Innovative Food Holdings (IVFH): Specialty Food Distributor Trading At Sharp Discount To Larger Peers, Attracting Activist Attention
Writeup 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!
Background
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.
Company History
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: iGourmet
2018: Mouth Foods
Operating Segments
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.
e-Commerce
Since 2018, IVFH has been growing their e-Commerce (B2C) business. That year, the company made two acquisitions:
- iGourmet
- Mouth Foods
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.
Brand Management
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.
Organic Food Brokers and Oasis Sales and Marketing are both brand management advisors for emerging food brands. They advise on national distribution, shelf placement, and related services.
Brand management is a very small portion of IVFH’s overall business, and may be a prime candidate for divestiture.
Valuation
IFVH is best valued using “sum of the parts” for each of three segments:
- Distribution
- e-Commerce
- Brand Management
With the distribution business largely a concession of US Foods, valuing the business piecemeal may give investors a better understanding of its underlying value.
Distribution (Direct-To-Chef)
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
- SpartanNash: 8.27x
- 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:
- 2016: $3.7m
- 2017: $5.2m
- 2018: $3m
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.
Additional Assets
Real Estate
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:
- Direct-to-Chef: $30m
- 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
Catalysts
Activism
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.
Pappas has had a history making activist moves against companies in the restaurant and retail food industry. Prior campaigns included Fiesta Restaurant Group, CST Brands, and The Pantry.
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. Gramm and James Pappas quickly became friends, with Gramm interested in picking Pappas’s brain about the food industry, and Pappas (who previously worked in investment banking) interested in launching his own hedge fund.
Over the next decade, Gramm’s Bandera Partners placed a strong focus on activist investments in the restaurant business (Famous Dave’s Popeyes), and Pappas built JCP into a successful activist fund.
Bandera and JCP have also been invested in the same companies, with both funds holding positions in Morgan’s Foods and Tandy Leather.
Looking beyond the irony (father of activist investor fighting off activist campaign from son’s friend), this connection underscores James Pappa’s relevant experience in the food industry, and his ability to sniff out value in the food service space.
“If A Company Can’t Grow or Buy, They Have To Sell”.
In an article about JCP shaking things up at CST and The Pantry, Pappas is quoted as saying: “If a company can’t grow or buy, they have to sell”.
When selecting “sideline activist” opportunities, this is the M.O. I prefer. There are plenty of activist funds out there trying to pull off long term turnarounds. Many of them end up stymied by poor business factors. Others attempt strategies that are profitable on paper, but tough to execute in reality.
But does Pappa’s maxim apply to IVFH? While IVFH has been aggressive making acquisitions, it lacks the scale required to compete against larger specialty food companies. IVFH could merge with similarly-sized rivals, but there are certain limits to growing their distribution business. With the output deal with US Foods in place, switching broadline distribution partners (or building their own) would disrupt operations.
What is Pappas’ Track Record?
Beyond campaigns at CST Brands and The Pantry, what is Pappas’ track record as an activist?
Here are some of Pappa’s successful activist investment (pulled from this Press Release from the Fiesta Restaurant Group proxy fight):
The Pantry: 138% return in a 9 month period (210% IRR)
Morgan’s Foods: 488% return in 27 months (120% IRR)
Casella Waste Systems: 144% return in 25 months (54% IRR)
AmREIT: 21% return in 5 months (52% IRR).
JCP has numerous examples of coming into an underperforming company, shaking things up, and pushing for strategic alternatives that generated above average IRRs in a short period of time.
One notable failed activist campaign was with Jamba Inc, with shares falling 54% in the 28 months following JCP’s involvement.
A few years back, JCP also took a small position in Kona Grill. They did not reach the 13D threshold, but did send an odd letter to Kona Grill stating their interest in acquiring 29.9% of outstanding shares over the next year. Kona Grill did not seem keen on giving JCP their blessing; they responded to JCP with a rehash of their “poison pill” provision.
JCP is likely relieved this investment plan was scrapped, as Kona Grill is now in Chapter 11. I mention this investment to show that JCP’s activist ideas are not all slam dunks.
Nevertheless, Pappas’ background and accomplishments make him a strong catalyst for change at IVFH. With IVFH’s insiders holding just 12.3% of outstanding shares, an activist campaign at IVFH should not be difficult.
B2C Diversification Pays Off
iGourmet and Mouth Foods Grow Into Substantial Businesses
Mr. Market has given its opinion on the B2C diversification by bidding the stock lower. These shareholders recollect the failed The Fresh Diet merger, and are skeptical at Klepfish’s attempts to transform the company via M&A.
However, past results are not indicative of the future. With their existing infrastructure, the company could rationalize the cost structure, enabling them to post higher operating margins in the coming years.
Like the investing public, I am skeptical this diversification will succeed. Even those not savvy to food industry trends must be aware we have reached “peak subscription meal box”. iGourmet may become profitable if it can utilize IVFH’s infrastructure, but long term it appears to lack the scale of larger gift-basket competitor (not to mention the specter of Amazon private label offerings).
SG&A Costs Reduced After B2C Infrastructure is Built Out
According to management, the increase in SG&A expenses is due to the build-out of the iGourmet/Mouth Foods platform. We will know in the coming months whether this is the case.
Past attempts at diversification (The Fresh Diet) did not pan out, so it is rational to discount these management selling points. But to achieve a strong return with IVFH, we do not need them to reinvent the wheel-all the company has to do is reassure investors iGourmet/Mouth Foods are not another Fresh Diet.
IVFH Acquires Additional Food Distributors
While IFVH has failed to impress investors with their B2C endeavors, they have demonstrated success building a profitable specialty food distribution business. A substantial part of this success can be attributed to IVFH’s president, Justin Wiernasz, who has substantial industry experience.
IVFH should focus on acquiring more bolt-ons such as Artisan Speciality Foods, consolidating operations to generate higher operating margins. Utilizing their output deal with US Foods, they can grow this specialty segment further, and perhaps build a business big enough to register on US Foods’ acquisition radar.
Risks
New Focus on B2C Specialty Food Sales
Anyone looking to build a business in e-Commerce is going to get “Amazon is Going To Eat You For Lunch!” pushback. This leaves IVFH with the challenge of building a meaningful B2C segment in a highly competitive, low-margin industry, with a generalist behemoth looking to absorb controlling market share (even in the smallest niche segments).
Along with selling on its own website, iGourmet utilizes the Amazon platform. While this gets their products out there (Amazon’s internal search engine rivals Google in terms of matching customers with retail products), dependence on the Amazon platform is a double-edged sword:
There are many cons to selling on the site. In addition, Amazon is taking advantage of the information asymmetry by data-mining their third-party vendors to develop their own private label alternatives.
This leaves IVFH with two choices:
- Prove the critics wrong, and build iGourmet/Mouth into a profitable segment.
- Divest the B2C segment, and focus on direct-to-chef distribution.
As I’ve mentioned above, cutting losses and divesting the B2C business may alone boost the share price. While developing iGourmet and Mouth Foods into a solid e-commerce franchise would move the needle, a bird in one hand (selling the B2C businesses, focus on growing/selling the Distribution segment) is worth two in the bush (investing millions into scaling B2C).
Relationship With US Foods
The lion’s share of IVFH’s revenue is derived from their output deal with broadline food distributor US Foods. 57.4% of 2017 sales came via this arrangement. The agreement essentially allows IVFH to focus on sourcing specialty food products, while US Foods handles distribution to restaurants and food service businesses.
Prior to 2018, this arrangement was subject to renewal caps, but going forward the agreement calls for unlimited 12-month terms until either party terminates the arrangement.
This dependence on US Foods justifies IVFH’s discount to some extent. But as Seeking Alpha contributor Value on The Street discussed in his May 2018 article, the two companies have strong ties, with IVFH President Wiernasz being a 12-year veteran of US Foods.
Value on The Street also believed in a high likelihood of US Foods acquiring IVFH down the road. By partnering with IVFH, US Foods can distribute speciality food products without the headaches of sourcing. Bringing this in-house may be worthwhile, even if US Foods can eliminate overhead costs from integrating IVFH into their existing operations.
I agree with Value on the Street, but also am skeptical US Foods will “waste their time” with such as small acquisition. It may make more sense for them to keep IVFH as a sourcing partner rather than bring their operations in-house.
The IVFH/US Foods distribution deal reminds me of the Craft Brew Alliance-AB Inbev arrangement, where AB Inbev distributes Craft Brew’s brands. In this arrangement, through 2019 AB Inbev has the option to buy Craft Brew Alliance. AB Inbev has yet to make a deal. Perhaps this is because of antitrust concerns. But it could also be that the cost savings from integrating CBA do not outweigh the complications of spreading AB Inbev’s management team too thin across a wider variety of brands.
Share Price Supported by JCP Purchases
IVFH is fairly illiquid, and the current share price is likely supported by JCP slowly building their stake in the company. It should be noted that JCP manages ~$120-$130m in capital, meaning their current position in IVFH is a very small piece of their portfolio.
Now that JCP has gone over the 10% mark, it is likely they are looking at IVFH as a longer-term play. Looking at their past activities as prelude (the Kona Grill letter expressing interest in acquiring a ~30% stake), they could be looking to take negative control (20-30%).
With no public statements from JCP, this is pure speculation. But there must a bigger idea in play if a nine-figure fund is playing around in an $18m market cap stock.
On the flip-side, if JCP ceases to acquire more shares, and the company continues to pursue the B2C strategy, the share price will likely take additional hits. Especially if continued growth investments increase SG&A and decrease operating results.
This may create a better buying opportunity in the future, as long as JCP maintains their stake in IVFH. Without the presence of JCP, IVFH’s only catalyst is the more speculative B2C diversification plan.
Dilution (Convertible Debt, Executive Compensation)
In prior years, IVFH issued convertible debt securities to fund acquisitions. In 2017, the company swapped shares for the remaining outstanding convertible notes payable (conversion price $0.25/share).
The company also has about 1.5m outstanding options. With the exception of 25,000 that have a strike price of $0.57, the rest of these can be exercised at prices above $1/share. Given that they company is likely not worth more than $1/share, this should not be a high concern.
However, one should consider that the higher strike prices imply management is incentivized to make big moves in order to push the stock up to these levels.
This indicates they will fight aggressively if an outsider (such as JCP) pushes for a sale around the company’s current fair value (~$1/share).
Another current risk in terms of dilution is future issuance of convertible debt or options/RSUs. To scale itself further, IVFH may again start acquiring larger businesses in all-stock or convertible-debt funded transactions.
This has occurred in the past (with the Fresh Diet acquisition), with lackluster results. But as seen with recent transactions, IVFH has gone the route of acquiring specific assets at relatively low prices, using back-end compensation (contingent liabilities) as a form of currency.
Bottom Line
IVFH sells at a sharp discount to peers. This discount is somewhat rational, given the company’s dependence on US Foods for output, their bad history of diversification, and their current attempts to enter the B2C specialty foods space.
On the other hand, these headwinds are the root of the opportunity. JCP has pounced, and is slowly building up a position. While they have yet to make their intentions public, their track records indicates success in realizing value in flounding food service businesses.
In light of the risks, at the current trading price IVFH is selling at a ~44% discount to its intrinsic value. While internally the company is executing a strategy it believes will move the needle, outside forces may help push for lower hanging fruit.
IVFH does not even need to sell itself to close the valuation spread. By cutting it losses and ditching the costly B2C diversification, the share price will likely see support.
Add in the likelihood that US Foods eventually purchases the company, and you have yourself a solid opportunity is a market reaching all-time highs.
IVFH may make a strong opportunity for a well diversified micro-cap portfolio. If JCP begins making more aggressive moves on the company, the opportunity may be stronger.