Will the Roots IPO fly like the Goose?

The Globe and Mail (Atlantic Edition) - - REPORT ON BUSINESS - DAVID MILSTEAD

There’s a strong sense of déjà vu in read­ing the Roots Corp. ini­tial public of­fer­ing prospec­tus. A dis­tinctly Cana­dian cloth­ing com­pany that calls it­self a “life­style brand” that says it’s “suc­cess­fully ex­port­ing our her­itage glob­ally,” with strong do­mes­tic sales and op­por­tu­ni­ties for U.S. and in­ter­na­tional ex­pan­sion.

It reads a lot like the Canada Goose stock-of­fer­ing ma­te­ri­als from March. And Roots would likely be pleased to repli­cate Goose’s flight, as the shares are up 50 per cent in the six months since its de­but.

There is, how­ever, an­other sim­i­lar­ity to be mind­ful of. As I noted in March, Canada Goose was pur­chased by its pri­vate in­vestors in 2013 for just more than $200-mil­lion, then sold to the public at a val­u­a­tion of more than $2-bil­lion, a fig­ure that has only in­creased.

We don’t know the Roots num­bers yet, as the pre­lim­i­nary prospec­tus filed on Thurs­day doesn’t say ex­actly how many shares will be of­fered, nor at what price. But we do know, from a note deep in the fil­ing, that its own­ers paid just more than $300-mil­lion for the com­pany in De­cem­ber, 2015 – less than two years ago. With Bloomberg News re­port­ing Roots is eye­ing a val­u­a­tion of at least $700-mil­lion, and the pos­si­bil­ity that in­vestors might bid it up even more, the ques­tion be­comes again: Are the pri­vate own­ers the only ones who will get a bar­gain in this IPO?

Now, cer­tainly, the case is not as strong this time around; the ten­fold in­crease in Canada Goose was eye-open­ing, while the mere dou­bling or more in Roots shares in less than two years is more in line with the IPO sys­tem. As I noted be­fore, early in­vestors and in­sid­ers in IPO com­pa­nies will nearly al­ways make out bet­ter than you, the or­di­nary in­vestor. And if you avoid stocks that some­one else has al­ready made more money than you, you might not ever find any­thing to buy.

As well, the dis­crep­ancy in val­u­a­tion seems jus­ti­fied. Canada Goose was able to report three­year rev­enue growth of 38.3 per cent; net in­come gains at a rate of 196 per cent; and “ad­justed EBITDA,” (earn­ings be­fore in­ter­est, taxes, de­pre­ci­a­tion and amor­ti­za­tion) which ex­cludes a num­ber of nor­mal ex­penses, at an 85-per-cent rate.

By con­trast, Roots has posted an­nual sales growth of 14 per cent over the pre­vi­ous three years, and its prospec­tus of­fers no as­sur­ance of great ac­cel­er­a­tion: The com­pany of­fers guid­ance of com­pound an­nual growth in sales be­tween 13 per cent and 17 per cent from 2016 to 2019.

Its pre­ferred profit mea­sures of ad­justed EBITDA and ad­justed net in­come should grow in ranges of 14 per cent to 18 per cent and 18 per cent to 23 per cent, re­spec­tively, over the same pe­riod.

A word about that: Roots is by no means alone among Cana­dian com­pa­nies in strip­ping out all man­ner of ex­penses in mak­ing its ad­just­ments, but the list is long, and the ad­just­ments boost the num­bers con­sid­er­ably. Net in­come of $14.8-mil­lion in the past 12 months per In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dards be­comes $22.7-mil­lion in “ad­justed net in­come” and $44.8-mil­lion in “ad­justed EBITDA” with Roots’ tweaks.

Which earn­ings mea­sure you choose for val­u­a­tion, of course, will help you de­cide if a $700mil­lion mar­ket cap­i­tal­iza­tion is rea­son­able. It’s just more than 15 times ad­justed EBITDA – but roughly 50 times net in­come.

Also worth not­ing is that, un­less plans change, this IPO is not de­signed to raise cap­i­tal to help with the ex­pan­sion the com­pany is sell­ing to share­hold­ers in the early pages of the prospec­tus. In­stead, the doc­u­ment notes “we will not re­ceive any pro­ceeds from the of­fer­ing” and the sell­ing share­hold­ers such as pri­vate-eq­uity spon­sor Search­light Cap­i­tal are the ones col­lect­ing the cash. When Roots amends its doc­u­ments, we’ll see just how many shares the pri­vate in­vestors are keep­ing in or­der to have skin in the game along with their new part­ners, the in­vestors in the public mar­kets.

Will any of this dis­suade in­vestors? Per­haps not too many. The Globe spoke with Bruce Camp­bell, the pres­i­dent of Camp­bell, Lee & Ross In­vest­ment Man­age­ment Inc., who said he’d con­sider buy­ing the stock once he sees more from the com­pany, par­tic­u­larly its in­vestor “road­show.”

While he’s con­cerned about Cana­dian re­tail­ers’ “spotty” track record with U.S. ex­pan­sion, he says Canada Goose’s per­for­mance should give Roots and its in­vestors some com­fort. Mr. Camp­bell, in fact, bought Canada Goose shares for clients on its IPO, but sold the stock shortly af­ter it hit the mar­ket, locking in its no­table run-up.

It’s look­ing like a re­peat flight in many ways: Ex­pect in­vestor en­thu­si­asm to boost Roots shares in the early go­ing – de­spite any con­cerns about val­u­a­tion, qual­ity of fi­nan­cial re­port­ing, or insider sell­ing. Whether the stock can de­liver in the longer term, how­ever, may be a large enough ques­tion that sug­gests tak­ing your money and run­ning away.

FRED LUM/THE GLOBE AND MAIL

Roots Corp. is eye­ing a val­u­a­tion of at least $700-mil­lion for its ini­tial public of­fer­ing, with the pos­si­bil­ity that in­vestors might bid it up even more.

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