Amfil Technologies Inc (FUNN)

[Felo31]

(REPOST)

How to value a company.

https://scalefinance.com/all-revenue-is-not-created-equal/

Not all companies are valued at 10x their earnings. In fact relatively few of them are. That article made a list of the characteristics shared by the companies that are valued at 10x or more of their earnings. I will try to see how they compare to AMFE.
(Everything quoted will come from that webpage)

1.Sustainable Competitive Advantage (Warren Buffet’s Moat)

“By far, the most critical characteristic that separates high multiple companies from low multiple companies is competitive advantage. This concept, well explained in Porter’s book by the same name, basically asks the question, “How easy is it for someone else to provide the same product or service that you provide?” If your company has “high barriers to entry,” Wall Street will be super excited, as investors will have confidence discounting cash flows many, many years into the future.”

Yes there are other board game cafes. Many of them. Hundreds possibly. But how many of them do the same thing that S&L does? How many of them function not only as a cafe, but also as a retailer, as a distribution center, and now as a publisher? How many of them make consistent relations with game makers and big retailers such as Walmart? Only 1. That’s right Snakes&Lattes.

2. The Presence of Network Effects

“No discussion of competitive advantages and barriers to entry is complete without a nod to perhaps the strongest economic moat of all, network effects. In a system where the value to the incremental customer is a direct function of the customers already in the system, you have a powerful dynamic that tips towards winner take all.”

“Unfortunately, strong form network effect companies are far and few between. Fortunately, when they do exist, they are typically leading candidates for the 10X+ price/revenue multiple club. Microsoft, Ebay, Skype, Google Adwords, and Facebook (in their prime) all benefited from network effects.”

We touched upon this in the previous point. S&L is different from the rest of the gang because of the relations it consistently creates. With the designer nights, game developers know who they can turn to to have more exposure for their games. When one sees the reviews they have on Amazon, everyone praises the excellent way S&L handles distribution. Even other game board cafes refer to S&L as “The Mothership”. The best thing about it all is how we are seeing everything develop right before our eyes.

3. Visibility/Predictability Are Highly Valued

“For the same reason that investors favor companies with sustainable competitive advantages, investors favor pricing models that provide a high level of predictability and consistency in the future....The more certain you can be of future cash flows, the higher premium you will put on a business, and as a result, you will see a higher price/revenue multiple. “

It must first be admitted that it has been fairly difficult to predict revenues for S&L, but this is only because they have been investing so heavily in growth, and we have seen the growth. Nonetheless there are a few things which point to the predictability: customers who come directly to the store must pay a fee just to get in; orders will be placed for popular games when they are sold out, and S&L has obtained many exclusive distribution rights to many of these games.

In all honesty, this one must be carefully observed because although there are very promising signs, we still can not be completely certain in the “predictable factor” of S&L, or even if we can, we still have difficulty gauging it.

4. Customer Lock-in / High Switching Costs

“If investors value predictability, than retaining customers for long periods of time is obviously a positive. Conversely, if customers are churning away from your company, this is a huge negative.”

“For non-subscription businesses, customer-switching costs also play an important role. If it is relatively easy for your customer to switch back and forth from your products to you competitors, you will likely have a lower price/revenue multiple as your pricing power will be quite limited. On the other hand, if it is quite difficult for a customer to switch away from your product/service, you are likely to have stronger pricing power, and longer customer life, which will inevitably result in better DCF dynamics.”

The question we must ask ourselves is: “what are S&L products and services?” Yes game board cafes exist, but do they have the same library? S&L has amassed a HUGE library of games that they offer their customers for a relatively low point of entry.

As mentioned before, Snakes has acquired exclusive distribution rights to many of these games, and this means that no matter where the customer buys the game, they have to depend on S&L to distribute it, and now that S&L has officially acquired a game making company, the games made and distributed by this company will have to pass, by necessity, through our hands. I.E. Customer lock in.

5. Gross Margin Levels

“This may seem super-basic or even tautological but there is a huge difference between companies with high gross margins and those with lower gross margins.”

Again, we have seen S&L work towards bettering their gross margin levels. They are doing so by obtaining exclusive distribution rights, and much more importantly, by creating their new division: Publishing.

The focus of management is directed at creating better gross profit margins. This is old news, but we should start connecting the dots by now.

6. Marginal Profitability Calculation

“Investors love companies with scale. What this means is that investors love companies where, all things being equal, higher revenues create higher profit margins. Microsoft had wonderful scale in this manner for many, many years. Selling more copies of the same piece of software (with zero incremental costs) is a business that scales nicely. Companies that are increasing their profit percentage while they grow are capable of carrying very high valuation multiples, as future periods will have much higher earnings and free cash flow due to the cumulative effect of growth and increased profitability.”

We should start noticing by now how important the Publishing division will be for S&L. Once games are made, selling the games over time will generate more profit percentage, which in turn will create a better bottom line for the company.

7. Customer Concentration


“In their S-1, companies are required to highlight all customers that represent over 10% of their overall revenue? Why do investors care about this? Once again, all things being equal, you would rather have a highly fragmented customer base versus a highly concentrated one. Customers that represent a large percentage of your revenue have “market power” that is likely to result in pricing, feature, or service demands over time. And because of your dependence on said customer, you are likely to be responsive to those requests, which in the long run will negatively impact discounted cash flows. You also have an obvious issue if your top 2-5 customers can organize against you. “

This is pure conjecture in my part, so feel free to correct me if I am mistaken.

Again, let’s ask ourselves an important question here: “who are the customers of S&L?” Let’s see if we can identify them:

1. The individual customers who enter their locations, and buy in store or online.
2. The big box retailers who buy games through S&L due to their exclusive distribution rights or simple good service.
3. Other places which buy games through S&L but are not necessarily big box retailers. Examples: other game board cafes, or any location interested in buying board games.

While it is easy to see that S&L caters to many customers, it is not so easy to see how concentrated they are as of yet. Still, we must consider that we are still observing how the foundations are being laid, and even now we can see that management has tried to cater to as many customers as possible.

8. Major Partner Dependencies

“Investors will discount the price/revenue valuation of any company that is heavily dependent on another partner is some way or form. A high profile example of this is Demand Media’s reliance on the best seo stuff. Google isn’t the customer per se, but they can heavily impact the outcomes for Demand. And even if they don’t impact them (the recent quarter was in line with expectations), the mere awareness that they could, can have drastic impact on long-term valuation, and therefore price/revenue multiple.”

“These strong dependencies eat away at investors simply because the company is exposed to issues that are out of the control of management. As an example, Kayak’s potential IPO buyers will need to get comfortable with Google’s acquisition of ITA, Kayak’s use of ITA, and whether or not Google goes from being a source of traffic to a competitor. Likewise, if and when Zynga files for an IPO, new investors will be inherently betting on whether or not Zynga’s Facebook dependency is a positive or a negative. No one wants a partner policy or algorithm change to have unpredicted negative impacts on a public company. These risks are accounted for with lower valuation multiples.”

As for S&L, the distribution branch is one of its biggest money earners. While S&L does not have any partnership which can negatively impact their earnings, a large part of the earnings are produced by the distribution side. This means that some quarters will be much more profitable than others. Something to be aware of is how management will try to balance this in order to maximize profits.


9. Organic Demand vs. Heavy Marketing Spend

“All things being equal, a heavy reliance on marketing spend will hurt your valuation multiple. Think about this simplistic example. There are two stores in the middle of town. One has a product/service that customers love, and as a result, customers flock to the store day in and day out all on their own. These customers then tell other potential customers, and through this “word of mouth” process, the customer base grows even larger. The second storeowner advertises frequently, and all new customers are a result of this advertisement and promotion (which obviously costs $$). Which business would you prefer to own?”

It is easy to see how the S&L business model so closely resembles the organic design. They do not need to spend heavily on marketing because their customers will do it for them. Once customers go through the door and live the experience on their own, they will tell others to do the same. Furthermore, this is a proven business model for S&L.

10. Growth

“Nothing contributes to a higher valuation multiple like good ole’ growth. Obviously, the faster you are growing, the larger, and larger future revenues and cash flows will be, which has direct implications for a DCF. High growth also implies that a company has tapped into a powerful new market opportunity, where customer demand is seemingly insatiable. As a result, there is typically a very strong correlation between growth and valuation multiples, including the price/revenue multiple.”

Is Snakes&Lattes growing? Consider that the company was bought 2 years ago, on the brink of bankruptcy. It now has 3 locations, with the 4th set to open in mere weeks, a new distribution division, a new publishing division, and set to have locations in the double digits by this time next year.

Is Snakes&Lattes growing? I believe so, and at an incredible pace if I may add.

It is extremely hard to see know at which multiple a company should trade in. But at least we can see that S&L (and by necessity AMFE) share many of the characteristics desired in a company which does trade at a 10x multiple.