• In recent legal disclaimers JYNT provides to potential franchisees, the company produced data suggesting that the vast majority of its money-losing clinics were opened in 2017.
  • Bulls have relied on the company’s representation that franchises breakeven in 6-9 months –this filing casts doubt on the eye-popping purported franchise opportunity (the crux of the bull case).
  • In 2018, franchise calculus flipped on its head and JYNT disclosures now show that independent chiropractors are better off working on their own rather than starting a JYNT franchise.
  • In March 2019 Zarco Law, a firm known for aggressive litigation against franchisors, showed up adverse to JYNT, highlighting the fracture in relationship between franchisees and JYNT.
  • JYNT needs a serious “adjustment” – we expect this stock to retrace all of its run from its IPO price.  TP=$6.00 — 65% downside.

Introduction

The Joint is a franchisor and operator of chiropractic clinics in the U.S. Roth, an infamous SoCal investment bank profiled in The China Hustle, took the company public in 2014. JYNT may be one of the rare companies in the world that still generates almost no profits despite boasting 5-years of average same-store-sales growth of ~30% (p3). How in the world could a supposed capital-light “franchise concept” generate 5-years of that type of explosive SSS growth yet still have almost nothing to show for it? Why in the world would this company need to rely on expensive Regional Developer middlemen if franchisees are truly breaking even within 6-9 months? Please keep these questions in the back of your mind as you read through this report.

When you actually peel back the onion, The Joint Chiropractic is not a legitimate “franchise concept”. First, the company generates substantially more of its revenues from company owned stores when compared to PLNT, DNKN DPZ and QSR (this comparison is provided later in the report). That alone negates the idea that JYNT can be “comped” to true franchise operators. Second, the company’s franchise growth – i.e. the segment that excites bulls – is now entirely coming through regional developer deals (p28). In other words, JYNT is having to give up 42% of the royalty fees (p11, 3% of the 7% royalty fee paid to regional developers) it will earn on future signings to regional developers that go out and push the company’s franchises. These two facts alone demonstrate that JYNT is not on the same plane as real franchise concepts that trade at high multiples such as PLNT, DNKN, QSR, and DPZ.

But valuation is not all that is off about JYNT. Recent disclosures from the company point to a catastrophically unhealthy franchise network.

We retrieved copies of The Joint’s franchise disclosure document (“FDD”) for YE17 (here) and YE18 (redlined version here) and performed a redline analysis to figure out what has changed. Our analysis uncovered preposterous claims that call into question key statistics that bulls have bought into in their analysis of JYNT. We expect this stock to retrace all of its meteoric gains since IPO and see 65% downside.

Breakevens Don’t Add Up

One claim the company has made that seems highly dubious is that its stores breakeven within 6-9 months. It makes this claim in its investor relations presentation, see below:

Source: The Joint IR Deck

Source: The Joint IR Deck

First of all, if this claim were true, you would expect clever cash flow investors across the country to be jumping for joy and lining up to open JYNT clinics. Yet, in the most recent quarter the company turned to regional developers to open 100% of its new stores. Franchise openings run about 12% a year (in 2018, the company added 42 franchise clinics against a base of 352 in 2017). This is not something you would expect to see of a company with such incredible breakeven math.

Nonetheless, this breakeven claim has captivated the minds of JYNT bulls who actually believe the claim and have parroted it write-ups such as this one (here).

We believe that the breakeven claim presented by the company is called into question within the company’s own FDD document.

How do we know this? Stick with us for a moment as we lay out some numbers.

First, a table of analysis. Notably, all of the datapoints below are derived directly from the company’s own legal disclosures in its FDD document.

Source: Our analysis using data provided from 2018 JYNT FDD

In its FDD, The Joint lays out survey responses from 103 clinics (103 of the total 356 qualifying clinics that were open for more than one year) that it surveyed to gather revenue and profit data.

Let’s zero in on “Quartile 4” respondents. In total, 19 clinics [A] responded and were bucketed into the Quartile 4 category. The company itself admits that Quartile 4 units are money-losing units in its FDD disclosure (showing average operating losses at Quartile 4 clinics of 37,770).

Source: 2018 FDD

The 19 clinics bucketed into Quartile 4 above that were surveyed claim to have generated about $216,000 [B] of average revenue per clinic in 2018, with 52.6% of clinics being above that average [C]. In other words, the average appears to be a “decent” average figure that we can work with.

The company discloses that the average age of those clinics is about 20 months [D], with only 6 clinics open longer than the average [G]. We also know that the clinics by definition had to have been open for at least a year to participate in the survey [E/F].

So now we have 19 clinics responding to the survey of which 13 were open somewhere longer than 12 months and shorter 20 months as of YE18. In other words, all 13 of these clinics must fall into the 2017 cohort of store openings [H]. They had to have opened at some point in early to late 2017.

As stated previously, we know that the average revenue per store is largely representative of the overall sample population.

So where do we arrive? Assuming the 13 stores that were open between 12 and 20 months operated at the average revenue of the survey (a fair assumption based on the item [D] in the table above), we know that 13 of the 19 stores that responded to the survey by definition were part of the money losing Quartile 4 as of YE18 [N/O]. We also know that those 13 stores were all 2017 Cohorts.

The natural question is therefore simple.

How could the breakeven period on the 2017 Cohort of clinics be 9 months when at least 68% of stores the company bucketed into money-losing Quartile 4 were opened in 2017?

Could this be attributed to store maturity? No, because by definition surveyed stores were open for over one year.

Could this be attributed to bad survey design? Perhaps, but what are the odds that the company went out and only surveyed its worst performing 2017 Cohort stores? This possibility seems remote.

We note that this is not the first and only discrepancy we have observed between the company’s data disclosures. For those who have not flipped through the company’s FDDs, we note that the company actually provides tables like the one below that is based on actual clinic revenue data (for clinics opened more than 12 months) rather than on survey data. An example of such a chart from the 2017 FDD is below:

Source: 2017 FDD

We went back to the company’s historical FDDs and spread the reported average gross sales per clinic below:

Source: Our analysis of FDDs from 2015/16/17 compared to JYNT reported comps in press releases

In 2016, the implied comp growth for the franchise stores reported in the FDD was essentially equal to the reported comp growth in JYNT press releases. However, in 2017 there was a wide gap between the implied comps out of the FDD data versus the reported press release comps – the gap was 15 points!

Yes we acknowledge that the company’s reported comps from SEC filings are a) tied to comps for stores open 13 months rather than 12 months, and b) exclude company owned stores. However, in 2017 there were 47 company owned stores, representing only 12% of the store base. So we doubt those two factors could have resulted in the wide gap between reported comps and FDD implied franchise only comps.

In light of the data discrepancies that we have found in the FDD documents, we question the significance and/or analytical value of the company’s breakeven analysis. In fact, we are troubled by the fact that in the FY14 (starts p2) and FY15 (starts p3) 10-K filings, the company represented cohort analysis in its filings yet omitted these figures from 10-K filings starting in FY16.

We therefore decided to dive deeper into the company’s breakeven analysis and conduct our own analysis of JYNT breakevens.

Independent Practice Seems to Be Winning in the Independent vs. JYNT Decision

Our revised breakeven analysis points to something even more troubling – namely, that opening a JYNT franchise appears to be a terrible idea for an average performing independent solo practitioner.

The company actually discloses aggregate revenues per quartile for “Qualifying Clinics” (356 clinics that were open for more than 12 months). We took those revenue buckets (that are appropriately split evenly between quartiles) and juxtaposed them with the implied cost to run a clinic that came out of the survey data. We did this to make sure that clinic costs that we use in our analysis appropriately reflect the size of the clinic. Using that data, we put together the following analysis for implied profit per clinic:

In our analysis above (the aggregate quartile table with the cost survey overlay), we show that the average income for a JYNT franchisee is around $75,000 a year (on an average revenue base of around $405,000 per year). We note that this figure excludes any labor payment to the franchise owner, which would have already been capture in operating expenses.

The company’s franchise agreement also requires you to partner with a licensed chiropractic professional corporation if you are not a chiropractor – we highlight this to point out that it is very clear the franchise opportunity is targeted and a most natural fit for someone who is already a chiropractor:

Source: 2018 FDD

Assuming the “owner/operator” model – i.e. manage and work at the clinic yourself – we therefore wonder – is it really worth it?

In 2018, according to Chiropractic Economics survey data, DCs earned on average $140,000. This dataset is essentially only independent practitioners, as only 1.77% of respondents were franchise owners. Ergo, this data set is a good comparison against The Joint franchise opportunity.

Source: Our analysis using FDD disclosures

We also found a Chiropractor organization website suggesting that it costs about $100,000 to go into private practice on average. So after spending an incremental $150K upfront to start a JYNT, a DC can on average expect to earn about $21,000 less per year than if they had opened their own practice. In other words, an average DC who could have opened an independent clinic is likely never going to breakeven on their investment.

Some bulls may argue that you can “open more than one franchise” so every incremental franchise is found money. That may be true, but you also need to hire managers for those incremental franchises and potentially more doctors (assuming you work as a doctor, you can’t be in two places at one time, particularly given the high throughput required to make JYNT economics work). So that argument is unconvincing.

This data is only further confirmed through a thorough analysis of The Joint’s own disclosures.

First, take a look at the table below that presents JYNT as a superior business opportunity to going it solo:

Source: JYNT 2018 FDD

Notably, JYNT claims that independent solo practitioners generate about $365,925 of revenues per clinic on average, compared to JYNT at $405,615 in 2018.

What this analysis of course ignores is that independents do not need to pay out a 7% royalty fee or 2% advertising fee to JYNT. They also are not burdened with the $450 monthly technology fee that is also paid to JYNT. So what if we “netted down” their revenues and did a side-by-side comparison. The results are shocking:

Source: Our analysis of JYNT 2017/2018 FDD

In 2018, using The Joint’s data, the revenue economics that JYNT presents as bullish actually tilt in favor of being an independent solo practitioner. We have not even included the upfront fees that an independent practitioner would have to pay to JYNT in order to move over to a JYNT franchise. But the conclusion from this data is simple – even using JYNT disclosures, it appears that being an independent solo practitioner is an economically superior decision for the average independent solo practitioner.

We find it highly notable that the 2018 economics shifted against the JYNT. We suspect that this is going to have significantly negative ramifications on JYNT going forward – it will likely have to recruit lower quality chiropractors and that is likely to have significantly negative ramifications for its business model going forward.

So how is it that JYNT clinics generate higher revenues than solo practitioners yet still have worse economics on a bottom-line basis?

The answer lies in the pricing model.

Source: JYNT 2018 FDD

JYNT generates only $27 per average patient visit versus a figure 2x higher at independent practices. Despite this, we spoke to industry experts including competitors who indicated that JYNT pushes its franchisees into high cost real estate in strip malls with higher traffic. So JYNT has high relative rents compared to suburban focused independent practitioners who are willing to set up shop in areas with less foot traffic because they price their treatment at higher rates with the expectation that throughput will be lower. Think about where you’ll often find a smaller independent chiropractor office – perhaps on the second story of restaurant or retail strip malls away from easy access. Contrast that to JYNT which places itself in visible retail locations that can attract eyeballs and traffic.

So, in order for JYNT to get its model to work, it needs to churn through lots of patients. But for that to work, it needs to be in high traffic areas and it needs to employ more chiropractors to work through all of the patients. To run a JYNT successfully and to actually generate lots of money doing so, the clinic owner needs to find a way to generate extremely high foot traffic and generate operating leverage from its chiropractors – not an easy task.

As a result, we think JYNT economics have turned violently upside down for franchisees. And when economics turn and franchisees go underwater, you will often see legal spats arise between the franchisor and franchisees.

The first signs of such cracks emerging in The Joint story showed up in March 2019…

Enter Zarco Law

Perhaps these discrepancies – that point to a very unhealthy franchise system that faces tremendous pressure – explains why attorney Robert Salkowski of the Zarco Law Firm just showed up on the scene in March 2019.

Source: 2018 FDD

Zarco law is arguably the most famous franchise law firm in the country. Zarco sues franchisors plain and simple and the firm is very good at it. The firm is known to be an extremely aggressive litigator. Readers who follow our work will recall that Zarco was the firm behind the Bryman v. LOCO lawsuit that resulted in massive changes to El Pollo Loco’s franchise agreements and a record $ million verdict to the franchisee plaintiff.

Needless to say, when Zarco shows up, franchisors run and hide. It is clearly bad news for The Joint that Zarco has approached them and we suspect that Zarco has entered the picture because of the fundamentally unhealthy status of The Joint’s franchise network.

Company Owned Greenfield Clinics Are Material Underperformers

As we noted earlier in this note, when compared to pure play franchise companies, JYNT is anything but a pure play franchise operator. About half of the company’s revenues are derived from company owned stores (and this piece of the business should in turn receive a far lower multiple as we show later). However, before we dive into the valuation considerations surrounding the corporate owned mix, we wanted to first ask a simple question – how well is the company doing on its new store openings.

Countering the bull case, our previous franchise analysis suggests that the odds of making money on a JYNT clinic are low and the reality is that solo practitioners would be better off opening independently or working as a salaried chiropractor.

Therefore, we think it is interesting to observe how the company’s own greenfield clinics are doing. Surely one would expect the company – that has extensive data on markets and knows where its concept is working versus not working – would be very good at opening stores.

The data suggests quite the opposite.

In its FDD, the company provides analysis of its 16 greenfield stores from 2018. The company provides the analysis to help franchisees get a gauge of what their expected costs are for a “model” store. The analysis takes the expenses that a company owned store faces and layers on the royalty expense. It layers on the royalty expense (7%) that would be assessed had its 16 greenfield stores been franchisees rather than company owned.

Source: 2017/18 FDD Redline for JYNT

Using that data, we can back into the implied revenue per greenfield company owned store.

Source: Our analysis of 2018 FDD

The company’s 16 greenfield stores – that the company discloses were open anywhere from 34 to 40 months (i.e. mature) – generated median revenues of $289,543 and average revenues of $319,200.

This result is startling because this would place company owned stores somewhere between quartile 3 and quartile 4 franchisees in terms of revenues.

In fact, if these 16 Greenfield stores that are company owned were actually operating as standalone franchise stores, the median store would be unprofitable and the average store would generate only 2% margins. It is therefore clear that these 16 Greenfield stores have abysmal economics.

Why is this significant?

Bulls claim that pure play franchise comps are the right comp set for JYNT (see p24). This is totally nonsensical and we can demonstrate why below.

Source: Our analysis using 2018 data, Bloomberg

As can be seen above, unlike high quality pure-play franchise companies, The Joint earns a far higher share of revenue from company operated stores. Let’s deep dive into PLNT given it optically appears the closest to JYNT. PLNT is not only far less exposed to company owned stores, but the margin on the company owned stores is also over 2x higher than JYNT stores as can also be seen in the chart below.

Not only is PLNT significantly less exposed to company owned stores economically, but the company owned stores in the PLNT stable are substantially more impressive from a margin perspective.

We have also shown above that greenfield company owned stores are in fact weak performers – they fall somewhere in Quartile 3 / 4 when benchmarked against the broader franchise network. In other words, the company that is supposedly the “expert” in opening these clinics appears to not be very good at opening stores. Yet the company continues to call for 8-12 store openings per year, which, assuming $300k or so of revenues per clinic, suggests that half of the company’s revenue growth will continue to come from new company owned Greenfields.

So here we have The Joint, a company that generates essentially half of its revenues and half of its revenue growth from company-owned stores. Historically those company-owned stores are pretty bad. Yet (as of 5/20/19) somehow the stock still trades at a premium to all of the comps above.

In our view, it makes little sense for JYNT to open these Greenfields given their historical performance. Yet, in a perverse way, because the market is valuing JYNT irrationally, management has a high incentive to keep opening underperforming stores. Why? Because the company is being rewarded with a franchise multiple on its earnings stream even for its woefully underperforming company owned stores that one could argue the company should actually be closing.

But the valuation math gets even worse.

As we discussed earlier, The Joint is now heavily relying on regional developers – with 100% of its 1Q19 franchise openings generated through regional developers. Between the 42% of lost economics to regional developers and the heavy reliance on company owned stores, JYNT should trade at around 15x forward – at best. This is because real pure play franchise concepts trade at around 25-40x forward earnings – and we have established that JYNT should receive a significant valuation discount relative to the pure plays because of its reliance on regional developers and company owned store growth.

That would put the stock around $6/sh on 2020 estimates – assuming the company even hits the lofty sell side estimates (we doubt that very much).

While bulls want to believe that the underlying unit economics are appealing and that The Joint is somehow on the cusp of a major turnaround and improvement in profitability, we note that the company claims to have put up average SSS of ~30% since 2013 and yet still, based on its own disclosures, experiences continued losses a significant chunk of its franchise network.

Are things really improving? Sure. But “improvement” is all in the eye of the beholder.

It appears to us that The Joint is simply improving off a ridiculous bad base, i.e. is improving from a position of “absolutely awful economics” to just “awful economics”. We therefore hardly think the meteoric run in the stock is warranted.

Conclusion

The Joint’s franchise system appears unhealthy. While the company touts breakevens of 6-9 months, their own survey data suggests that at least 68% of its unprofitable stores were part of the 2017 Cohort. Something simply does not add up. We have also demonstrated that chiropractors would likely be better off “going it alone” – through a solo practitioner model – rather than incurring the high upfront fees and ongoing costs of running a JYNT. We think this calculus flipped violently against JYNT in 2018.

Furthermore, we are disturbed by the company’s focus on high patient throughput. At the end of the day, The Joint is a company that provides medical services – does the company really want to be known as the “fast food player” of the wellness industry?

The company presents this table as a selling point to potential franchisees:

Source: 2018 JYNT FDD

Sure, this may be a selling point for potential franchise owners. But what patient prefers to be part of a high throughput model rather than get individualized attention?

The problem with the high throughput model is that it opens The Joint up to reputation risk. We found the lawsuit below from 2018 that included expert testimony alleging that an adjustment at The Joint was not performed with adequate pre-adjustment evaluation:

Source: Case Number: A-18-773258-C, District Court Clark County NV

We also note that the chiropractors tied to the company are under investigation in North Carolina for quality of care issues (p33). Given there are already signs of quality concerns at JYNT, we think the company will need to tread lightly if its goal is to “run and gun” even more patients through its already high throughput business model.

Given that JYNT now provides data that shows average independent practitioners would be better off remaining independent (as we laid out earlier), we question whether the company will be able to continue to deliver robust franchise growth. We also question whether new franchisees will be able to make money based on our analysis of 2017 Cohort data provided in the company’s legal disclosures to franchisees. We expect a significant slowdown in SSS going forward after growing off a ridiculously depressed base – and have noted that the company’s biggest risk should it continue to push massive patient throughput is on the quality side – an area that is already showing cracks.

Finally, the arrival of Zarco law suggests that there is conflict brewing between JYNT and its franchisors – this is never a good sign. Zarco won a landmark settlement against LOCO and even forced the company to change its franchise agreements. The law firm is no joke and the developments between Zarco and JYNT are worthy of further scrutiny.

We therefore view the company’s recent “business momentum” as merely bulls buying into a false narrative relating to the company’s unit economics. Despite 30%+ average comps for years, the company has still gone almost nowhere in terms of profitability since its IPO. Furthermore franchisees appear to be quite unhealthy. We therefore expect The Joint to retrace its meteoric rise from its IPO price and see 65% downside in the shares ($6 target price).