We had someone post a comment to my late last night post on OVEN price activity. I would like to thank whoever this person was and here is his comment reposted on the blog to get the attention it deserves.
I would like to invite the person who posted this to our blog. I completley agree with your point of view on the stock and despite being bearish on the stock never quite had the guts to go short on it.
-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-
Betting on short squeezes is dangerous. Witness MOVI, in which the flost got 60% short when it was at about 8$, and kept getting shorter down to 2.5$. Those that bet on a squeeze when it based af 5 (after falling from 35) got smoked.
Here is the short case for OVEN, written June 20, when the stock was at 18. Just so you know that money can be made shorting.
I recommend shorting Turbochef (OVEN) $18.50 because it is a business that received a very large 1x in nature contract with Subway that the market has mistakenly perceived as the next hottest restaurant trend and has given OVEN an equally hot valuation. In reality, Subway is many multiples larger than any other restaurant chain Turbochef should reasonably expect to win business with and our conversations with restaurants decision makers and industry experts do not suggest widespread interest in their products. The market is mostly limited to c-stores, sandwich chains, coffees chains, and to a lesser degree, independent units without a major kitchen on premise. We think Turbochef is more realistically valued at $6 per share, including the $3 cash per share.
BUSINESS DESCRIPTION:Turbochef sells one product: Commercial use countertop ovens that combine microwaves, convection, and infrared ray to cook food 12x faster than normal ovens. The Turbochef technology has been in existence for over 5 years but has found new life in the menu expansion trend at various Quick Serve Restaurant (QSR) chains. Turbochef is also trying to adapt the oven for the residential market. It has high hopes for this segment but the technology is only 85% complete and is slated for a mid-2006 release.
SHORT THESIS:-Subway contract was a special situation and OVEN is unlikely to secure contracts of similar size in the future. -Oven only makes sense in Coffee/Sandwhich/C-stores and end market is much smaller than bulls expect in addition to a 6 year replacement lifecycle and exclusive contracts with major customers-Strong competitors and worthy product substitutes reduce the size of an already small market-Residential market unlikely to embrace OVEN & established players have similar products in the market selling poorly-Significantly overvalued given peak annual recurring unit demand of 15,000 units
SUBWAY CONTRACT WAS A SPECIAL SITUATION IN TERMS OF DEAL SIZE AND NEED FOR THE TURBOCHEF OVEN. CONTRACTS OF SIMILAR SIZE ARE UNLIKELY IN THE FUTURE:The Subway contract was a unique situation because Subway had been looking for a way to compete with toasted subs from Quiznos. Turbochef was the perfect solution given Subway’s lack of other cooking equipment and the oven’s small footprint that is well suited for Subway’s limited space. A contact at the Subway told us they had tested a number of rapid cook oven brands a few years ago and went with the OVEN oven because it had the fastest cook time. Furthermore, Coca-Cola footed half the bill as part of a recent arrangement to switch from Pepsi to Coca-Cola, after 15 years of loyalty. At 22,000 locations, Subway is almost twice the size of the next potential customer; the market does not realize that the easy pickins’ have been picked. In their favor, recent follow-ups with Subway owners lead us to believe the campaign has been highly successful, driving more than 10% same store sale growth.
SMALL END MARKET WITH 5-7 YEARS REPLACEMENT LIFE; RESEARCH SUGGESTS ~90% OF LARGE CHAINS NOT LIKELY CUSTOMERS:The oven really only makes sense in sandwich shops, c-stores, and coffee shops, where there is not a major kitchen on premise. Furthermore, Turbochef signed an exclusive agreement with Subway and cannot sell the same device into Subway’s major competitors. They will likely sign similar exclusives with all major customers. With a 5-7 year replacement cycle and our research ~90% of large restaurant chains are unlikely customers the end market appears to be a fraction of expectations. According to industry stats, there were roughly 240,000 total franchised restaurant units under 400 brands across the globe at the end of 2003. About 70% of the units are controlled by the top 40 franchises, which each have over 1000 locations. Our specific research suggests that less than 90% of these top 40 are highly unlikely to become Turbochef customers in the future. This leaves ~20,000 units, as potential rapid cook oven customers, including Starbucks, 7-Eleven, and other small convenience stores, but Turbochef will not be able to capture this entire market given the competition.
Additional research assessed the amount of industry buzz around new food concepts and the likelihood of QSRs making rapid cook oven like equipment purchases. It does not seem like any major customers beyond Starbucks (~4500 US units, 9000 total) has plans to introduce a new food concept that would require a Turbochef oven in the near future. This only represents a 1x ~ .15-.20 EPS, or .03 EPS recurring since rollout will likely be limited to full size US stores (Not kiosks etc.)
SPECIFIC CHAIN RESEARCH:
03’ Units Restaurant Chain(s)
32k Yum! Brands, KFC, Taco Bell, Pizza Hut30k McDonalds6k Dunkin Donuts6k 7-Eleven9.5k Wendy's7.5K Starbucks
FINDINGS: 91k total units researched. Yum! Brands with KFC, Taco Bell, Pizza Hut unlikely according to contacts: no new menu shifts, equipment on hand adequate, pizza chains married to current cooking process and don’t want to alter taste.
McDonalds has rolled out Enodis, Turbochef competitor in numerous countries (Canada, Australia, New Zealand) and is testing 400 Enodis conveyor style rapid cook ovens in US for a Hot deli sandwich concept. Likely to go with Enodis.
Dunkin Donuts- doesn't fit into strategy and currently testing Blodgett convection ovens for two stage donut cooking only.
7-Eleven- testing Turbochef right now but began recently. Testing usually takes 12 months minimum. Contact claims it was a little big and not much cooking room, she prefers other brands currently.
Wendy's (Baja Express, Tim Horton, Café-Express)- IR didn't think any menu changes were likely to come, new equipment is huge obstacle to them and they avoid it at all costs.
Starbucks- testing Turbochef in DC in 100 locations currently. But also testing Turbochef + Maytag’s Amana in Seattle market, will have to see how this evolves but we think it is a likely OVEN customer.
STRONG COMPETITORS AND WORTHY SUBSTITUTES REDUCE THE SIZE OF AN ALREADY SMALL MARKET:Turbochef directly competes with Amana, a commercial cooking equipment division of Maytag and Enodis, UK holding company with more than 300m in annual rapid cook technology sales. Both companies offer rapid cook ovens of similar quality & price, but Turbochef is the leader in cook time. To verify our research on the size of the market, contacts at Amana thought the market was more limited to C-stores. Management at Enodis admitted the particular market for Turbochef’s technology would start off slow but he could see it eventually growing into a larger size.
There are also many substitutes to rapid cook ovens including advanced microwaves from Panasonic that use convection to help toast. Other substitutes include standard convection ovens, which use propelled hot air to cook 2-3x faster than normal ovens. An contact from Blodgett, a major manufacturer of convection ovens, confirmed the rapid cook oven market was of small size and limited to C-stores, which is why Blodgett did not pursue the market despite once having a relationship with Turbochef. Conversations with a high level sales manager at one of the largest distributors (three distributors make up 75% of commercial cooking equipment sales in the US), who carried Turbochef, Amana, and Enodis said that this market was “not even on his radar,” however, he said it took many years for conveyors ovens to find a following and everyone uses them now.
RESIDENTIAL MARKET WILL NOT EMBRACE THE TURBOCHEF OVEN AND ESTABLISHED PLAYERS HAVE SIMILAR PRODUCTS IN THE MARKET THAT SELL POORLY:Established residential brands have experimented with rapid cook ovens for nearly 20 years but the product has never been a hit seller with consumers. Today, lines from Thermador, Maytag, KitchenAid and others cook between 2-3x faster than traditional ovens and range from $1,100 to $6,000 dollars. Turbochef wants to introduce a residential oven in mid 2006 for $6,000 that is 8-10x as fast as traditional ovens. This will likely fail because major brands will block their entry, ovens that cook more than 3x faster require precise cook times and this margin of error does not work well in the home environment (if you’re 10 seconds off in your cook time you’ll burn the food), it will not be effectively priced, and the technology isn’t even completed. In addition, it will not serve as a substitute to the microwave oven because it will take time to pre-heat just like all ovens, and it will not be a substitute for the conventional oven because it cooks too fast to be readily useable. Conversations with professionals in Maytag’s residential cooking division confirmed that Turbochef’s dreams for this market were far fetched.
VALUATION: Significantly overvalued given peak annual recurring unit demand of 15,000 units:We looked at valuation a number of different ways:
First, we wanted to look at an expected peak recurring earnings stream. Using conservative estimates we discovered that a total of ~63,000 stores were potential installs. To get this figure we took the 240,000 (2003 figure) restaurants chains across the globe and divided it into categories ranging from burger joints, pizza shops, coffee/snack, chicken etc. and applied a reality metric to each category to see what made sense. Our values ranged from “doesn’t make sense for this market,” or 10% of all units across globe would become customers, to “makes total sense”, meaning 75% of those establishments would install the oven
Category 03’ Units % Realistic Potential Installs
Burger 60,000 10% 6,000 Pizza 34,000 10% 3,400Coffee/Snack 40,000 50% 20,000C-Store 14,000 75% 10,500Chicken 19,000 25% 4,750Sandwich Bakery 35,000 50% 17,500Mexican 10,000 10% 1,000
Total 212,000* 63,000
*excludes customers we think have already gone with competitors
We then adjusted for modest chain growth, potential customers with multi unit installs, non quick serve restaurant chains customers, and gave Turbochef a very generous 70% market share and applied a 6 year replacement life cycle to the peak install figure.
Potential installs 63,000Franchise growth 30,000Multi-installs 25,000Non-QSR 10,000
Total potential installs128,000Turbochef 70% share 90,000Replacement life 6 yearsAnnual recurring units 15,000 ASP @ $4,800 72,000,000EBIT @ 16% 11,500,000Taxes (w/o 45m NOL) 4,000,000NI 7,500,00
EPS @ 31.59m diluted .23 cents @ 13x forward PE $3Cash per share $3
Value per share $6
A worse case scenario is 60k annual peak recurring units sold each year, which yields a $15 per share valuation. We think the probability for this is less than 5%.
Another way to look at how absurdly valued we believe the company is…. The subway contract at ~85% fulfillment (international locations are still being rolled out) generated only .26 cents in free cash flow per share.
RECENT DEVELOPMENTS: -Changed ticker from TCF to OVEN -Stock has recently rebounded from $11 to north of $18 based on:-mgmt. appearances on CNBC and Jim Cramer -expectations for a deal with Starbucks-numerous positive spins in the recent conference call on customers testing the oven-Possibility for Subway to rollout 2nd ovens at each location for another expansion of the menu
-We believe the only real concern is a possible 2nd oven rollout by Subway. This 2nd oven would be for their Pizza concept, which had been tested a number of years ago without much success as a standalone product because it did not impress the customer and the overhead of new equipment didn’t justify the concept. Based on our analysis we do not think an announcement is likely in the NEAR future for the following reasons:
- Our conversations with multiple developing agents suggested very few were currently testing the concept and virtually no one was confident it was certainly being rolled out in the US- At the very least we are multiple months away from Subway having enough data to make a solid decision on rolling out this concept
However, here are the facts to sort through about this possibility:- If Pizza is rolled out, capacity problems with current ovens would make it highly likely a second oven is needed to support new concept. During peak times a meaningful number of locations are experiencing wait time for their Turbochef ovens. - Each Turbochef oven cost $300+ a month in electricity to operate and owners do not want to front that additional bill- First Turbochef oven purchase was subsidized by Coca-Cola for roughly half the price. Store owners will likely have to pay for second oven themselves and many are opposed- Many subway locations are limited on countertop space and do not have any more room for a second oven. - Many of developing agents do not believe the concept is a smart move given contrast with the healthy subway image- Subway tests lots of products and any new food concept that comes to the table is thoroughly tried and tested. Pizza is one of many.
-Turbochef claims 30 major chains are testing their ovens and could make a decision within the next year. Again, our industry research and conversations with test kitchens and various R&D departments make this seem unlikely.
-In addition, Turbochef is 85% complete on a rapid cook oven for the residential market. A market it pegs at 16 million US households. We think the likelihood of this being a realistic market is very small. Although from a timing perspective, it does provide a fantasy for the market to trade on despite the outlook for poor earnings into the foreseeable future.
RISKS:
- A significant number of QSRs could easily adopt a menu change that requires the use of a rapid cook ovens- OVEN is able to leverage brand in Rapid Cook ovens and build into other lines. They’re already trying this with a normal convection oven. Sales will disappoint though. - Subway elects to install two ovens per location, management is hyping this possibility, it is clearly explained below- Headline risk from deals with large chain operators or even small chains that help fuel the Turbochef dream for another few quarters- At ~$4,800 ASP the Turbochef oven is not a major expenditure for most restaurants -Subway will probably grow 1000 units a year for the next few years and will provide some recurring stream
Catalyst:
CATALYSTS:
- Significant expectations have recently been built into the stock, without any major delivers the market will quickly forget the Turbochef story. If major wins occur we’ll have to wait to get paid b/c this dream will remain alive. - Residential market opportunity proven unrealistic
* Click on pictures for a larger view. 
