Butcher offer whets palates

19:47, Apr 07 2013
Meat the boss: Mad Butcher owner Michael Morton.

There are changes afoot at the Mad Butcher. Its signs will no longer be red, the colour of blood leaking from a rare fillet steak, but black, the colour of charred onions. Where it used to sponsor a racing car team, sporting events and charity dinners, it will keep its hands in its pockets. Where distressed franchisees were once helped through their troubles with financial support, brotherhood and fellowship will be available only up to an annual cap of $200,000, after which it's strictly business.

This much we know from disclosures around the famous franchise's sharemarket float. Apparently there are no plans to change its cringeworthy slogan "You can't beat the Mad Butcher's meat", but perhaps that will come later.

Although the branding change is significant - part of efforts to focus customers on quality as well as price - for the most part it seems investors can expect more of the same from the Mad Butcher after it becomes an NZX-listed company.

That's not a bad thing. The business has been around long enough, and grown big enough, to suggest it knows what it's doing. Its name recognition alone will put it on the investment radar, despite its small size - prospectus figures imply a market capitalisation of $45 to $48 million.

The mechanics of its arrival on market are not straightforward. This is a backdoor listing in which a listed shell company, Veritas, with no business of its own, "buys" the Mad Butcher for $40m from its owner Michael Morton. It does this by issuing shares, some to Morton directly and some to investors for cash, which is then paid to Morton.

When the deal is complete, Morton will have $20m cash and 42-45 per cent of Veritas/Mad Butcher.


The bulk of the rest of the business will be owned by investors who pay $1.30 a share in the current share offer.

At that price, the company is projecting a net yield in the year to June 2014 of 5.3-5.7 per cent, which will probably be enough to interest some income-focused investors.

As well as the size of the dividend, another key issue is its sustainability - can the business pay out that much year after year?

On this score, the record shows it has managed to pay out much more to Morton.

Over the past six years Morton has taken out $20.8m in dividends at an average $3.5m a year (the projected 2014 dividend is $2.5m). So much was extracted that the business was driven into negative equity in 2010, 2011 and 2012.

Morton points out, with justification, that the business didn't need capital so "it would be foolish to leave cash sitting in a business that doesn't need cash".

Where the money went is his business, but one conclusion to draw is that the Mad Butcher has good ongoing cashflow.

However, it's worth remembering that the Mad Butcher business is a franchisor, and as such, it relies on the performance of its franchisees.

There are currently 36 Mad Butcher stores, 34 of which are owned by independent franchisees. The other two, in Whanganui and Upper Hutt, have been owned by interests associated with Morton for several years.

According to the prospectus, the Whanganui store was bought from its franchisee in 2006 because of underperformance, while the Upper Hutt store was intended to be sold to a franchisee in 2007, but the deal fell through.

Morton says he was happy to own the stores in the interim, as they provided extra income and, post-listing, both franchises are due to be taken over by their managers.

Still, investors may worry that the fact both remained unfranchised for so long could also suggest suitable franchisees are not two a penny. The way Mad Butcher works, new franchisees have to be butchers themselves, which limits the pool a bit, and the firm also likes them to have local knowledge, which limits it a bit more.

Given its growth relies on opening new stores - the company wants to open four more by June 2014 - the availability of franchisees will play a big part.

Morton doesn't see a problem.

"Two of those [new stores] are locked and loaded - Invercargill and New Plymouth - and we're very close with the other two," he says. "There's a lot of supermarkets that don't have butchers in them that previously had butchers, so there's a lot of butchers out there."

Another factor in the franchisee equation is the quality of the franchise deal. At Mad Butcher, pure franchisee fees are relatively small and the company gets its revenue by clipping the ticket on meat sales. It does this in two ways: one, it buys meat from suppliers and sells it on to franchisees for a mark-up; and two, approved suppliers provide meat directly to franchisees and pay Mad Butcher for the privilege, known as a supplier rebate.

Last year Mad Butcher bought carcasses for $22.6m and sold them to franchisees for $23.7m, leaving a margin of $1.1m, while supplier rebates produced $4.5m.

Franchise and management fees, meanwhile, were $0.6m.

The structure is sensible because it aligns the interests of franchisee and franchisor so that both benefit from higher sales.

According to the prospectus, the margin on carcass income will increase from December 2012 - the result, says Morton, of sharper deals being struck with suppliers.

So far it seems broking firms and some institutions have shown plenty of demand for Mad Butcher shares and there is certainly a lot to like about the business. It has track record, experienced management, good cashflow and scope to expand.

It will be interesting to see how it copes with the change to a public company, as well as its new black look.

Tim Hunter is deputy editor of the Fairfax Business Bureau.

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