Freshii: Can This Recent Restaurant IPO Deliver Despite High Expectations?

Just when I thought the restaurant sector was dead on Wall Street, we see that fast casual, Canadian-born Freshii (FRII.TO) has pulled off an impressive IPO, offering shares recently at $11.50 each (CAD). With the stock near $14, Freshii’s market value is approaching $430 million (CAD). Adjusting these figures into a U.S. dollar equivalent, FRII stock fetches around $10.25 with a total equity value of $320 million.

Today the company reported 2016 revenue of $16.1 million and EBITDA of $3.7 million (both in USD). Based on those numbers, it would appear that Freshii shares are quite overvalued, but there are reasons that many investors are impressed with the company.

When I reviewed the IPO prospectus, what jumped out at me was the extraordinarily low unit build-out cost ($260,000). For a 99%-franchised fast casual chain, such a low initial investment requirement will make it relatively easy for the company to grow quickly. While average unit sales in 2016 were only $468,000 per location, a reasonable 10% margin would net franchisees a mid teens return on investment (including the initial franchise fee).

I recently visited the lone Freshii location here in Seattle and I was impressed with the food offerings. The average entree price point is pretty much in-line with the fast casual industry ($7.50) and seems especially reasonable given the quality and healthy nature of the food.

On the surface, the Freshii concept appears to be well suited for rapid growth, especially in younger, more health conscious urban areas. But when we look at the stock, it already reflects very high expectations. Freshii collects a 6% royalty on gross sales and system-wide revenue in 2016 was $96 million. If we assume that the company can earn industry-leading margins due to its high franchise percentage, EBITDA at maturity could rise to the mid 40’s in percentage of revenue terms.

Freshii predicts total units will surpass 800 by the end of 2019, which would bring in upwards of $25 million in annual recurring royalty revenue, and possibly ~$11 million of EBITDA. Accordingly, based on expected 2019 profits, Freshii stock currently trades at roughly 30x EBITDA. Yikes.

In addition to valuation, a big concern for investors should be Freshii’s limited operating history coupled with a lightning fast expansion plan. Just three years ago Freshii had 70 locations globally. Today that figure is around 300, with more than 150 new opening planned for 2017. To reach the company’s 2019 goal, new units would need to accelerate to around 200 per year in both 2018 and 2019.

Can a small company like this grow that quickly without running into any roadblocks? Will the next 500 units perform as well as the first 300 locations? These are risks that are real and should not be ignored.

Of course, if Freshii becomes the next Subway investors stand to do very well. It will be interesting to see how well the company can deliver against the hype (the founder and CEO, Matthew Corrin, is only 35 years old).

I have not figured out if there is a certain price at which point I would be interested in initiating a position in the company. What I do know is that the current price is a little bizarre (~$1 million per opened location, despite the fact that the build-out cost is just $260,000 and Freshii doesn’t actually own the location).

I will probably want to see how new units perform for a little while before I nail down a possible entry point. After all, the company is set to increase its unit base by 150% between 2015 and 2017. Moving at that rate could very well give investors buying opportunities (read: volatility) along the way. Regardless, Freshii is one fresh restaurant idea to watch.