EP83: Melon Drama
Stock Ideas From Investment Professionals
Welcome, subscribers!
We sifted through another pile of 2Q investment letters, and we’re ready to share more new ideas!
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This week, we’re excited to highlight 6 new ideas, including:
A microcap provider of payment solutions to niche markets such as vending machines and laundromats.
A ~$1 billion market cap franchisor of boutique fitness with a strong pipeline of future growth.
A ~$400 million market cap consulting firm specializing in business transformation and strategic transactions.
A national food distributor, down significantly from its highs due to inflation and operational issues, with a new management ready to turn things around.
Keep reading to learn more.
Disclaimer: Nothing here constitutes professional and/or financial advice. You alone assume any risk with the use of any information contained herein. We may own positions in the securities listed. Please do your own due diligence.
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Let’s get to it.
When an investor re-enters a new position they’ve owned in the past, we take note. That’s exactly what happened with Laughing Water Capital and Cantaloupe (CTLP). Cantaloupe provides payment solutions to niche markets such as vending machines and laundromats. Laughing Water believes the company’s operations have turned the corner, and the market isn’t appreciating it.
Cantaloupe Inc. (CTLP) - Cantaloupe is new to our portfolio for the second time, as we previously owned this company in 2020 and 2021. The original thesis was part special situation as the Company regained compliance with the SEC related to timely filing of financial statements and would thus be a beneficiary of forced buying by index funds, and part fundamental improvement under a new and much improved management team. In my view, both legs of that thesis have been playing out, but the market has thus far failed to reward Cantaloupe for the fundamental improvements they have made.
Cantaloupe, perhaps best known in the vending machine world, provides hardware, payments and software solutions to self-serve retail including micro-markets, laundry, arcade, auto air/vacuum, and others. Self-serve retail is reasonably recession resistant, and Cantaloupe's products help customers increase revenue and cut costs. Payments and software revenue are recurring in nature, and historic churn has been close to zero.
In December 2022, management laid out a three-year plan detailing their ambitions around growing revenue at a 15% CAGR by continuing to penetrate their markets, expanding internationally, and increasing ARPU. Importantly, there is significant operating leverage in the model, which management believes will lead to a 70% CAGR in EBITDA. This operating leverage is already beginning to kick in, and Cantaloupe is out-growing a history marred by a lack of profitability. Thus far, the Company is on track to reach their goal of approximately $75M in EBITDA for fiscal 2026 (June 2026 YE), although with a different revenue mix than expected. In brief, they have been overperforming on Transaction growth, and underperforming on Subscription fees. That being said, management has indicated that the problem with Subscription revenues is not a demand problem. Rather, they have a significant backlog of sold hardware that has not yet been installed due to a lack of labor. As these devices are installed and activated, presumably Subscription revenue will continue to grow.
To be clear, Subscription revenue is more attractive than Transaction revenue, but in my view focusing on this "disappointment" without referencing valuation is short sighted. If the Company hits their goal of $75M in EBITDA, given a net cash position, substantial NOLs, and limited CapEx, I estimate this EBITDA will translate into approximately $60M in FCF regardless if the revenue is from Subscriptions or Payments. This suggests the company trades for a mid-high single digit multiple of FCF looking out a year or two. Considering that other payments linked companies trade at north of a 20x multiple, there should be plenty of upside to come for CTLP. Insiders at CTLP are seemingly confident as they recently purchased shares near current prices.
As a bonus this week, we include Laughing Water’s thesis on Xponential Fitness (XPOF), a fitness concept franchisor.
Xponential Fitness (XPOF) - Xponential fitness is a franchisor of boutique fitness concepts including Club Pilates, Pure Barre, Stretch Lab and others. The stock was previously a stock market darling, having nearly tripled from the 2021 IPO through 2023 highs, but then became the subject of a well-regarded short seller at this time last year, causing shares to plummet. The short report focused on 1) questioning the integrity of XPOF's CEO, and 2) cherry picking commentary from unhappy franchisees in select verticals to imply that the entire business was at risk. In May, XPOF's CEO was removed, causing shares to plummet, and I purchased our position on this weakness.
Generally speaking, being a franchisor is a very good business, which explains why franchisors often trade at 20x EBITDA or more. At the time of the decline, if one assumed that every single franchisee had financed 75% of their franchise with debt, and then sued XPOF to recover this liability and won, I estimated that XPOF would have been trading at 12.5x their guidance for 2024 adjusted EBITDA. The idea that every single franchise would sue was extremely farfetched because first, many franchisees own more than one franchise, and it is unlikely this would be true if they were unhappy with their first franchise. Second, information on franchisee/franchisor litigation is widely available, and through 2023 XPOF averaged less than 2 conflicts per 1,000 units. Importantly, Club Pilates - XPOF's crown jewel - had zero lawsuits.iv Further, I believed that Club Pilates by itself could be worth more in a private sale than the price that public markets ascribed to the entire portfolio of concepts.
Since the time of our purchase, the company has named an impressive new CEO, made it clear that they are open to divesting underperforming concepts, and indicated that share repurchases are likely in the not-too-distant future. Additionally, future growth is all but guaranteed as the number of global licenses sold far exceeds the number of global studios that are currently open. Importantly, this dynamic should cushion the business during any economic downturns as license holders who have not yet opened studios would be incentivized to take advantage of favorable lease terms during economic downturns. I would note that XPOF grew and gained market share through COVID, while the industry suffered.
Shares have rallied considerably since our purchase, but there is still a fair amount of uncertainty surrounding the business related to an SEC investigation instigated by the short report. I expect this investigation will be resolved with time, and shares will re-rate higher. If XPOF continues to execute and gets a franchise peer multiple, the stock could rally more than 200% from here. This leaves plenty of room for success if the market is suspicious about the durability of fitness concepts and XPOF trades at a discounted multiple.
This week, we have 4 new ideas for our paid subscribers.