Dollarama Buy Reports3.amazonaws.com/zanran_storage/johnmolson.concordia.ca/Content...L’Archevêque - 1 Dollarama – Buy Report ENNETH KENNETH WOODS PORTFOLIO MANAGEMENT PROGRAM

L’Archevêque - 1

Dollarama – Buy Report

KENNETH WOODS PORTFOLIO MANAGEMENT PROGRAM

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Dollarama

Evelyne L’Archevêque January 18, 2010


Investment Highlights

- PRICE is excellent. Trading BELOW secondary issue price. PRIMETIME TO BUY NOW. Dollarama is trading at a very good range since IPO. It would be an excellent opportunity to obtain a position.

- Last week Bain announced a secondary offering of shares that they were selling. This will not cause any dilution. After the issue Bain will hold ~45% of the company.

- Proven track record of profitable growth using internally generated funds

- 4X larger than any Canadian competitor

- Strong pipeline for future store growth 40 stores per year. Current stores have excellent profitability

- Unsaturated Canadian Market for dollar stores lots of room for growth

- Balance sheet de-leveraging is good for future earnings growth in addition to sales growth.

- Multi-price points, alternative payment methods (i.e.debit,Visa) can be important growth factors as it encourages more spending

- Excellent location and store layout strategy

- Strong supply chain which can accommodate further economies of scale

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Company Background

Providing compelling customer value has been the goal of Dollarama since its inception in 1992. The company which was 80% acquired in 2004 by Bain went public on October 16, 2009. Dollarama offers a broad selection and assortment of products combined with a low price point make it an ideal destination for the value shopper. Moreover, Dollarama is moving beyond the “cheap” image, similarly to Wal-Mart, middle and higher income families are shopping there too. Value drives purchases. Products offered are general merchandise, seasonal and consumer products. They offer 3,700 SKU’s year round and 700 seasonal SKU’s. The price points are $0.65 to $2.00. Dollarama has also moved into private label, offering their own products at compelling prices. The company is present across all 10 provinces and has the largest presence in Quebec and Ontario. Dollarama’s store count is 4X larger than its closest competitor.

Recent News of Interest Dollarama filed a preliminary short form prospectus on January 15,2009 in which Bain, the primary shareholder would be selling off some of its shares. All the shares being sold are secondary shares and therefore all proceeds will go to Bain. Price per share: $21.50 Shares to be sold: 11,650,000 Total Offering: $250,475,000 Proceeds going to Bain. Over-allotment option: 30 days after the offering the Selling Shareholders (Bain) can sell up to an additional 1,747,500 shares (for total proceed of $288,046,650 – excluding fees).

PUBLIC FLOAT = 43.2% On a fully diluted basis including the over-allotment option the public float will be 47.3%.

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History In November 2004 Bain Capital acquired 80% of the corporation and the remaining 20% was held by management and the Rossy family primarily. The company has seen strong performances historically. Below is a chart of the growth in the store network. Moreover, in the past five fiscal years, store growth has been entirely funded by internally generated free cash flows.

Source: Dollarama Prospectus

Below we can see that sales and EBITDA have been growing at a healthy rate.

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Sales Growth Last 3 years by comparables

Dollarama is in a superior position and is more comparable to high growth and large discount stores. High growth retailers include: Shoppers, Tim Hortons, Lululemon, Northwest Co.

EBITDA Margin Last 3 years by comparables

Dollarama is closer to High Growth Retailers in comparison and has a superior performance.

Stores Average store size: 9,785 square feet Product Mix: private label and nationally branded products

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Ownership: corporate owned Store locations: High-traffic areas such as strip malls and shopping centers in various locations, including metropolitan areas, mid-sized cities, and small towns. Layout: the same in every store (whereas it differs in the competition)

More on location: According to the Consulting Study, on average, over 85% of visitors that enter a Dollarama store purchase products. They locate their stores in close proximity to leading mass merchants (usually Wal-Mart). Based on the company’s experience, their convenient and consistent store format provides a shopping experience that is complementary to that of mass merchants.

Store set up costs

Minimal investment required : $0.4 million for capital expenditures and $0.2 million for inventory. Usually stores generate $1.8 million in sales on average in the first year of operation and achieve an average capital payback period of less than two years. In Fiscal 2009, over 99.5% of full year comparable stores had a positive store contribution margin, averaging approximately 21%.

Sourcing Dollarama has a superb sourcing strategy. They source directly from low-cost foreign vendors. In Fiscal 2009, the products directly sourced from low-cost foreign suppliers accounted for more than 50%. Moreover, they are developing more and more private label goods in-house. Due to the size of their operation, they obtain economies of scale and efficiencies for their sourcing as well as their warehouse and distribution operations.

Their supplier base is well diversified, which reduces their supplier risk. No supplier accounts for more than 6% of their purchases. The top 10 suppliers account for 25% of purchases, whereas the top 25 suppliers represent 39% of their purchases. The have established long-term relationships since 1992 with their top 10 suppliers.

IPO Information

** This is prior to the secondary offering of January 2009. Please see Page 2 for new ownership details. Please note that secondary offering proceeds are going to BAIN only.

Dollarama went public on October 16, 2009. The initial public offering consisted of newly issued shares and the over-allotment consisted of secondary shareholders (Bain Capital) selling. After the IPO Bain still holds the majority ownership.

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IPO Overview

Ownership Breakdown


Use of proceeds: 1. $70.1 million to repay the Reorganization Promissory Notes 2. $38.2 million to repay in full the term loan A facility forming part of the Credit Facility 3. $167.5 million towards the repayment of the 8.875% Subordinated Notes Please note that the proceeds from the over-allotment went to Bain, since they were the selling shareholders. Industry & Competitive Analysis

Compared to the U.S. there is still much more growth possible for dollar stores. Thus, the market is by no means saturated and there is much potential growth for Dollarama.


Analysts view that Dollarama can grow up to 40 stores per year for the next 8 years before reaching U.S. saturation levels.

Growth Strategy

So, the question is….how can Dollarama keep growing? Firstly, they plan on doing this by strengthening their current market position and expanding into new markets. They plan on opening 30-40 new stores into the foreseeable future = $24 million in CAPEX required for store openings per year. Based on their market analysis they see a potential for 900 more stores in Canada (Dollarama Prospectus). Even if the company can add 500 more stores in the future we see this as a strong opportunity.

The following table shows the stores by region. As we can see, even in Quebec, there is 37,000 people per every Dollarama store (this excludes competition). The Western Provinces, which have been the least penetrated, is the next focus for Dollarama as there are strong growth potentials in that region. Although, the competition is mostly in the West right now.

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Another area for growth in earnings is that they plan on improving the effectiveness of their existing distribution network. Their current network should be able to support another 150 stores, thus, expansion of distribution facilities can be delayed in the short term, and the company does not have any plan on investing in this in the short term. Location Location Location. Dollarama is a destination. According to a Consulting Study, on average, over 85% of visitors that enter a Dollarama store purchase products (Dollarama Prospectus). The company’s location strategy is to position the stores in close proximity to leading mass merchants as they have noticed that their stores offer a complementary experience. This strategy has been successful so far as Dollarama is very different than mass merchandisers.

Continuing to expand their private label line. They offer in-house product development. Since this is rather new initiative there is still a large area for growth in this. Their close relationships with their suppliers is making this initiative prosperous. And we can expect further growth from this.

Continuing to offer convenient payment methods. Cash is king. But since Q3 2009 debit cards are being accepted and statistics from this have shown that some promising growth in this ares. The debit card penetration rate in our stores has continually increased since its implementation, with debit card transactions representing approximately 29% of sales in the quarter ended August 2, 2009. Moreover, the average transaction for debit card sales is approximately 2.5 times greater than the average transaction size for cash sales. Dollarama is currently running a pilot project in 80 stores to see the acceptance of credit cards as a convenient payment mentor. The objective in providing multiple payment methods is that they believe it will facilitate the shopping experience and encourage customers to spend more at every visit and to come more often.

What were they planning on doing in fiscal 2010? 1. Effective February 2, 2009, they introduced additional price points of $1.25, $1.50 and $2.00 which have created greater merchandising flexibility and allowed a further broadening of their product offering as well has higher average transactions per customer (DONE)

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2. Continue to develop their information technology system in order to improve their internal processes, notably better inventory management and improved organizational communication (Ongoing) 3. Improve store-level execution; realignment of store operations management. They began measuring store labour productivity and implemented enhanced loss prevention activities (Ongoing) 4. Continue improving customers’ in-store experience through active category management and format evolution (Ongoing) 5. They are conducting a pilot project to analyze customer receptivity to the introduction of credit cards as a payment alternative in 73 of our stores (results to be seen shortly) Source: Dollarama Prospectus

Same store sales growth

Below shows the most recent same store sales growth


Competition Analysis

Dollarama is a behemoth in Canada. It has 4X as many stores as its closest competitor.

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The Canadian dollar store industry is highly fragmented with many privately owned multi-outlet chains as well as independently-operated dollar stores. The other multi-outlet dollar stores include: Buck or Two, Dollar Giant, Dollar Store With More, Everything For a Dollar and Great Canadian Dollar Store. The competition operates on a franchise model primarily. And interestingly enough all of these stores except for Dollar Giant have reduced their store count since January 2004 (Dollarama Prospectus). Dollarama also competes with variety and discount stores as well as mass merchandisers. The company has the widest presence in Canada, with stores across all 10 provinces. This is the most of any value retailer. We view the risk of any other dollar store ramping up its operations as low considering that strong supplier networks are essential to success and moreover, the trends do not show any competitor even trying to re-gain market share. The main threats can come by large discounters such as Wal-Mart. However, even then, this risk is minimal considering that Dollarama and Wal-Mart have been able to grow currently in Canada over the last few years, thus showing its ability to target different customers.

Employees The company employs more than 12,000 people and they have seasonal employees as necessary. None of the employees are unionized. Dividends No dividends are anticipated in the near future, which we see as positive as there is much more growth in Dollarama’s future. Marketing Not really necessary…. Dollarama has grown without spending huge amounts on marketing and promotions, primarily because of their strong brand recognition and their ability to choose locations in high traffic areas. No sales are necessary due to their everyday low pricing policy. Advertising is only used for new store openings using radio, local

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newspapers, circulars and television. The new store campaigns can last 2 to 6 weeks depending on their location. We view this ability to grow without marketing as a prime example of Dollarama’s successful strategy and store concept. In addition, its brand awareness is extremely high. Based on the Consulting Study of Québec and Ontario, Dollarama’s brand awareness is approximately 98% and 94%, respectively. To Hedge or Not to Hedge? Sourcing products can produce important differences in exchange rates. Dollarama enters into forward contracts to hedge part of its exposure to fluctuations in the value of the U.S. dollar against the Canadian dollar, but they do not hedge their exposure to fluctuations in the value of the Chinese renminbi against the U.S. dollar. Balance Sheet




Debt/Equity Prior to IPO: 8.03X

Current Debt/Equity: 1.21X

Cash per share: $3.28

Below is an overview of their long term debt. They have significantly de-leveraged since their IPO and going forward, this should further contribute to earnings growth.




This de-leveraging should increase their credit profile to investment grade.

Shares Outstanding Breakdown *Prior to Secondary Issue

** please see page 2 for new breakdown

Comparables




Pro Forma Income Statement

CAPEX FORECAST




Thus, Dollarama is in an excellent position considering it has such high growth potential. (Source: National Bank Financial)

Discounted Cash Flow Analysis

Sensitivity Analysis




Multiple Valuation

Blended Valuation

APPENDIX: Analyst Recommendations




APPENDIX: Management and Ownership

The majority of top management has been with the company for over 25 years. (**directors)

**Larry Rossy: CEO & Founder: has been a retailer since 1965 and founded Dollarama in 1992. In 1992, Mr. Rossy made the strategic decision to convert the company to the “dollar store” 69 concept. Since that time, Mr. Rossy’s principal focus has been on the expansion of the Dollarama retail network. In addition to overseeing the organization, Mr. Rossy is directly responsible for new store development and site selection. Mr. Rossy serves as a director of Colart Design Inc. and Confection Courcel Inc.

**Neil Rossy: Senior VP Merchandising: was part of Dollarama’s founding management team in 1992 and is currently Senior Vice President, Merchandising. Mr. Rossy is responsible for merchandising, creating house brands, overseeing the graphic design staff and conducting special projects such as head office/ warehouse construction and store fixture design.

**Nicholas Nomicos: Interim CFO: Mr. Nomicos is an operating partner at Bain Capital. Prior to joining Bain Capital in 1999, Mr. Nomicos held several senior corporate and division management positions at Oak Industries Inc., a publicly traded component manufacturing conglomerate serving the telecommunications and appliance control industries. Previously, Mr. Nomicos was a manager at Bain & Company. He also serves as a director of Bombardier Recreational Products.

Leonard Assaly: Senior VP IT & Logistics: has been working with Mr. Rossy in the retail business since 1973 and was part of Dollarama’s founding management team in 1992. He is currently Senior Vice President, Information Technology. Mr. Assaly is responsible for information technology design. He oversees the development and implementation of retail and replenishment software applications. Geoffrey Robillard: Senior VP Imports: has been Senior Vice President, Import Division since October 2006 and prior to that was President of Aris Import Inc. a wholly-owned subsidiary from November 2004. From 1973 to November 2004, Mr. Robillard was the owner and President of 9148-7264 Québec Inc. (formerly known as Aris Import Inc.), which was at that time a major distributor for imports from overseas. In 1992, Mr. Robillard, through Aris Import Inc., began working with Dollarama towards establishing Dollarama’s direct overseas sourcing capabilities and this relationship became exclusive in 1996. Mr. Robillard became an officer of Aris Import Inc. when Dollarama acquired the assets of 9148-7264 Québec Inc. as part of the Acquisition. He has been building the import division and manages a team that sources product internationally, evaluates supplier’s offers and samples, and works with our buyers to choose merchandise. He supervises pricing negotiations, quality control issues with import suppliers and coordination of all import delivery logistics, duties, and customs. Stephane Gonthier: COO: has been Chief Operating Officer since September 2007. From 1998 until 2007, Mr. Gonthier was employed in various positions by Alimentation Couche-Tard Inc., a North American convenience store chain, most recently as its senior vice president in charge of four divisions consisting of approximately 2,600 convenience stores in Canada and the United States.




APPENDIX: Sales by Product Type

APPENDIX: Other Industry Data

Source: NBF Initiating Coverage Dollarama




Source: NBF Initiating Coverage Dollarama

Thus, the Western Provinces have a high potential growth as this market is not yet penetrated and the Ontario/Quebec market is still not saturated.

Source: NBF Initiatin SoSource: NBF Initiating Coverage Dollarama

APPENDIX: Questions Answered




1. What about leasing risk?

Approximately 4%, 11% and 7% of store leases are with third party lessors and will expire in Fiscal 2010, fiscal year 2011, and fiscal year 2012. Dollarama’s warehouse leases will expire in fiscal year 2024, respectively, and our distribution centre lease will expire in fiscal year 2024. 2. Can they really do 40 store openings per year? What if they decide to grow faster?

Since fiscal 2000, they have opened on average 42 new stores per year. They’ve been quite steady in the past so we can expect this for the future, moreover, just setting up distribution forces them to take gradual approach.

3. What is the risk that they issue a dividend? Dollarama intends to retain all of its earnings, for at the very least debt repayment. They have no plans to declare a dividend in the foreseeable future. However, dividend issuance is still a possibility . 4. What is the Lock-Up Agreement? In connection with completion of the Offering, the Underwriters have requested that the Corporation, the Selling Shareholders and the Corporation’s directors, officers and senior management agree not to, directly or indirectly, without the prior written consent of the Underwriters, issue, sell, grant any option, right or warrant for the sale of, lend, secure, pledge or otherwise dispose or monetize, or make any short sale, engage in any hedging transaction, or enter into any form of arrangement the consequence of which is to directly or indirectly transfer to someone else, in whole or in part, any of the economic consequences of ownership of, or offer or announce any intention to do so, in a public offering or by way of private placement or otherwise, any Common Shares or any securities convertible or exchangeable into Common Shares, for a period of 180 days following Closing. The holders of 55,549,078 Common Shares, representing 100% of the Common Shares outstanding before giving effect to this Offering, have entered into such agreements. Lock up agreement should end roughly in April 2010. 5. History of Bain Transactions? Have they dumped companies? How are the now public companies performing? Bain Capital is subdivided into different branches: Bain Capital Private Equity, Brookside Capital, Sankaty Advisors, Bain Capital Ventures, Absolute Return Capital (Bain, website). However, only the Venture capital arm cites their investments. Thus, it is difficult to know from their website what they owned and their history. Thus, I searched the internet for some hints and here is what I found.




Currently, Bain Capital manages $65 billion in assets and has complete more than 230 investments/buyouts over its history. Some of its transactions include Toys "R" Us, Burger King, Burlington Coat Factory, Brookstone, Staples, Domino's Pizza, Dunkin’ Donuts, Micheal’s Stores, Dollarama, Sealy Corp., Sports Authority, and Duane Reade, SunTelephone, D&M Holdings, MEI Conlux, Stream International. Source: www.bloggingbuyouts.com/bain-capital/ These are Bain’s Investments (Wikipedia and other sources):

• 2009, Dec – Bain Capital completes acquisition of BELLSYSTEM24, Japan’s leading call center operator for US $1.1 billion

• 2009, June – Bain Capital announces a deal to acquire a 16% stake in Chinese electronics manufacturer GOME Electrical Appliances for $300 million. The deal is currently the 2nd largest deal for Bain in the Chinese market.

• 2008, July – Joins with Thomas H. Lee Partners to purchase Clear Channel Communications.

• 2007, Sept – Joins with the Chinese networking company Huawei Technologies in an attempt to acquire 3Com for $2.2 billion in cash. However, they were unable to structure the deal to satisfy constraints set by Committee on Foreign Investment in the United States (CFIUS). In March 2008, Bain and Huawei abandoned the transaction.[4]

• 2007, June – Signs an agreement with Guitar Center to purchase the music retailer for $1.9 billion, plus $200 million in debt. The buyout will be for $63 per share, a 26% premium on June 26's closing price. The deal was approved by shareholders on September 18, 2007 and closed October 9, 2007.

• 2007, June – Agrees to acquire HD Supply for $10.3 billion, along with Carlyle Group and Clayton, Dubilier & Rice (with each agreeing to buy a one-third stake in the division). Home Depot sold their wholesale construction supply business to fund a stock repurchase estimated at $40 billion.

• 2007, June – Acquires Bavaria Yachtbau for a price rumored to be about €1.3B Euros.

• 2007, May – Acquires Edgars Department Stores (Edcon Limited) of Zimbabwe and South Africa.

• 2006, Aug – Joins the enlarged private equity consortium headed by KKR that agreed to acquire an 80.1% stake in the Semiconductor Division of Royal Philips Electronics. The new company is called NXP Semiconductors.

• July - Morgan Stanley represents HCA in its definitive agreement to be acquired by consortium consisting of Bain Capital, KKR and others. The transaction, valued at approximately $33 billion, represents the largest leveraged buyout to date (Source: Morgan Stanley)

• 2006, Apr – Acquires Burlington Coat Factory Warehouse Corp., which operates more than 360 retail stores.

• January - Morgan Stanley advises Texas Instruments on the sale of its sensors & controls business to affiliates of Bain Capital for $3 billion in cash (Source: Morgan Stanley)

• 2005, July - Bain Capital Partners LLC, Kohlberg Kravis Roberts & Co. (KKR), and Vornado Realty Trust (NYSE: VNO) announced the completion of the acquisition of Toys "R" Us, Inc. for $6.6 billion.




• 2005, June – Teams up with Haier Group, China's largest appliance maker, and private equity firm Blackstone Group in an attempt to acquire Maytag for over $1 billion. The bid was dropped a month later.

• 2005, Mar – Proposes a $3.5 billion buyout of all 30 teams in the National Hockey League during the league's lockout. The offer was rejected. In June 2005, the company made a revised bid of $4.3 billion for the 30 teams and allow the current owners to maintain a stake in the league. This bid was also rejected.

• 2004, Nov – Purchases the Dollarama chain of dollar stores, based in Montreal, Canada and operating stores in the provinces of Eastern Canada for $1.05 billion CAD.

• 2004, Mar – Acquires Brenntag Group from Deutsche Bahn AG (Exited in 2006; sold to BC Partners for $4B).

• 2003, Nov – Invests in Warner Music Group. • 2003, Aug – Purchases Bombardier Inc.'s recreational products division , along

with the Bombardier family and the Caisse de dépôt et de placement du Québec, and created Bombardier Recreational Products or BRP. Bain Capital took a 50% interest in the new company.

• 2002, Jul – Acquires Burger King in July in a leveraged buyout with TPG Capital and Goldman Sachs Capital Partners.

It was quite difficult for me to find out the performance and history of all the companies they dealt with however, the fact that they are on boards shows they want long term performance. Nothing significantly bad showed up. 6. Does Dollarama have any public debt? Does Bain own some of Dollarama’s debt?

According to Bloomberg, Dollarama has no public debt securities. Thus, I can assume that the prior debt which they had which was public was the one that was repurchased in November 2009. Please see the table on Long Term debt in the report for a breakdown.

7. What proportion of the Board of Directors is composed of Directors at Bain? (**) DENOTES BAIN

5/12 board members are from Bain. See the Board details below

Gregory David: Director Since 2004: CEO of GRI Capital

**Matthew Levin: Director Since 2004: MD of Bain Capital, Director of Bombardier Recreational Products; Director of Unisource Wrldwide; Director of Toys “R” Us; Director of Michaels Stores; Director of Guitar Center **Joshua Bekenstein: Director Since 2004: MD of Bain Capital, Director of Bombardier Recreational Products; Director of Waters Corp; Director of Bright Horizons; Director of Michaels Stores; Director of Toys “R” Us, Director of Burlington Coat Factory




**Todd Cook: Director Since 2004: MD of Bain Capital, Director of Michaels Stores, Director of Dunkin’ Donuts **Felipe Merry del Val Barbavara di Gravellona: Director Since 2009: MD of Bain Capital, Partner at Hemisphere one Younes Zemmouri Rochdi: Director since 2009: Principal of Bain Capital Stephen Gunn : Director since 2009: Chair and CEO of Sleep Country Canada, Director of Connors Bros, Director of Golf Town **Nicholas Nomicos: Director since 2004: Operating Partner at Bain, Senior VP Dollarama, Interim CFO of Dollarama, Director at Bombardier Recreational Products Larry Rossy: Director since 2004: CEO of Dollarama, Director of Colart Design Inc, Director of Confection Courcel Neil Rossy: Director since 2004: Senior VP Merchandising Dollarama Stephane Gonthier: Director Since 2007: COO of Dollarama, Director of Spectra Premieum Resources, Director of Investissements Trevi Leonard Assaly: Director since 2004: Senior VP IT and Logistics for Dollarama Geoffrey Robbillard: Director since 2004: Senior VP Import Division Dollarama

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Dollarama Buy Reports3.amazonaws.com/zanran_storage/johnmolson.concordia.ca/Content...L’Archevêque - 1 Dollarama – Buy Report ENNETH KENNETH WOODS PORTFOLIO MANAGEMENT PROGRAM