Alternative asset manager Apollo Global Management (NYSE:APO) took Phoenix-based Sprouts Farmers Markets (Nasdaq:SFM) public July 31. Its first day return on its $18 IPO price was an amazing 123%. Apollo made out like bandits. How can you benefit? I'll look at the possible scenarios. 
 
Scenario # 1
It's possible that the lead underwriters--Goldman Sachs (NYSE:GS), Credit Suisse (NYSE:CS) and Bank of America (NYSE:BAC) dramatically underestimated investor interest in the organic grocery store chain. Based on an IPO price of $18, Sprouts' enterprise value was $3.2 billion. After the first day of trading it jumped to $6.3 billion by the close or 43 times adjusted EBITDA. That's almost three times Whole Foods' (Nasdaq:WFM) EBITDA. I suppose they could have gone with a higher initial range than $14-$16, but hindsight is 20/20. 
 
Is there enough growth to justify the pricey valuation?
 
Well, let's look at the valuation from both its IPO price of $18 and its August 1 closing price of $40.11. In its second quarter ended June 30 it expects to grow revenues by 30% to $622 million. Its pro forma 2012 revenue was $1.99 billion. Let's assume it does $3 billion in 2013 and $4.5 billion in 2014. Let's also assume that its net margin of 1.5% generates $67.5 million in net income in 2014 or $0.46 per share. That's a 2014 forward P/E of 39 based on $18 per share and 87 based on $40.11 per share. If it's able to grow earnings per share by 25% annually over the next five years, its PEG ratio at $18 was 1.56, which is very reasonable. At $40, it jumps to 3.48, almost double Whole Foods. 

SEE: How An IPO Is Valued
 
This tells me the underwriters did a good job valuing Sprouts' business. Investors simply decided it was worth more. If you don't feel that way, I suppose you could always short its stock. However, it seems to me like momentum is going to carry this stock higher over the next week or so. I'd say a better solution would be to wait until the excitement wears off and its stock drops down to around $26. It's not $18 but it's better than $40.   
 
Scenario # 2
It's my hypothesis that Sprouts merge with The Fresh Market (Nasdaq:TFM) to create the nation's second national health food chain. Both companies have similar-sized stores (between 20,000 and 28,000 square feet) selling higher-margin, quality products. Together they would have 279 locations in 34 states with annual revenues of $3.3 billion. 
 
Of the two businesses, The Fresh Market has higher margins. With Sprouts 123% jump in price its enterprise value is more than double The Fresh Market. Granted, Sprouts' Q2 comparable store sales growth is expected to be 10.8%, 780 basis points higher than The Fresh Market. However, at the end of the day, The Fresh Market delivers better earnings. 
 
Whether or not a deal is possible, The Fresh Market is a smarter way to play the healthy food industry, especially after Sprouts' big opening day. Don't be a patsy for Apollo - take your money elsewhere. 
 
Scenario # 3
If you can't beat 'em, join 'em. Apollo acquired Los Angeles-based Smart & Final in February 2007 for $813 million including the assumption of debt. In October of that year Smart & Final acquired Henry's for $166 million. In April 2011, Apollo acquired 58.5% of Sprouts for an equity contribution of $214 million. At the same time, Sprouts acquired Henry's from Smart & Final for $275 million. 
 
Lastly, Apollo sold Smart & Final in October 2012 to Ares Management for $975 million. Add in Apollo's $147 million cut of a dividend paid by Sprouts in 2013 and you'll find that Apollo owns 65.2 million shares of Sprouts while putting $96 million in cash in its pockets since 2007. Those 65.2 million shares are now worth $2.6 billion. 
 
It's not very often that you can walk away from six years of work with $2.6 billion and your time being the only cost of that work. This has to go down as one of Apollo's most successful deals in its history. Why not buy its stock and participate in its future success.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  3. Active Trading Fundamentals

    The Companies of Peter Theil's Founders Fund

    Learn about the major public companies that Peter Thiel has invested in and companies that are on the verge of going public at multibillion-dollar valuations.
  4. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  5. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  6. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  9. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  10. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What kind of assets can be traded on a secondary market?

    Virtually all types of financial assets and investing instruments are traded on secondary markets, including stocks, bonds, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!