EWCZ - A Joe's Pros Interview

Note: On September 7th, we interviewed a long time EWCZ franchisee currently operating 5 locations. The full interview can be accessed here.

Joe

Good afternoon, it's Joe DeMatteo calling on Friday, September 24th, and welcome to our Joe's Pros Interview. I understand you want to talk about European Wax Center Inc (EWCZ). 

Pro

Yes, indeed-- ticker EWCZ. So EWCZ is a recent IPO. It IPO’d at $17, now trading at $28, or a market cap of $1.8B. Admittedly, the valuation is pretty full here, but I think it's an underfollowed, good smid-cap growth name that people should at least be aware of and I think could be a great name to buy on a pullback, whether that comes on its own or whether the market does it for it. The sponsor here who bought the business in 2018 is General Atlantic. To get right to the thesis, EWCZ is professionalizing a highly fragmented and largely mom and pop out of home waxing industry. They're doing this with a franchisee model that has some of the highest cash-on-cash franchisee returns out there. Their marquee offering is first wax free and they have a Wax Pass program for customer savings and to drive loyalty, which is underpenetrated but will be relaunching this fall. So what you really get here, I think they will end up growing units in the low teens. You add to that a 5% - 7% comp for maturing units and you get to a 15% - 20% EBITDA CAGR over a number of years. They have 800 units today, they think they can do 3,000 with the current format alone. People may question whether they can get all the way to 3,000, but regardless, it's very early and it's very early even in the markets where they have had units. And so there's a very nice runway that actually looks a lot like the Planet Fitness story of a few years ago. A lot of people are familiar with that story, and it was a real home run up through COVID. So, it's a name where I think there's a three-year upside to $42. That's based on 2025 EBITDA of about $120MM and an EBITDA multiple of 22x, which is a slight discount to where Planet Fitness traded pre-COVID. 

Taking a step back, these boxes are 1,300 square foot boxes, so they're not big. In that space, they put 6 - 7 suites. So these can go in a ton of different locations. It's a 99% franchised model today and it will remain that way. And what's so great about this, and the reason why there are family offices and private equity lining up to bring these units to market, is that the upfront capex is about $400k. This compares to a Planet Fitness unit, which I think of as the most comparable today, at several million. They get to 20% EBITDA margins in a couple of years, and so by the time you get to Year 5, there's a 45% after-tax return, assuming no leverage. So the franchise economics are here, they've done a good job disclosing them, they're happy to talk through those, and those cohort curves were disclosed in the S-1 and I think are remarkably consistent, and there's actually some levers that they can pull to improve performance going forward. 

Thinking about the industry here, it's a highly fragmented industry. They say it's an $18B TAM. It's a little bit hard to come up with information otherwise, but that would suggest they have about 5% market share. We know that there are 100k independent spas and other waxing locations across the country. It is expected that about 10% of those, or 10k independent operators, will remain closed post-COVID. So not only do I expect them to keep taking share by professionalizing the service with a clean, more institutional offering than a mom and pop can, I also expect a lot of mom and pops to just leave the market. Today, they are 6x the size of the next largest player in terms of stores and 10x the size in terms of sales. So, they're clearly the leading player here. They have 800 locations and they have unit growth in the high single digits. I think that's going to end up being in the low teens over time, but they'll have to get there. I don't see good reasons why they can't. 

Another important part of this thesis is the management team. It's not the most complicated model to run, but the current CEO, David Berg, was on the board at Planet Fitness for five years. Berg, as it’s been described, basically came out of retirement to take this job after General Atlantic bought it in 2018. He brought in an entirely new team of executives, including a Head of Franchising, who had spent basically her entire career at Dunkin Donuts. So, you have a team in here that's very polished, that's worked in these spaces before with this type of a business model, and has made some important changes. And there are more changes to come, but not all of these have fully hit the numbers. The business was bought by General Atlantic in 2018, Berg joined in late ‘18, built his team over the course of ‘19, and at that point they bought a bunch of regional development contracts where the previous team had put in middlemen in the franchising process. They bought these in, which brings a bunch of margin back in-house, gives them better control to grow at a faster pace if they want, and just have better control of where the units are going. They've also sort of institutionalized that framework. Previously, the way these regional development agreements worked is the representative would go and visit a unit maybe once or twice a year and have a steak dinner, as it's been described. They now have EWCZ representatives that are going to all of these locations throughout the year, are in touch with them on a consistent basis, focusing on key KPIs in order to drive better unit economics for the franchisees, which feeds back up to parent company, EWCZ. So, there are a number of these changes that they put into place, but it's still really early because they did these over the course of ‘19 and ‘20. We're now starting to see results trickle through. 

In addition to some other upside levers to growth, they are testing three new potential sources of units right now. First, international. I think it may be a few years, but they do expect to put some units outside the US. Second, a smaller format, so call it three or four suites. That's being tested just north of their headquarters in Plano, Texas. And then lastly, a store-in-store format where they would go into something like a Nordstrom or other department stores and actually put their waxing suites in those stores to help drive traffic.

In short, I think it's a pretty simple model, there's a really good industry structure here, they have a clearly differentiated offering versus the competition who is significantly smaller, it's really early in their growth, they have a good management team, and I think that there's real potential for them to grow EBITDA 15% - 20% per year on a consistent basis. The multiple has run, frankly, much further ahead than I would have expected at this point. We’re north of 25x EBITDA on an NTM basis today, but I do think over three years as they prove that they can hit their guided growth numbers and more, this can be a very nice, steady compounder for small and mid-cap investors. 

Joe

Thank you. Since you started out saying it's kind of full and you just ended by saying it's 25x NTM, where would you think it would be something you'd be looking to add a lot to? And then, on the 3,000 units-- does that include store-in-store?

Pro

No, the 3,000 units they describe as their market potential is for just the existing format, which is 7 - 8 suites per and 1,300 square feet. So, the store-in-store is potentially additive.

Joe 

OK. Can you talk about quality control, the main changes of General Atlantic management, how that all came to pass, and perhaps why the CEO came out of retirement in a little bit greater depth, some of the bigger picture things that get you excited about the long-term compounding that you expect?

Pro

Sure. So from an offering perspective, if you look out there across the market today, it's highly fragmented. You have some really high end spots where you can get great treatment, but most people aren't going to go and spend those prices. From there, you're left looking for mom and pops and independent spots. Some of them are excellent and are great alternatives, but what EWCZ has done-- I like to think of it in the same terms of what Planet Fitness has done with their off-price gym offering-- is have a very consistent playbook, so this is exactly how a franchise is going to run. They sell all of the materials to the franchisees. There is material quality control, they help with the hiring, they have a very strict manual and standards for the care just like you would at a lot of different franchisee models. And so, that in and of itself is a differentiator versus most of the other players in the industry. To answer the question of where I think it would be really attractive to buy on a one year basis, I think if you could buy this in the $22 - $24 range, which is obviously down a fair bit from here, that would that would be a really attractive price to buy on a multi-year basis. It may not get there-- the market seemed to put a lot in the multiple from the get go here-- but we'll just have to see. 

Joe 

All right. Why don’t we toggle into risk factors and your overall risk/reward. Is there anything that would spook you here? 

Pro 

Yeah, I think the key risk that gets talked about the most is the potential for them to face headwinds from some sort of new waxing technology-- entirely possible. That's obviously hard to predict, but something to keep an eye on. And then also laser treatments. On the laser side, which gets a lot of focus because it's easy for somebody from the outside looking in to say, “What about laser, etc.? We hear about women doing that these days.” It's true, but part of the problem is it's more expensive, it can be more painful, and oftentimes it doesn't work. So laser is most effective for people with fairer skin and darker hair. It doesn't work well with light colored hair, and frankly it doesn't work well for some women in general, and it doesn't work well for darker tones of skin. It's something that simply can't work for everybody, but it's worth mentioning that if there's development in new technology or a new offering, that's something to keep an eye on. At present, I don't see it as something that's going to stop the growth story here. It's just not a big enough part of the market. 

Joe 

If it were to sneak up on them, is there a way to incorporate that service? Have they discussed that in any way? 

Pro 

I've very briefly discussed that with them. Their response was, “We are studying those types of services now.” Their additional point here is when General Atlantic bought this business and when the CEO came in, they had an independent party study the marketplace and really focus on the laser offering to try to understand whether this was a real threat or not. The conclusion was basically, it's great for some people, it's not for every demographic. Laser has also been out there for a long time. It's been around for over 10 years and hasn't eaten into their market share. But going forward, I personally think that there would be room, and if there's a new offering that comes out, I don't see why they couldn't be the leading edge as a well capitalized, best scaled industry player to put some of these units in their franchisees. That takes capital, but I don't think it's something that is out of the realm of possibility for them to do themselves. 

Joe 

Could you address the issues, if any, around labor? My understanding is this is either minimum wage or close to it, plus tips. Are they having any of the issues that we've seen in some other service industries? 

Pro 

The biggest pressure they face here is in getting certified estheticians on board. These are people who have graduated from beauty school, for example, and a number of those schools were closed during COVID. Those are now starting to reopen, so they have those people that they're able to bring back into the pipeline. The Q2 growth was a bit slower than I had expected, and they haven't materially changed the guidance for this year, but this is certainly something to keep an eye on. But these are above minimum wage jobs. These are better paying jobs. I don't expect a ton of pressure over a 1 - 3 year period. In the short term, it could impact how many units they can get in the ground in the next couple of quarters, but it doesn't sound like this is going to be an issue over 1 - 3 years. 

Joe 

Since you brought that up, what is the national average to get this degree as an esthetician? And then, what is your set of opportunities if you had that degree at a mom and pop versus EWCZ? Do they also bring in other benefits? Is there anything that makes it a much more attractive job which keeps the snowball going in your direction? 

Pro 

One of the nice things about EWCZ is their unit volume. This was mentioned in the expert report you published. Their unit volume is far and away above what other independent spas can do. If you are a waxer, you just want as many appointments per day as you can get. That's one of the benefits of being there. They've talked about examples of estheticians leaving EWCZ to try to bring their relationship-- because this is a very personal, intimate business-- to other spas, and oftentimes those people end up coming back because they don't have the same support and standardized services and materials for the treatments themselves that exist at EWCZ. EWCZ is also the single largest purchaser of wax in the US. They have an equity stake in the business-- I believe it's in Spain-- that produces this wax and its proprietary formula. It sticks to the skin less, it's softer, and more comfortable on the skin. These are things that a waxer would not have access to at an independent spa. There may be other reasons, but at this point in time, they don't see an exodus or trouble with these waxers jumping to competitors. 

Joe 

Understood. I've done a little personal, anecdotal research on this. I understand that it's quite simple to schedule with EWCZ.

Pro 

It's quite simple.

Joe 

Do they have a front end that just basically blows away the competition? And if you're traveling and you wind up in another city, do you get this comfort level where you just go on the portal, use the login, and know that you’re going to have something that's reasonably likely to be a high quality experience at this time, at this price, in this other city? 

Pro 

So, the first thing here is a lot of people go back to the same EWCZ for the reason that they found somebody who they're comfortable with, especially for more intimate services. However, to your point, if you're traveling between cities and need to go to a different location, they do have an app where you can log in and make appointments right on the app. They're in the process of relaunching it, which will include some more of the new loyalty program rollout. That loyalty program is going to look something like the Starbucks Star system where it will amount to ~10% savings over time. And they see a lot of potential to do more with that system in order to drive retention, drive loyalty. The current system, which is called the Wax Pass, comprised 60% of transactions. They think that can be significantly higher. This is going to be integrated into the app that's getting relaunched. To your point on having a really user friendly front end, people will be able to go to their app, find a location, click on a time, walk in the door, and they're actually working on building an even more seamless experience where you basically scan a code and check in at the front desk where there's a service person sitting and then are immediately led back to one of the suites. 

Joe 

So scheduling should be a breeze. Did they break any of this out yet or is it too early for that?

Pro

Too early.

Joe

OK, interesting. It sounds like there's a setup for them to be quite hard to avoid in certain senses, if you will. 

Pro 

Yeah. Going back, this business was founded about 15 years ago in Florida by a couple of brothers. It's been slowly institutionalized since then and they've been franchising for the last 10 years or so. I think part of the reason General Atlantic bought this and why the current CEO joined is they see a lot of opportunity to do a lot of the same things that Planet Fitness has done, which is standardize the offering, do better national advertising, find better ways to drive retention, engage with the customers more. The same way that Planet Fitness has had really good success with their app over COVID, I see this as something similar, which is using these other forms of customer interaction through an app in order to engage people and keep them coming back. This is a habitual behavior. Yes, there's a little bit of cyclicality in the business at times. Sometimes people tend to go more often around the summer months or around the holidays, but hair grows back every 4 - 8 weeks depending on the person, so this is something that they just need to remind people, “Oh, it's been six weeks, it's been eight weeks. Do you want to book another appointment?”

Joe 

Right. You reference the expert that we hosted. She talked about the products that they sell internally. Can you talk about the breakdown of revenue of products sold? And I think there's been some mixed reviews on that. I know some people are probably already wed to the products that they use, but perhaps you could just shed some light on that and how important it is the story if you see it as a key thing. 

Pro 

Yeah. I haven't factored in almost anything in my model for upside here because this spring they relaunched their retail products. These are skin products pre and post care for waxing areas that are sold in the spas. They produce these, they push these in the spas. They think that there is potential for them to drive much higher attachment rates. Those attach rates have grown. The attach rate in 2019 was 11% and then that grew to 15% in 2020. They think they can grow much higher than that. I haven't put in anything in the model for that, nor for them selling these products outside of the wax center system. I think it's a toss up, I don't have a strong view on whether they will or won't be successful there. I think what's more important is them offering the good service that they have built and improved over the years in the suites. It's possible that that may disappoint, but I don't think that is material to numbers at all. 

Joe 

Maybe just to wrap up, what are your out year gross revenue, margin, and EPS figures, you versus the Street. 

Pro 

I don't have a consensus-- it isn't loading in Bloomberg, I think because it's so soon. What I do know is versus the syndicate estimates, I had 10% - 15% upside in 2023 - 2025. This was largely based on their conservative guidance on comps. A big part of the story is they should get a 5% - 8% comp just from the units maturing.That will come every single year, and there's good evidence that that should happen because of the cohort curves they've shown. And then the extra growth on top of that, I think instead of growing high single digits, they're going to end up growing in the low teens. That gets you to call it 10% - 15% upside to what the syndicate had from management's estimates over a couple of years. I get to $120MM of EBITDA in 2025 and that's on about $350mm of net revenue for corporate. 

Joe 

And you said your price target three years out is $42?

Pro 

$42, yes. That's using 22x EBITDA. That is a slight discount to where Planet Fitness traded pre-COVID. I don't think this is quite as good as the Planet Fitness model for a few reasons, largely because the Planet Fitness offer is a subscription. Yes, you can cancel it, but people don't cancel their Planet Fitness. Outside of COVID, there were pretty low churn rates for Planet Fitness. This is ultimately a habitual purchase. There is pretty good penetration of Wax Passes, but it's a recurring sell on behalf of the waxers in the suites. 

Joe 

Understood, makes sense. Anything that I've neglected to ask that you think is germane to the story? 

Pro 

The only other thing I'd mention is I think when you speak to management, they have been fairly conservative in the way they talk about the growth opportunity and frankly, most of the KPIs. I think that is a really great setup because with the CEO coming from Planet Fitness, where it was a persistent beat and raise story for several years, I think that's what they are setting up to do. There's no reason why they can't grow faster. They have ~800 units today, they have about 225 licensed units in the backlog that are set to come. Just in those backlog units, there's several years of growth covered. So, I think there's real potential for them to accelerate, but I think they're leaving that for the quarters and years to come so that expectations don't get too far ahead of themselves. I think they're doing a really good job setting the bar low that they'll be able to beat over the next couple of years. 

Joe

Great. Thanks again for your generosity with your time. Enjoy the weekend. 

Pro 

Thanks, you too.