Chit Chat Stocks - Joint Corp (JYNT) with Edward Chang

Episode Date: June 30, 2022

Joint Corp owns and operates chiropractic clinics. The company operates within two segments, Corporate Clinics, and Franchise Operations. Listen as Brett and Ryan ask Edward questions about the company, its business model, and valuation. Enjoy the show! This episode is sponsored by Commonstock, a social network for smart money investors. Check-out the platform here: https://commonstock.com/  Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested to see more of Braden's work? Find him on Twitter here: https://twitter.com/edwardwchang?s=20&t=ljAQJEJtXdm1enNH39Mp5A Contact us: [e-mail]  Timestamps Joint Corp | (8:42) Competition | (16:28) Customer Satisfaction | (30:15) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode where we have on a guest to discuss a single stock that they are an expert on. And today we have on Ed Chang. He is the founder and portfolio manager or investor at Pledge Capital. And we're talking about the Joint Corp, which is a franchisor of chiropractic facilities. It's a very interesting pitch. You can tell just how smart he really is as we get into the interview. But before we get to that, Brett, what were some of your highlights? Yeah, the whole interview was good. The company is quite interesting. I think the biggest concern someone listening to this will have is, isn't chiropractic kind of a thing in your mind? Like, isn't chiropractic kind of mumbo jumbo,

or at least a lot of people think that? We kind of go through the size of the industry, the quality reviews that the places get, the quality service that they run, and how it really is a medical profession, and they have the best brand in the industry, at least throughout the chains. Yeah, and they are, I believe, the largest chain in the chiropractic space. But I want to talk about our sponsor before we get to the interview. Today, we're talking about Common Stock. Common Stock is a community of experienced traders and investors, and it's the only social investing platform that lets you connect your existing brokerage account. They call it sort of a Bloomberg terminal for main street. Something I really like about the community is there seems

to be a lot of candor and people are, you're getting sort of the honest side of a lot of these investors. You've been a little more of a regular than I have. You got to get on there. You got to next time you do that, or you got to get on there. I know. I know. What, uh, what has your experience been like? It is great. The, there are a lot more posts than there used to be. So if you went on when it was, you know, started up earlier and there wasn't much activity that has changed a ton i'm seeing multiple posts every hour if you have your big feed here and it's not just like twitter where it's a lot of blurbs maybe people doing stuff just for retweets people are trying to start conversations they're posting quality work here i like to post our podcast

shows and pose a few questions about the show that anyone interested in that security may be wanting to discuss or any concerns they might have stuff like that uh and just think about that but with any other individual investor. So lots of quality work. Yeah. We were talking about it with our friend, Brian Feroldi, and he said, I believe he described it as the signal to noise ratio is much better on common stock than Twitter. So go ahead, check them out. You can visit commonstock.com to join today. It's commonstock, C-O-M-M-O-N-S-T-O-C-K.com to join. Without further ado, let's get to the interview. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview

industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. Today, we are joined by Ed Chang. We met in Omaha at the Berkshire Hathaway shareholders meeting through a mutual friend. Listeners may know him, Luis Sanchez. He's been on the show before. But today, we've got Ed on and we're talking about a company that

has had a wild ride. And it's maybe one that listeners aren't familiar with, but it's got an interesting story and we'll get to that in a sec, but I wanted to introduce Ed and kind of talk about maybe some background for anyone who doesn't know you, doesn't follow you on Twitter. You run Pledge Capital now. How did you end up starting that and how has that journey been? Yeah, sure. So I started Pledge Capital in 2016 after covering restaurants on the sell side at UBS in their equity research department. And, you know, it was really a childhood dream of mine to start my own investment business, managing money for clients and, you know, friends and family and myself. It's been a passion of mine since I was a young teen right after the tech

bubble um bought my first stock uh gateway computers uh right after the tech bubble i think it was trading at five mid single digit pe and uh you know anything you bought kind of just made money it was good time to to get in and uh i had bought a computer on there it was cheaper direct to consumer i was able to customize it so you know kind of that peter lynch know what you know what you you know shop buy what you shop kind of story and everything just went up at that point i think it was like 2003 so i mean long story short you know fast forward to you know six years ago um had some experience on on on in wall street uh studied finance at nyu stern uh and uh you know was was able to raise some capital and launch launch pledge capital do you have i know you said

you worked in with a focus in retail is pledge kind of do does the fund have a focus on retail or can it span anything yeah i so you know at ubs i covered franchised restaurants and also company-owned restaurants um and um i mean i've invested all over um to the companies that we were just talking about chuck acre and meeting at chuck acres event and uh he has been um you know an inspiration uh i invested in mastercard in college um a decade ago congrats largely especially learning from Chuck Aker. And I used that mental model to invest in Google at the same time, around 2010, 2011. And I really held those stocks. Those were two of my companies at inception of Pledge Capital. I loved MasterCard and also Visa, same thing. They were doing a ton

of credit card rewards, their partners were. And I thought that was a nice rebuttal to the short thesis that we're all going to switch to digital you know everyone in my age group was on the credit card rewards games and we're signing up for all these credit cards and it just seemed like a great retention and recruiting tool for for the credit card ecosystem um so you know i've i've expanded you know beyond and i've tried to leverage mental models to learn about other businesses like restaurants um you have unique economics right one location leads to another and you have a sample and you can see if it goes from regional to national. The franchise model is high margin, capital light. It's B2B. You're actually selling to

partners, franchisees. And so I've used that to think about software businesses and learn about software businesses. So, you know, pitched the joint in 2019 at MOI. And then, you know, I've followed that up with, you know, a pitch on Avid in 2020 at MOI. And then Nuance was another software company that I pitched. So I've definitely tried to expand beyond retail into other, I just in general, when I think of compounders, I like to compare companies to Google and MasterCard. But, you know, that that's kind of like where I like to focus consumer chains, compounders, software companies, things with network effects like MasterCard, just businesses that I feel have an advantage, a addressable, a big addressable market, some sort of secular growth. And there's just good models, good business models. And today we are talking about Joint Corp or Joint, I guess it's Joint Chiropractic kind of their franchise chiropractor.

How did you come across them and can you explain briefly what they do? So I guess I have to also shout out to Artco Capital. He's written some stuff about it. um i follow a lot of uh franchise um publications i keep my eye out on a lot of franchises i mean there's goosehead there's uh ewcz there's uh there's a bunch out there right there's a there's a car focused on driven um there's a bunch of fitness ones when when we launched um uh we were invested in planet fitness we were also invested in a chinese hotel franchise there's two of them we're invested in one of them called hdht it's like a budget hotel i love going to

franchise expos um i go to them every year um i passed on the joint initially because it was unprofitable but in that 2019 2018 you know march 2018 time frame um i started to see i started to expect that you know they're on the verge of profitability um you know i uh and and that's when i really did it did a you know kind of beginning 2018 end of 2017 kind of started to do a, uh, a deep dive on them. And, uh, and that's when, uh, I made my initial investment. Um, I think it was like five 50 to $6 a share. Okay. And what, what is their model like business model? I know you meant it's chiropractic and franchises, but is there anything else we need to know about that? Yeah, it's, it's two segments, right? So on one hand,

15 of the units are company owned so you can think of like a starbucks or chipotle any chain right even florida core uh floor and the core or five below where there's opening more locations um taking the cash flow from established mature units and building new ones that are unprofitable and losing money and then scaling those into maturity when they you know generate cash flow. And then you have the franchise segments, 85% of locations where they partner with franchisees who do all the work, spend all the money. And so those are the two lines, the two segments of the business. Okay. And joint chiropractic has grown pretty rapidly, at least if I'm remembering the IR presentations correctly over the last few years.

what makes them different than competitors and why are they able to grow you know versus say these single practices or maybe they're not stealing market share they're kind of able to market share and specifically why are they able to evade the insurance uh ecosystem great question um insurance is pretty complicated a lot of doctors and also chiropractors and physical therapists frankly don't like to take it but that's where you know most customers are right historically and we've had a shift from you know the insurance mob that i think our parents had to a lot of high deductible plans these days um so that that's a a good setup for the joint. It's been a good setup for the joint to change. They call it

revolutionizing access. I think that's a pretty good way to put it. So how they differ from that independent chiropractor who, you know, may operate on his own or, you know, maybe has one or two chiros under him part-time or full-time is that, you know, the joint doesn't take insurance at all. Um, they save a lot of time on paperwork. Um, that's a pretty high cost for some chiropractors that are hiring someone at $30 an hour. Sometimes that person is actually making quite a bit of money just to handle. If you have someone who really knows how to deal with insurance, they're very valuable and they're kind of rare. You're constantly fighting for, the insurance companies to get what you're owed, right? And they can reject you for a lot of

reasons. So the joint really created another system, a cash-based, well, credit card, debit card, cash-based system to provide chiropractic care. So on one hand, I think there's a couple pieces of their value proposition um you know the typical chiropractor is charging insurance you know thousands of dollars potentially over like a two or three month period um and um if you are in a high deductible plan you're often you know asked to pay that out of pocket right it could be hundreds of dollars five six thousand you know fifteen hundred dollars for that regimen that they lay out. The joint has a $80 per month membership model, you know, and they charge an extra $10 for every visit that month. So if they tell you to come in twice a week, you know, that

will run you $120 a month. So over like a three month period, it could be anywhere from $240 to $360. And during that same time, if you go to a typical Cairo who's insurance based, you know, If they have high prices, you could be paying $1,500, $1,000, $1,500, even in some cases, $2,500 to go to that Cairo. There's some cheaper ones who are adopting cash-based models. Those will still run you more. I think you're still going to spend upwards of $5,000, $8,000, $1,000. So that's one piece. You know, they've, they've, they've gotten rid of that entire insurance infrastructure that you need, um, that most doctors have. Um, and that's, they already spent a lot of time on their own, their own time to, to, to handle those claims.

um the joint also has higher cost real estate they locate they love to locate next to a trade of joe's planet fitness you know your big box grocery store or or gym so make it super convenient versus most chiropractors are in some medical office you know they're on the fifth floor and you know some you know typically more out of the way and so so the joint is uh it's more affordable um it's easier and more accessible and the last piece is that they're just really out there with marketing right very few chiropractors can spend the level of money that the typical location uh spends so you know one of the great things about the joint is that they're actually expanding um the the you know the industry they're they're expanding the chiropractic industry you know 36

A third of their clients have never been to a chiropractor before. So that's really how they're different. to conquer the day tonight laquinta tomorrow you triumph book your stay at lq.com uh who are they i guess competing with like is it sort of a is what's the typical chiropractor is it another like chain or is it mostly just like individual chiropractors like you mentioned that are have their own room on a medical floor so there are a few chains right the next two biggest chains are you know probably about 150 170 so the joint's like 730 740 units so they're like four times bigger um and they're growing really quickly the joint's growing like 20 a year the next two chains

are kind of stagnant or even shrinking they're a little bit more insurance focused um and then below that you have this you know long tail of small chains um i don't think you can assume the joint is going to be the only um chain right it's not already and there's some young promising um you know 20 chiropractic 100 chiropractic new spine uh you know these smaller units with like you know we're almost like an order of magnitude smaller right um the joints just much bigger they're already starting to do tv ads i think in the next couple of years they're going to do national tv ads to really raise awareness um and build a brand they're on the cusp of that um and then you have the whole long tail of uh chiropractors that are single mom and pop maybe

they they you know maybe they have one or two chiropractors under them that's the vast majority of the, um, you know, the industry. Right. How did COVID impact them? And I guess the industry at large? Uh, I thought the joint handled COVID extremely well. Um, you know, during, during COVID people really are free to go out. I mean, if you talk to the typical doctor, um, Their offices saw big drops in visits. U.S. physical therapy, I think they reported a 40% decline in revenue. People just thought of doctors' offices as places where a lot of sick people potentially with COVID would go to. And the joint, they really responded well.

They installed sanitation stations. They handed out masks to everyone. They had people wait in cars. If you look at some of the other retail concepts out there that I consider similar, franchise businesses that are a little recession resistant, gyms, who wanted to go to a gym and exercise for 60 minutes and have to wear a mask. Whereas if you're going to a joint's chiropractic clinic, wearing a mask for five minutes or 10 minutes that you're in the clinic, it's no big deal, right? And so you saw visits at a lot of these other retail or doctor's offices fall 20%, 30%, 40%, 50%. And you saw their revenues just fall significantly. um the joint reported negative six percent same store sales in the second quarter of 2020 it i believe it bounced back to like plus 10 percent in the third quarter and then by 2021 they were growing same store sales 20 again right um so similar to what they were reporting before the pandemic um yeah for me from my point of view you know it really showed how you know how strong this

concept is, right? People really get a tremendous value proposition, right? You're addressing your pain. It's a $20 per adjustment, $10 to $20 solution to your back problem, right? You throw out your back shoveling snow. What do you do, right? And a $20 adjustment, a 15-minute consult, like oh what do you do now how do you fix this you go get that adjustment it helps alleviate pain right i mean you're you're seeing on um you know ted lasso or or you're hearing about mike tyson or or or you know mayweather who you know and how they use chiropractors to to address their pain and and and so you go in and give it a try and um it's located right next to the trader joe's it's so easy to get to. So, you know, people love it. They gave them such high reviews on Google Maps

and Yelps. I remember, I think it was either in one of your write-ups for joint or in the MOI pitch, but you talked about COVID possibly being a benefit to their competitive positioning in the chiropractic industry. Did that end up playing out? Did that, were there like, was it a chance for them to kind of take more market share? Yeah, no, that's a, that's, I think that's a good point too. So, you know, typically, um, look, chiropractors, they're very well-educated folks, right? They're, they're, they're smart. They tend to be pretty, um, you know, hardworking they're, you know, they're educated people, right. With a lot of degrees and they've been through a lot of school however not all of them are great business people right i've i've talked

to chiropractors who have like a hundred thousand dollars in credit card debt right like they're not doing well running or they didn't do well running a business that you don't learn that at chiropractic school um not all chiropractors are natural business people. They're not natural salespeople. They don't have that business hat, right? They're really good at treating pain, fixing your, you know, physical ailments, but a good, I would assume 25, 30% of the chiropractors out there, they're not, they're not great. They're not doing well running their own clinics. Right. And so, you know, so that's why I think you have a lot of chiropractors who just at some point decided they just or they don't they don't even try to

begin with they don't they don't want to take that financial risk they just would rather work for someone um get you know experience collect a paycheck maybe try to do it in the future and the the uh the pandemic hurt a lot of doctors that hurt a lot of chiropractors um financially and um you know it it i i don't have the statistics but i would assume that some doctors and chiropractors had financial difficulty and even financial trouble and um you know part of the appeal of the joint is that you can just show up for four hours or eight hours and just collect a nice paycheck right like it annualized right a lot of their chiropractors are making $89,000 a year, which in a, you know, a city like Nashville or Atlanta

or Denver, that's a pretty good living, right? Versus trying to start your own business and going through the stress of, you know, managing rent, marketing, payroll, potentially, you know, having to deal with insurance. I tend to think that, you know, the pandemic was a benefit to the system, to the joint system. Okay. And to the majority of people listening, the chiropractic industry is a bit of a mystery. So I was wondering if you'd give any context to say how large is it? How fast is it growing? I know the joint is trying to expand that total addressable market and what sort of opportunity versus say their numbers they have today financial numbers is joint chiropractic going after yeah so the chiropractic industry is about

17 billion in in um you know size the the joint had about 360 million in system-wide sales last year right of which you know some of it is through their own clinics some they take a seven percent royalty check off of um i i kind of look at it as um similar right the joint today is doing something similar to like what planet fitness did right planet fitness helped expand the total number of americans who are part of a gym member a gym right they helped expand it from 10 to 20 percent and the joint because it's um you know more affordable more convenient more accessible and they're also really marketing it and raising awareness right um they're they're bringing a lot of people and they're expanding the chiropractic industry so i think they're doing something

similar we're kind of you know see it from go from maybe 15 to 30 percent right of of the u.s population. I think you could see that in the next decade. Um, you know, historically chiropractors have been given a bad name. Um, and I think there's been some lawsuits, um, the U S medical association, uh, really attacked it unfairly. Um, you know, I think past generations may think of often think of chiropractors as quacks, right? It's like a pseudoscience um but they these are medical professionals that know a lot about your body like i personally have benefited from a chiropractor um i used to run a lot a lot of wear and tear on my body uh from from all those miles every single day i talked to a chiropractor and

she told me look your back problem um it's you you need to strengthen your glutes you need to strengthen your leg muscles you need eventually to you know once your back is not flaring up you need to do deadlifts you need to do back exercises that's like the regimen i prescribed to you it's going to take time it's going to take months right or even weeks at the very least to months to you know do those exercises squats you know the the jane the jenna fonda exercise with the glutes and in the meantime i mean your back's gonna hurt there's nothing all i can do is temporarily relieve your pressure right it's chiropractic in my opinion a little bit like cannabis for older generation right older generations like athletes love some athletes

really like cannabis and chiropractic right they they use it to address work-related pain right cannabis does have anti-inflammatory uh properties and also pain relieving properties a chiropractor fits in the same bucket right um they're you know getting those adjustments from my point of view right it helped me it it relieved my my pain for like a day or two it was a temporary solution you know you have to listen to your chiropractor you know i've talked to a lot of joint chiropractors they really stress that part right and and they see from the younger generation that they're really willing to listen and i think with the older generation they're you know a little bit less inclined to follow those instructions um but in

in my opinion that that image is changing um i i think with the millennials and gen z and even some percentage of of you know people who are in their 50s and 60s they're more willing to give chiropractic a try you know there there was a lawsuit um you know now it's recognized as a solution for back pain um and um so you know to answer your your question right like it's it's a bit of a mystery. It's only a mystery until you've tried it or you've heard of someone who gets a benefit. And I think society is shifting in that area where it's been beat up and looked down, but it really serves a purpose. And the joint has... Just look at the reviews. There's so many happy customers who've gotten a benefit. You talk to their wellness coordinators or their doctors,

they feel good about what they do. They feel good about what they do on a day-to-day basis. And they talk a lot about how there's a lot of happy customers. And they have a lot of word of mouth. I haven't seen a franchise chain grow same-store sales 20% year after year for so long. And even recently, it's stepped down to 15%. But that's still phenomenal. Cox Panoramic Wi-Fi includes advanced security to help protect all your connected devices. You'll get real-time alerts. Oh, like this one, so you don't have to worry about malware. Or when your kid downloads a song from a shady link.

And now all your computer can play is... Red color, red color, where are you? All blocked, thanks to advanced security. Included with Cox Panoramic Wi-Fi. Advanced security must be enabled in the Panoramic Wi-Fi app. Restrictions apply. Right. Let's talk a little bit about those.

You mentioned how happy the customers are. We saw on Google Maps that the locations get really strong reviews as well. You mentioned Yelp. I think you touched on it briefly, but what other factors are driving that customer satisfaction? And is that replicable by competitors? So, yeah, the joint has four to five star reviews on average. I think it kind of clusters around four and a half. You know, you can just pick six cities and go look at every single location and read those reviews.

Is it replicable? Yeah, I think it is. I don't think there's anything proprietary in their model, right? And there's three key ingredients. One is it's very conveniently located. You're paying up for that real estate. This is right next to a Trader Joe's. a fresh market, you know, maybe a Whole Foods, you're next to a lifetime fitness,

a planet fitness, some sort of big box exercise facility. You don't, there's no monopoly over that kind of space, right? 1,000, 1,200 square foot space. You know, the price is another big part of the value proposition right you need you do need um brand uh you do need a strong brand right you need to be recognizable you know the joint started from nothing and now they have 700 something locations there they have word of mouth it helps right that so they they have higher auvs right they have a sustainable business model so for a small company to come in and and do that right away it might be hard but the fact is that you know i think uh new spine is starting to do it 100 chiropractic is you know i i'm not as familiar with you know some of their numbers but

um you know mcdonald's has wendy's burger king shake shack five guys in and out right like jack-in-the-box like this is not um it's not just going to be the joint right but the joint what what who are they are competing for is they're competing for franchisees right and the joint has the most um recognition they're starting to do tv ads um they you know have the biggest brand they're they're 20 times bigger than than you spine um they they have that as an advantage and i think that's hard to replicate um you know doing tv ads and and you know telling more consumers you know 50 of people i've never heard of don't don't know what chiropractic is right and doing tv ads to raise awareness um of the industry and also of

the joint that does give you an advantage that's going to be hard to replicate until those uh Chains are, you know, six, seven, eight or a thousand units strong. But, yeah, it's just that the value proposition is there and it's a very big market. You know, even at seven hundred and thirty locations, there are a fraction of the total addressable market, which which they're increasing. Gotcha. And when I looked at the earnings statements or their IR presentation, I saw that the company-owned stores, and this might have been just recently, are unprofitable versus the franchise model, which is highly profitable. and that seems to be masking the strong unit economics at the moment. One, is that true? Two, when does that change? And what sort of margins do the company owned ones versus the franchise ones have? And I guess maybe if you want to just go through any sort of financial numbers you think

are relevant. Yeah, at this point with the stock trading at like $13, $14, you're basically getting the company-owned segment for free uh you're basically only paying for the franchise segment like you said it's profitable it's highly profitable longer term you know they're talking you know up to you know i think 40 plus um operating margins is you know 40 to 50 percent yeah like with a franchise business um especially as they buy back more um regional developer rights um and they get back some of that royalty income um the in general these these franchise businesses they have very high incremental margins that could be 70 80 percent right and so that should drive the margins up from the current levels which you know i believe are um like 20

just off the top of my head it's like around 20 you know 20 maybe a little bit lower and that's specifically for franchise yeah yeah exactly so the the franchise only business is it it in my opinion it generates enough ebita to to you know warrant the current stock price and so you know let's talk about the corporate level. You know, they've talked about 30% margins at maturity. You know, the, the unit level economics are that, you know, you, you spend $200,000 to open a location in the first year, you lose a hundred thousand. That's very,

that's weighted to the first six months. And, But eventually, when the stores mature, you're making $150,000, maybe $130,000, $150,000, $180,000 on a sales volume of $550,000 to $600,000, right? So, yeah, you're getting close. Eventually, you should move towards 25% to 30% margins. before corporate overhead. And so what's been happening, it's really three challenges, or three headwinds. On one level, they're facing the same headwinds that everyone's facing with not a lot of people out there. There's a lot of competition for labor. So wages are going higher. so wages went 20 went up 20 percent right i think that's what they went up in 2020 they were probably

up five percent last year and they're probably going to be up five percent this year that's what i hear um so that's one the second factor is that they're opening a lot of stores right they're expanding very aggressively this is you know one of the fastest one of the faster um expansions that that i think we're witnessing right they they went from 64 to 96 units last year um this year they're adding they're probably going to open 30 or so stores 30 or source 30 or so stores and and so those stores lose money in the first six months right probably about a hundred thousand dollars so you know fifty thousand a quarter after after they open so you can you know do the math what kind of pressure there is if so if they opened eight units um you know that's around

four hundred thousand dollars in um kind of a headwind so that that's the second level and then the third level the third headwind has been that you know they're basically staffing up ahead of growth right there they probably need one manager for you know four to six locations you need to hire those folks before you build those four to six locations right so you know a location might um make um you know and it's not making money right away right you're you're you know the first year you know profitability right so the first six months you lose a hundred thousand then then the next next 12 months you might make might you might make you know 40 50k um if you hire one manager um his salary very well could be greater than that 50 60k that that

first location makes right so you know eventually that location is going to go to 100 130 150 180 000 in profits uh but you also need to build those extra locations and those extra locations lose 100 000 initially and so there's those three levels that you know you have to you just And that's just the reality of opening company-owned locations versus a franchise model. The beauty of a franchise model is that it doesn't matter if you have $250,000 in sales or $350,000 or $500,000 or $600,000, you're just collecting 7%. And it's a very high margin revenue, even though you're only collecting 7%. But the joint believes, because you're incurring $200,000 in CapEx, you're incurring $100,000 in losses to get the breakeven. Eventually, these units are making $100,000, $150,000, $180,000.

You're earning a very nice return, 40-50% returns. And that's an attractive use of shareholder capital. But it does take time to get there. And they, you know, they've gone from, I believe, like, you know, they're going from 60 units to 130 units in a two year period. And most of that, the vast majority of that is just organic bills. And so you're going to lose money on the new units you open, but you're also going to lose money from hiring people, right? You're going to incur costs from hiring people before those units are fully built out and also fully mature. So I imagine the joint is probably more than happy to get franchisees to just sign on. So what, is there any, I guess, hold up in terms of like, are they finding enough franchisees? What are they doing to incentivize franchisees to come on board? They don't need to. I think it sells itself, right?

you know compared you know franchisees are always looking for different concepts right there the joint is competing with restaurants it's competing with fitness facilities it's competing with massage concepts like massage envy and you know hand in stone it's competing with barber shops it's um so you know on one hand these units make like 40 50 cash on cash returns right um you You know, we like to talk about IRRs as investors, but, you know, the people who look at franchises, especially if you're an individual investing in opening five, you're building out, you're looking at a monthly basis. You know, you're looking at cash on cash returns at the six month mark, 12 month mark. And so they're looking at, oh, in year three or four, I can make, you know, $10,000 a month. Right.

And they're analyzing that, and then they're dividing that by their, you know, by their, by their investment. That's how they're looking at it. They're looking at payback periods. The 40-50% return is very attractive, right? A lot of other concepts out there, you know, food ones, you know, the big ones that you can think of 10, 12, 13%, right? But everyone wants to open a McDonald's, there's not a lot of area left to open those. um you know dunkin donuts you know you're talking like 25 30 returns like and then you know so so relative to like those concepts not only is this return better but frankly it's also more simple to manage right with with restaurants you're with uh these franchise chains you're dealing with a lot of part-time um teenagers young 20s who you know this is not like this is not their life's purpose right they they're not out there to to you know when you hire chiropractors you're dealing with someone who's highly educated very responsible like they want to help people they're they're a lot more dependable and so you know instead of managing

like 20 something 30 40 employees that are mostly part-time in some of these other concepts that you're competing with the joint you're you have like five six four five six employees right and and like even in an also it's actually easier to to run three or four or five locations which appealed opening a few joints is that you know if you have one location and one of your two chiropractors calls in sick all of a sudden you're are you going to close your door for a day or two until he gets better it becomes very stressful um so if you have like four or five locations and all of a sudden you have 10 chiropractors you're more likely to have someone who can fill in uh so it's a very competitive right people want to open these right they they have a long uh

pipeline there that's it's part of the reason they're they're growing their units 20 a year it's that there's a lot of demand for it they don't have to go out there and push these they can be selective and work with the best um operators who you know some of them have open plan of fitness in the past right some of them open massage envy they have been successful in other businesses you know the the franchise um you know network that they built it's a true asset for this company. Okay. Last question on the business. And I want to talk about the valuation and the stock. How do the chiropractors get compensated? Is it just like a fixed salary? Is it up to the franchisee or is it like, depending how many patients they see? Do you know?

It really depends. In general, it's not on a per patient basis. It could be on an hourly basis. it could be a salaried position um with you know and in both cases there could be some sort of bonus depending on uh how busy the location is or or how profitable the location is uh on you know on the high end you know for for someone with a little bit more experience like the ideal candidate is someone you know who has a few years of experience maybe gave is you know give their own location to try and didn't do well and now just wants to you know kind of tired of that hustle the you know the the self-employed hustle and you get you get paid 80 90 000 right or even 100 with some with some you know profit share um and then below that you know you also

have some folks who are kind of in between right they're making 70 80 000 uh and and some of these these could be part-time so they're making half of that now right for for part-time work and you know oftentimes you know the joint has a four-day full-time uh model where you know these chiropractors are getting paid eighty ninety thousand dollars to work uh four days four days a week full-time you know from from morning to evening morning to close and uh you know chiropractors i think that's one area where people have been attacking them um and they've been making adjustments they added a lunch uh lunch break right to really give these folks you know hearing you know the complaints um and you know they're they're working on some mentorship programs to really help retain um

their their chiropractors um and you know they i think they've done a good job in that area to to respond to some of um the the unhappiness that chiropractors reported all right how do you go about valuing the joint stock or not joint stock the joint corp uh and what caused that big run-up it could have been it could be unknown i guess but what's caused the big run-up in 2021 And what's causing investors to be nervous now with the stock down, what is it, 80% or more from its highs? Yeah, look, it went up a lot. I think a lot of that was driven by, you know, just momentum and, you know, just greed. um i think what people were doing was that they were looking out six seven eight maybe even 10

years and extrapolating extrapolating growth extrapolating some of the targets the margin targets that the company was was was saying and you know at the peak i thought they were pricing and everything the joint could do um that what i believe they could do in the next seven years so You know, I thought at 110, you're holding dead money for the next, you know, potentially six, seven years. And so, you know, I think there was maybe a short squeeze. There were, it got added to an index. So there are people who had to buy a lot of various different reasons why it went up to, you know, 110. I started to think it was really expensive around 50 to 60.

I started to, you know, I was trimming here and there, trimming 10, 15%. in the 50s, 60s. I started to sell more aggressively in the 70s and 80s. And I sold out in the 90s, trading at 200 times income and 110 times owner's earnings, which is a metric that Buffett likes to use. It was very expensive to me. And I didn't see a lot of upside from that level um now you know now fast forward to less than a year i feel like it's gone the other way right it it um you know it overshot on the upside but significantly and now it's um under it's undershooting it's it's overshooting to the downside again right you know owners this box is extremely simple there's it's not like a gym where there's a ton of equipment to replace i

I mean, you have three chiropractic tables, you know, they cost like $3,000 each. They're very durable. Chiropractors say that you can use them for a year, decade, right? They almost never need to be replaced. This is not like a restaurant where you have a ton of kitchen equipment that breaks down and you have to replace it every couple of years because you're using it so much. You're opening these refrigerators all the time, right? There's none of that, right?

There's very little maintenance cap tax, if any, right? So if you look at the cash flow, which is greater than their net income because they're buying back these locations, right? They're very low closure rate, right? And so they're amortizing these clinics that they're buying back over a three to seven-year period. They're buying back these regional developer rights. They're amortizing those over three or four years. There's no cash expense to maintain those assets, but they're writing them off and it's hitting the income. It helps reduce taxes. Cash flow is higher than income. And at this point, they generated 15 million in operating cash flow last year. This is now a sub $200

million dollar company uh with very little maintenance capex i mean the vast majority of that operating cash flow is is actual sustainable profit um you know they have like a million plus million and a half maybe of stock comp so it it's an attractively uh very attractively um you know valued company at this point growing units 20 well maybe like 15 percent long term for the next few years and also still growing same-store sales 15 maybe you want to assume five to ten percent right that's and it's most of the business is a franchise business um which is very high quality capital light high margin um and and the business itself right it's it's an affordable solution to pain it's a tremendous value proposition so i i think it's undershot to the downside at these

levels what do you think about the i guess who who runs the company what does the management team look like and what do you think about them how crucial are they to this investment So I believe Peter Holt is actually a great manager. He's very long-term thinking. I mean, if you looked at last year during the run-up, he didn't sell his shares, right? He was worth a considerable amount of money. I mean, for any, almost anyone, that's, that's a pretty nice, like, you know, 30 something million, 25 million, he didn't sell his shares. And so he's really looking at growing this thing to a thousand units. Then eventually I think the 2000 units, um, I think he's really, he worries and he thinks a lot about growing pains and also just, you know, the risk of growing too fast. And that's why I think he embraced the regional developer model, right, where you bring in these guys who have had a lot of success, maybe in real estate, maybe as a Planet Fitness franchise or a franchisee, sorry, or a Massage Envy franchisee. and and now they own a cluster of the joints and and they're willing to train other franchisees and help them and coach them and also recruit franchisees to open uh units right it's a it's a it really de-risks the growth and you know i i feel like you know part of the reason they're

losing money now um at the corporate level right or you know profits ebitda has dropped uh they're only making a seven percent ebitda margin um at the corporate level is because you know they're hiring people ahead of growth right so he's again he's being um they're very thoughtful um like i think in a lot they have a lot of great management at at the mid uh mid uh mid executive level i mean i think someone who gets unfairly attacked is actually eric simon I personally think he's a he's a good guy. He in his past, he tried to open, you know, he tried to try to franchise his, you know, he franchised the concept and and he tried to, you know, become a business person. Unfortunately, he failed and he had to file a bankruptcy. Right. That's what it was related to. I truly believe he doesn't want other people to follow his footsteps and fail.

And I really believe he's very thoughtful in assessing applicants who try to open, who want to open a joint location. And, I mean, this team is, they're looking for people they believe will succeed, right? and they're also trying to give them resources um they're you know the rds regional developers help in my opinion this is this is actually a really good uh management team um who i believe they will succeed at taking the joint to a thousand and then two thousand units are they we're running running short on time here but are they buying back stock at all or Or are they trying to take advantage, I guess, of what you think is an undervaluation? Yeah, I hope so.

I mean, both the CFO and the CEO, they were buying back shares. They were buying shares personally in the 30s. I mean, when I look at their cash flows, right? I mean, they could potentially buy back shares, you know, but they've chosen, you know, thus far, right, to buy back, you know, well-performing. So recently they bought back some units in Arizona. Those units are probably really profitable from franchisees. um but yeah i would hope you know and i will voice to them um that it would be their stock is a is a good uh good target for for that capital you know that free cash flow they're generating

if they're listening hopefully uh yeah exactly hopefully you know if they're listening it would be the right move all right last question pre-mortem here what do you think you go wrong, what are the biggest risks, biggest risks to an investment in the joint corp? So I do believe, right, that, you know, the execution risk is key, right? The failure to execute would be something, you know, that I would put up there. But I believe they're making the right moves. You know, the mentorship model that they're working on, right, like holding on to doctors

is i think really key um and and they've made right moves in in this in in this area right they reduce the the um the churn of doctors from from 50 to like 26 i mean these are highly educated like individuals you know make with an upside of you know 90 to 100k some of them want more i really think the joint needs to you know come out with uh with a path to ownership i mean it's something that they're working on. Um, you know, I've spoken to several chiropractors who left, but would have stayed if they were able to buy into a location or if the joint helped them, um, you know, open or co-own a,

a joint franchise. It's just a, it's a shame to see these people leave the system. Um, and turnover is never good. Um, so it's nice to see that they reduced their turnover. Uh, do want to see how that kind of spreads across the the franchise um you know you know right now i think most of that is on the company side um it would be nice to see them roll that out successfully and i think that's something that they need to do um and um i mean post more pre-mortem Um, stagflation just, it is, it could be worrying, right?

I mean, they raised, uh, labor costs, 20%, right? A lot of, a lot of franchisees raised, uh, labor weight, raised wages, 20% in 2020, five, probably 5% last year, maybe three to 5% this year. I, I'm not an economist. I tend to be optimistic and think that we're going to get out of this, right? Like the other day I was at a Uniqlo and half the registers and on the fifth Avenue Uniqlo are now, um, self-checkout. You don't even have to scan anything.

You just drop all your clothing onto the, the, you know, the sensor and it automatically figures out exactly what you've picked up. And it was a hundred percent correct. And you just, you can just swipe your card and move out. Right. Like I feel like there are solutions like in general, technology and and a lot of these like cost pressures that we're seeing like i believe they're in the long term they will ease right i mean food gas it it's a commodity um and you know the solution to high prices long term is is high prices that's like what all the what all the old

timers like to say. And I mean, right now, there's a lot of inflation. But I tend to think that, you know, if we go out two, three, four years, we will have resolved that. But it would, I think, be scary. And I think to some degree, the stock is pricing in a scenario where, you know, there's a 10% increase in chiropractors, five to 10% increase in chiropractor salaries every year for perpetuity so um now it had big margin pressure potentially yeah they're they're raising prices this year right um but yeah it it that would be something that could cap some of the upside right if you know an ideal scenario we go back to like a normal level of like you know two to three percent inflation and you know they're they're

still growing. You could see unit economics improve from 40% to 50%, and maybe 60% long-term. But unit economics could get hit or capped if there's inflation. Okay. If joint is increasing prices, does that mean the chiropractors that are also accepting insurance probably doing the same thing? Or does that- Yeah, some of the surveys are kind of suggesting that prices are bouncing right now. We'll have to see what the next survey says. But you are seeing that in general, there's a lot of inflation in medical services, right? So, yeah, we're still waiting on chiropractic specific numbers.

But in general, if you look across health care, for example, the Center of Medicare Services just approved one of the biggest price increases for Medicare reimbursements. It's high single digits, I believe, like 8%. So you'll probably see something similar in chiropractic services. Okay, I think that's all the questions we have. Do you have any more? Okay, well, for any listeners that want to keep up with you, want to see maybe more of your work,

what is the best place to follow along or keep up? I'm on Twitter at Edward W. Chang. You can also feel free to shoot me a message on LinkedIn or through email. My email is listed on my company's website. I always love hearing feedback, whether it's short pieces or other new ideas. I'm always happy to chat. Okay. And pledge.capital, right? Yeah, www.pledge.capital. Perfect. All right. Well, that is going to do it. We want to remind our listeners that Brett and I are not financial advisors.

Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. We are, however, general partners at Arch Capital, so clients may have positions in the securities discussed in this podcast. Thank you all for listening. Thanks, Ed, for coming on the show. We'll see you guys next time. Thank you for having me. Thank you.