equity plus debt less cash). For such a strong consumer brand with so much future potential, that is just dirt-cheap.

By the end of this year 2013, Jamba should be on track to generate approximately $33 million in EBITDA (or $28 mil-lion in free cash flow) in a normal year going forward. For a high quality capital-light business like Jamba with plenty of growth ahead, it should deserve a valuation multiple of 12x to 14x EV/EBITDA. Assuming 12x, Jamba would be worth about $4.90 per share, over 80% upside from today’s price. To put it another way, the current enterprise value stands at less than 5.5x our estimate of 2013’s year-end normalized EBITDA. Considering the valuation in more absolute terms, you could buy Jamba’s entire business and generate a free

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cash flow yield of over 15% by next year. And, this cash flow will continue to grow for years to come. This is just way too cheap no matter how you slice it.

Let’s look ahead three years including some reasonable estimates such as 4–5% same store sales growth, adding 70 new franchise units per year, and growing the consumer-packaged goods busi-ness and JambaGo. Jamba should be able to generate pre-tax cash flows of over $60 million, and should be worth over $8 to $10 per share — that’s 300% upside in three years. In future issues we will show in detail how the growth of each of these segments will translate into rapidly rising cash flows.

Even better, we believe that this huge asymmetric upside carries relatively little permanent downside risk. Jamba is cash flow positive, has zero debt, and has $30 million in cash (over 40 cents per share). Jamba’s turnaround is already complete, the growth strategies are already proven in the marketplace, and you couldn’t ask for better management. Finally, its high- margin, capital-light, business model of franchising and licensing helps ensure that the company can remain profitable and survive any economic downturns.

Just for kicks, let’s consider the future value of just one of the nascent hidden business segments. The sales of the con-

sumer-packaged goods business is expected to be over $150 million for 2012, triple the sales compared to the year prior. For 2013, management has guided for sales of $250m, but we think that this is severely understated. We believe that within a couple of years, this segment should generate about $500 million to $1 billion in sales.

Assuming that Jamba gets a 3% licensing fee (also likely on the low end) of $500 million, that’s about $15m of almost pure profit. This is a very reasonable estimate since management has stated a goal of $15m by 2016. Indeed, it may prove very conservative, given management’s long history of under promising and over delivering. Given its secular growth and high-quality capital-light characteristics, the CPG segment should be valued at least 12x, or $180 million. You read that right — in a couple of years, this one obscure segment alone will be worth more than the entire enterprise value of the whole company today!

Your editors could also run through a similar exercise with the JambaGo segment. Or consider just the royal-ties from the franchised units. Or we could even casually mention the fact that these kinds of asset-light cash-flow

generating companies can afford to lever up their balance sheets. Jamba could easily accommodate some modest debt and buy-back half its stock, significantly increasing the earnings power per share. The future possibilities are just enormous.

For an alternative view on just how ridiculously cheap this company is, we might think about the business as my parents would, like a small business owner (Eugene here). For $180 million, we would be paying $550,000 for each of the 325 company-owned units. Paying $550,000 for an existing prof-itable store is a very low price, since it takes about that much capital upfront to open a new store from scratch. And each of these stores can generate over $140,000 in cash flow per year yielding a 25% cash on cash return. It’s certainly a much better business than a Team Electronics store.

Now that by itself would be a fantastic investment opportu-nity. But don’t forget that in addition we would also be getting some VERY valuable kickers for free: a perpetual 6% royalty on sales from each of Jamba’s 450+ franchised stores, a perpetual 3%–5% royalty on sales from licensing the con-sumer-packaged goods business, plus thousands of dollars per year from each of the hundreds of JambaGo units. Yes, you read that correctly: at the current price investors are getting

Less Corporate G&A

Operating Income

Add back D&A

Ebitda

Less maintenance capex

Less dividends for preferreds

FCF or Owner earnings

Total Revenue

JambaGo

Consumer-packaged goods

Franchised stores

Company-owned stores

Revenue streams $Millions Assumptions

325 units, 735k sales per unit (5% SSS growth),20% 4-wall store ebitda margin

525 units (70 additional units), 525k sales per unit (5% SSS growth), 6% royalty rate

Management estimate (likely conservative, assumes 2% licensing fee on 250m in sales)

1500 units, 2.5k per unit

Total capex will be ~10m

8% dividends on remaining preferred stock

No debt interest, $112m of tax NOL’s

47

16

5

3

71

-38

Less D&A -10

23

28

+10

33

-5

-0.4

FY 2013 Run-rate Estimates

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the most valuable pieces of the growing Jamba enterprise for essentially less than nothing!

Summary Recommendation

Buy JMBA up to $3.00 per share. Our medium-term target is $8 to $10 per share over the next three to five years. This is a long-term holding, and we expect the business to significantly compound in value over time. However, this is a microcap stock that can be volatile. We should always use Mr. Market’s irrational emotional

swings to our advantage and be prepared to purchase even more shares at lower prices should we find ourselves fortunate enough to be presented with that opportunity.

Let’s delve a little deeper into the numbers of Jamba’s business to try to determine a range of reasonable valuations. We will also incorporate some of the latest data from Jamba’s earnings release on March 5.

http://ir.jambajuice.com/phoenix.zhtml?c=192409&p=irol-newsArticle&ID=1792488&highlight=

As your editors had correctly anticipated, Jamba did indeed post a net profit for the very first time since becoming a public company. While the absolute amount was small ($300,000), we believe this is an important milestone, as more investors will begin to take notice of this wonderful gem. More importantly, James White and his team continued to make great strides in growing and transforming the business into an asset-light model focused on franchising and licensing.

Looking into the future a bit, we might ask, “What would this kind of company eventually be worth?” Let’s look at some comparable comps within the QSR (quick service restaurant) franchise industry.

While these QSR businesses have a varied percentage mix of company owned units versus franchised units, the table gives us an approximate range of reasonable values for this industry. Based on these comps, fair value would range from 10x to 14x EV/ebitda (trailing metrics), which your editors would agree is a reasonable valuation for an asset-light, cash-generating, recession-resistant business.

Jamba operates in a similar industry and possesses all of these

Your Portfolio Ops TeamRyan O’Connor,

Eugene Huang,

Chris Mayer,

Units Mk Cap (m)

P/E EV/ebitda Net debt/ebitda

YUM (KFC, Taco Bell, Pizza Hut)

39,000 31,000 20.4 11.8 0.8

McDonald’s 33,000 98,700 18.4 11.3 1.1

Burger King 12,000 6,700 27.8 14.2 3.9

Domino’s 10,000 2,800 26.3 14.1 4.9

Wendy’s 6,600 2,200 - 9.7 3.1

Appendix/Update

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wonderful characteristics, and thus a similar valuation should be warranted. Actually, we believe that given Jamba’s long growth runway both in the num-ber of franchise units as well as other segments like consumer packaged goods, a valuation towards the higher end should be deserved. As outlined in the original write up, we believe that by the end of this year, Jamba should be on track to generating a run-rate EBITDA of approximately $33 million.

If Jamba trades at a mid-point valua-tion of 12x EV/ebitda, this would imply a per share price of $4.92, fully diluted. This would be an upside of 70% from today’s price of ~$2.85 in the next year or so. If Jamba’s qualities and growth were more fully appreciated by the market and traded at a 14x mul-tiple, then this would imply share price of $5.68, or 100% upside from today.

Another interesting takeaway from the table of QSR comps, is that due to the stable cash-genera-tive nature of these businesses, they can easily accommodate some level of debt to maximize the economic returns to equity shareholders. The amount of debt can range anywhere from 1x to 5x ebitda. In the future, if Jamba were to take on a conserva-tive level of debt of $66 million, or 2x ebitda, then it could easily buyback well over 25% of its shares!

Now that Jamba has been restored to profitability, the cash-generative nature of its business will become more apparent. With some smart capital allocation, management will have some good options available to maximize value for sharehold-ers, such as instituting a dividend. If Jamba continues to trade at a very attractive valuation, then a large buyback would be an excellent use of cash plus serve as a catalyst to unlock value.

FY2012 FY2013 est. Assumptions for 2013 est.

Revenue streams ($ millions)

Company-owned stores 39 47 325 units, 735k sales per unit (5% SSS growth), 20% 4-wall store ebitda margin

Franchised stores 12 16 525 units (70 additional units), 525k sales per unit (5% SSS growth), 6% royalty rate

Consumer-packaged goods 2 5 Management estimate (likely conservative, assumes 2% licensing fee on 250m in sales)

JambaGo (Included in franchise rev)

3 1500 units, 2.5k per unit

Total Revenue 53 71

Less Corporate G&A -41 -38

Less D&A -11 -10

Operating Income 0.6 23

Add back D&A +11 +10

EBITDA 12 33

Less maintenance capex -3 -5 Total capex will be ~10m

Less dividends for preferreds -2 -0.4 8% dividends on remaining preferred stock

FCF or Owner earnings 6 28 No debt interest, $112m of tax NOL’s

FY 2013 Run-rate Estimates

Valuation Sensitivity Analysis

Assumes run-rate estimates by end-of-2013: $33m ebitda, $32m cash as of Jan 1, 2013, 87 million shares fully diluted.

Ebitda multiple 10x 11x 12x 13x 14x 15x

EV (m) 330 363 396 429 462 495

Implied mk cap (m) 362 395 428 461 494 527

$ Per diluted share 4.16 4.54 4.92 5.30 5.68 6.06