April 29, 2016 Volume XLII, Issue IV

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GNC Holdings, Inc.

NYSE: GNC

Dow Jones Indus: 17,773.64 Initially Probed: Volume XL, Issue VI @ $34.10

S&P 500: 2,065.30 Last Probed: Volume XL, Issue XI & XII @ $43.77 Russell 2000: 1,130.85 Trigger: No Index Component: N/A Type of Situation: Business Value; Fallen Angel;

Consumer Franchise

Overview

NOTE: GNC announced a comprehensive review of strategic alternatives on May 2, 2016. Please turn to page 55 to read our initial thoughts on the announcement.

GNC Holdings, Inc. (“GNC” or the “Company”) is a specialty retailer of health and wellness products including vitamins, minerals, herbal supplements (VMHS), sports nutrition products and diet products. The Company generated more than $2.6 billion in revenue in 2015 with its 9,000+ GNC locations in more than 50 countries including Company-owned stores (40% of total), domestic franchised locations (12%), international franchised stores (23%) and store-within-a-store locations (26%). The Company also operates a manufacturing business which provides branded products to the retail and franchise stores as well as third parties including Rite Aid, Sam’s Club, PetSmart, and www.drugstore.com.

Asset Analysis Focus initially profiled GNC at $34/share in June 2014. At the time, GNC had recently experienced its first stumbles since its 2011 IPO as same store sales turned negative for the first time in over 8 years and negative media reports on the efficacy of vitamins and supplements had rattled investors. Shortly after our initial report, GNC fired its longtime CEO/chairman and replaced much of its executive ranks in response to ongoing operational underperformance.

Price: $ 24.36 Shares Outstanding (MM): 68.4 Fully Diluted (MM): 68.7 Average Daily Volume (MM): 1.7

Market Cap (MM): $ 1,672 Enterprise Value (MM): $ 3,206 Percentage Closely Held: Insiders 1%

52-Week High/Low: $ 50.93/23.56 5-Year High/Low: $ 60.56/18.12

Trailing Twelve Months Price/Earnings: 9.5x Price/Stated Book Value: 5.8x

Net Debt (MM): $ 1,533 Upside to Estimate of Intrinsic Value: 115%

Dividend: $ 0.80 Yield: 3.3%

Net Revenue: FY2015: $ 2,639 FY2014: $ 2,613 FY2013: $ 2,627 FY2012: $ 2,430

Earnings Per Share: FY2015: $ 2.60 FY2014: $ 2.81 FY2013: $ 2.72 FY2012: $ 2.29

Fiscal Year Ends: Company Address: Telephone: CEO/Chairman:

December 31 300 Sixth Avenue Pittsburgh, PA 15222 412-288-4600 Mike Archbold

Clients of Boyar Asset Management, Inc. do not own shares of GNC Holdings, Inc. common stock.

Analysts employed by Boyar’s Intrinsic Value Research LLC own shares of GNC Holdings, Inc. common stock.

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The new management team began to show progress in stabilizing sales by mid-2015 and unveiled a strategic shift toward refranchising its domestic store base. Investors reacted favorably, sending GNC shares back over $50 by August 2015. However, events quickly swung full circle—GNC reported another disappointing 3Q15 and then a barrage of negative regulatory and media scrutiny over the supplement industry resurfaced in late 2015-early 2016. While GNC shares began to rebound nicely from <$24 in January 2016 to nearly $36 by late April, the surprise announcement of another disastrous quarter on April 28 (1Q16 SSS down 2.6% at Company-owned stores and 5.6% at domestic franchises; operating margins down 200 bps) sent shares plunging by ~30% to the current $24 price tag.

At the current share price, GNC trades at less than 6x P/FCF and approximately 7x EV/EBITDA (TTM) compared to post-IPO medians of 22x FCF and 10.7x EV/EBITDA. Even projecting the disastrous 1Q16 earnings trends persist throughout 2016, we estimate GNC trades at just 10x 2016E P/FCF or 9x 2016E P/E. While the near-term picture is certainly ugly, long-term investors should bear in mind that the bulk of the 1Q16 miss reflects (presumably) short-term issues related to destocking of aging vitamin inventory and delays in implementing a new sales/inventory strategy at franchised locations. GNC is only in the early stage of testing/implementing several strategies to improve performance including a revamped pricing/marketing strategy, an updated loyalty program, and restocking inventory with more proprietary and innovative products. This is aside from the most substantial change: in February 2016, GNC formally unveiled plans to transition from just a 23% franchised store base domestically to ~50% within 3-4 years.

In estimating GNC’s intrinsic value, we forecast out to 2020 in order to capture the new “steady state” post-refranchising efforts. In the interim, we conservatively project 1Q16 trends persist through 2016, new store build-outs slow drastically, and GNC does not return to 2% same store sales growth until 2019. While we estimate there will be some margin dollars lost in the refranchise transition (management claims that it will be essentially profit-neutral), we believe this negative will be far outweighed by the increased stability and higher ROIC of the new model—which should translate to a higher market valuation multiple for GNC shares. At a 15x P/FCF multiple—which is still well below GNC’s historical average of 22x—GNC’s intrinsic value could reach $52 per share in 2020. Inclusive of dividends (held at the current $0.80/share annual rate), this translates to an impressive 130% total return upside or an IRR of approximately 20% over close to 5 years. Incremental upside could come from opportunistic capital deployment—aided by refranchise gains on sale, we estimate GNC should generate ~$920 million in incremental free cash flow through 2020 or ~$13.50/share (~55% of GNC’s current market cap). Finally, we would not dismiss the possibility that GNC becomes a leveraged buyout target at some point given its strong underlying free cash flow and the attractive refranchising opportunity. The Company has been acquired by private equity owners on three prior occasions, most recently at a healthy 11.2x trailing EV/EBITDA in 2007.

Update: GNC Volatility Continues

Asset Analysis Focus initially profiled GNC in June 2014 after shares had fallen nearly 50% in a matter of months. Shortly thereafter, in August 2014 GNC fired longtime CEO (since 2005) and chairman Joe Fortunato following the announcement of the latest in a string of poor quarterly results that began in 3Q13. GNC shares actually performed well over the subsequent year as results began to show early signs of improvement. GNC shares peaked above $50 in July-August 2015 after GNC reported stabilizing operating performance in 2Q15 and the new management team announced initial plans to move toward more of a franchise-based retail store model.

The new management team’s honeymoon was short-lived, and GNC has faced an overwhelming barrage of negative industry headlines and weakening financial results since last fall. On October 22, 2015, the Oregon AG sued GNC for selling dietary supplements containing ingredients (picamilon and BMPEA) which the Oregon AG claims did not meet legal guidelines for supplements. GNC shares plummeted over 14% that day to $34.50. GNC shares fell another 29% to ~$28 on October 29, 2015 after GNC reported weaker than expected 3Q15 earnings. Then on November 16, 2015, the Department of Justice, the FDA, and the FTC (among other agencies) charged some dietary supplement manufacturers with fraud in marketing and selling (unsafe/illegal) dietary supplements. GNC was not listed among them but shares briefly fell as much as 27% intraday before closing down in excess of 6%. Shares rallied back into the low-$30s by early January 2016 before plunging as low as <$24 in mid-January 2016 as negative industry headlines became even more dramatic, focused on a special investigative report into the supplement industry by popular PBS investigative program Frontline. The

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program premiered on January 19, 2016 but contained no “smoking gun” or direct references to GNC, and GNC shares rebounded. Volatility has remained extremely elevated in recent months, with shares rallying all the way back above $35 by late April. Then GNC reported another surprising weak quarter on April 28, sending GNC shares down 29% in one day and back to the current lows not breached since 2011.

New Management Team and Activist Presence

In addition to former CEO and chairman Joe Fortunato, several other top executives left or were forced out at GNC beginning in 2014. This included CFO Michael Nuzzo in June 2014, and later executive vice president of business development Carmine Fortino and chief merchandising officer Tom Dowd. Mike Archbold was named CEO concurrently with the departure of Mr. Fortunato, and lead independent director Michael Hines assumed the chairman’s role. Mr. Archbold most recently worked at Talbots as CEO and CFO following the company’s purchase by private equity firm Sycamore Partners in August 2012. He previously spent several years at GNC competitor Vitamin Shoppe (VSI) including as COO from 2007-2012, during which time VSI successfully completed an IPO and rapidly grew the store base. Mr. Archbold has also served as CFO of Saks Fifth Avenue and AutoZone.

In March 2015, GNC hired a new CFO in Tricia Toliver. Ms. Toliver had been a director at Ernst & Young and previously worked at AutoZone for 9 years including during part of Mr. Archbold’s tenure as CFO. Overall, GNC replaced ~half of its vice president leadership team in 2015. The latest notable additions include EVP of operations Michael Dzura in February 2015 and EVP of merchandising Tim Mantle in early 2016. In assessing the new GNC management team, the recent underperformance is clearly disturbing. However, for

June 2014 AAF initially profiles GNC @ $34.10

August 2014 GNC reports 2Q14 earnings miss and fires its CEO/Chairman

4.28.16 GNC reports 1Q16 earnings miss and

lowers guidance

January 2016 Shares plunge on PBS Frontline investigative report

on industry

November 2015 DOJ sues several nutritional product manufacturers

May 2014 GNC produces first quarter of negative SSS trends after 34 consecutive quarters of growth

October 2015 GNC reports weaker than expected 3Q15 earnings

October 2015 Oregon AG sues GNC for selling adulterated supplements

July 2015 GNC reports improved 2Q15 results and announces initial

refranchising strategy

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the most part senior management has not yet had time to fully implement their new initiatives and we believe it is still too early to reach a verdict.

In any case, it is likely that shareholders are already exerting heavy pressure on the new management to show improved results in the near term. GNC’s shareholder base includes a number of firms with histories of shareholder activism. TPG-Axon has held a stake in GNC since 3Q14 and owned 5.2 million shares (~7.5%) as of February 2016. The firm has taken activist stances in the past and has increased its GNC stake over the past year. Activist hedge fund Eminence Capital recently owned >5% but never publicly initiated an activist campaign at GNC and had pared its stake below the 5% reporting threshold as of February 2016. With GNC shares at their lowest price since 2011, most shareholders are likely heavily underwater at this point and patience with the new management team may already be running thin—the case for an activist campaign is strong.

Business Transformation Continues

When Asset Analysis Focus first profiled GNC in June 2014, we described how GNC was in somewhat of a transitional phase. As illustrated below, GNC began to rapidly grow its domestic store base in 2009 through both Company-owned and franchised stores. Company-owned store growth (net) accelerated from ~50 per year to reach ~150 per year between 2011-2014. After reacquiring or closing 400 underperforming/undermanaged franchised stores from 2004-2010, GNC also began to re-grow its domestic franchisee base from 2011-2014. Internationally, GNC had been steadily adding 100-200 stores per year for the past decade. While GNC expected to continue to grow the international franchise business at similar rates, domestically the Company appeared to be coming closer to the saturation point. As of mid-2014, management planned to slow domestic store growth from ~200 (combined) in 2014 to ~100 per annum going forward with a target of 5,000 domestic stores (excluding Rite Aid store-within-a-store locations).

Growth of Store Count

Stores 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Company Owned 2,642 2,650 2,688 2,745 2,774 2,832 2,917 3,046 3,188 3,342 3,497 3,594

Domestic Franchise 1,297 1,156 1,046 978 954 909 903 924 949 1,012 1,070 1,084

Int'l Franchise 739 858 961 1,078 1,190 1,307 1,437 1,590 1,830 2,024 2,140 2,085

RAD Locations 1,027 1,149 1,227 1,358 1,712 1,869 2,003 2,125 2,181 2,215 2,269 2,327

5,705 5,813 5,922 6,159 6,630 6,917 7,260 7,685 8,148 8,593 8,976 9,090

As already mentioned, GNC sales continued to disappoint in 2014 and by August the Company had replaced its CEO/chairman and CFO. As illustrated in the chart on page 46, same store sales (SSS) have yet to show a sustainable rebound. This and other factors led the new management team to reevaluate the store expansion philosophy. Domestic store growth slowed to ~100 in 2015 as planned (almost all via Company store openings) and GNC still expects to add 125 net new stores in North America in 2016. But in July 2015 CEO Archbold announced more drastic action: the Company would alter its strategy and move to increase the percentage of domestic franchised locations by both refranchising Company-owned stores and increasing the proportion of new stores that are franchised.

The international store growth trajectory has also been significantly disrupted by economic conditions in key markets such as Russia and Latin America. Net store growth decelerated from ~200 per annum from 2011-2013 to just 116 in 2014 and a net closure of 55 stores in 2015. Last year GNC was negatively impacted by the termination of one large franchisee with operations in Venezuela, Colombia, and Spain that was underperforming due to the issues in Venezuela. The Company expects to return to international store growth in 2016 albeit at a more modest pace of ~50 stores, which likely reflects the more challenging conditions in emerging markets.

Refranchising Strategy Unveiled

After studying the issue for several months, in February 2016 the GNC management team finally unveiled their formal refranchising goals. GNC expects to transition ~200 Company-owned stores to franchisees during 2016 and ~1,000 over the course of 3 to 4 years. This is equivalent to 28% of the current domestic retail store base and compares to just 33 franchise conversions (and 44 acquired franchise stores, or -11 net) in 2015. Overall GNC expects to reach roughly 50/50 parity between franchised and Company-owned stores

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domestically by the end of the transition, which implies an additional ~125 new franchise store openings per annum. As part of the process to facilitate faster franchise conversion, GNC will consider taking on larger, well-established franchisee partners. Currently, GNC’s average domestic franchisee only operates 6 stores and its largest franchisee only controls 21 stores. By contrast, GNC has taken on much larger partners internationally with its largest partner running ~200 stores. Importantly, the strategy of bringing in high quality, professional franchisees should help minimize the risk that GNC repeats the errors they ran into around the millennium with many undermanaged, poorly performing franchise locations. We would also note that domestic franchisee renewal rates were a healthy 96% between 2010-2015.

Favorable Economics

On whole, the transition to more franchised stores looks like a positive from an economic standpoint. CEO Archbold recently described,

“We sell them [the stores] off at a profit, and more importantly, we make the same money owning them as selling them off. It’s a cash-flow generator. … They pay us a franchise fee for the store, royalties (on sales) and they buy a lot of the product we make at a margin.” 1

GNC expects the total revenue decline to be ~$100k per franchised store, with lost retail sales partially offset by franchise fees and wholesale product sales. GNC generally charges initial franchise license fees of $40,000 or $30,000 for existing partners, with ongoing royalties of 6% of sales plus an additional 3% budgeted to a national advertising fund. GNC leases all of its stores and sub-leases them to franchisees at cost. Operating expenses will decline in the retail segment, and GNC expects the leverage point for occupancy and other expenses at its owned stores will still be ~2% SSS growth. The Company will receive a gain on the sale as well as a non-deductible goodwill charge which will result in a higher reported tax rate initially. Encouragingly, GNC will separately report these refranchising gains in its earnings going forward so investors can see through the one-off items.

GNC Franchise Business Performance ($K)

2013 2014 2015

Product Sales $363,810 $358,247 $387,716

Royalties 58,247 59,561 58,306

Franchise Fees 7,936 7,076 6,129

Other 6,924 7,944 6,184

Total Franchise Revenue $436,917 $432,828 $458,335

o/w Domestic $251,418 $267,517 $287,800

International $185,499 $165,310 $170,535

Operating Income $153,545 $157,342 $164,525

Margin 35.1% 36.4% 35.9%

It is difficult for us to make the math work to back up GNC management’s suggestion that refranchising a store is profit-neutral, given the differential between GNC’s Retail (Company-owned) segment margins of ~14% and the royalty rates and franchise fees. GNC also supplies a large portion (est. ~35%-40%) of franchisee’s product at “healthy margins,” which could make up some of the difference. This includes both third-party product and (higher-margin) proprietary products. The level of store profitability recaptured after the franchise transition will also depend on the cash received from the sale (appropriately amortized), which could help close the gap. GNC expects to record a meaningful pretax gain of ~$20 million on an initial sale of 94 stores in 2016 (detailed later) net of the carrying value of assets sold (principally inventory) and closing costs—implying a price tag of roughly $200K/store. Including these factors, GNC should recover a substantial portion of the store-level profitability and there will be some attractive working capital improvement/cash flow from the sale of store inventory to franchisees (average store holds ~$100,000 in inventory) and franchise fees. This will be

1 The Pittsburg Tribune-Review, 17 April 2016

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partially offset by higher receivables from franchisees. As GNC reduces its retail footprint, this could also open up more opportunities to cut corporate overhead. The transition should allow GNC to free up incremental capital, enhancing ROIC and substantially reducing the volatility of free cash flow. Investors clearly favor this lower-risk model, with GNC shares surging 12% after the announcement in July 2015 despite concurrently announcing a slight reduction to the Company’s 2015 EPS guidance.

Initiative Underway

In an early sign of progress on the refranchise strategy, GNC recently announced the Company will sell 84 domestic corporate stores to one franchisee during 2Q16. Sun Holdings, the new franchisee partner, is a leading franchisee in the U.S. with over 600 stores across several major brands. The vast majority of the stores to be sold are located across Texas, principally around Dallas and Austin. Sun Holdings also plans to open an additional 30 new franchise locations over the next 3 years. GNC also obtained an LOI for another franchisee for 10 stores, expected to close in 2Q16 and suggests they see strong demand for additional transactions. The Company expects to record a pre-tax gain of $17 million on the Sun Holdings transaction.

Reviewing the Challenging Sales Environment Since 2014

On May 6, 2014, GNC reported Q1 2014 results below consensus, including negative same store sales (domestic Company-owned -0.7%, franchised -3.2%)—breaking a streak of 34 consecutive quarters of positive same store sales growth. GNC reduced guidance but still predicted 7%-9% year-over-year revenue growth in 2014. Instead, as illustrated below, GNC’s SSS trends remained sharply negative throughout 2014 and into 2015. Results began to show some incremental improvement during 2015 and Company-owned SSS finally turned positive in 4Q15. However, any optimism quickly evaporated when on April 28, 2016, GNC reportedly reported sharply worse than expected 1Q16 results.

GNC Same Store Sales Trends

-6%

-4%

-2%

0%

2%

4%

6%

8%

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16

Company Owned Domestic Franchised

Dreadful 1Q 2016 Results

During 1Q16, SSS declined 2.6% at Company-owned stores (which includes GNC.com) and 5.6% at franchise stores. Operating margins declined 210 bps in the retail segment to 16.2% and EPS declined from $0.72 in 1Q15 to $0.69 despite a 17% reduction in average share count; operating income decreased by 14%. This compared unfavorably to management’s preliminary 1Q16 guidance issued in January which called for a low single-digit negative SSS comp (attributable to bad weather in January and the timing of Easter) and some margin impact from higher marketing spend, with EPS below 1Q15.

GNC management attributed the incrementally negative sales results principally to challenges in the vitamin category. GNC had previously cited challenges in the vitamin category in 2015, with vitamins causing a (1%) hit to SSS during the year. However, in February 2016 management expressed optimism that its efforts to re-engage customers with its Vitapaks line of vitamin programs were having success. Apparently, this did not

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hold. In April GNC specifically cited underperformance in the Vitapaks line as well as the need to take deep discounts on excess vitamin inventory that was nearing expiration, which impacted sales and gross margins. The Company attributed a roughly (1.5%) to (2.5%) impact on sales and an 80-120 bps hit to retail product margin due to the deeply discounted expiring product. Overall, GNC attributed a (4%) impact on SSS from the vitamin category in 1Q16. GNC also increased marketing spend during the quarter but did not see as attractive an ROI/sales uplift as expected.

GNC suggested that high sales of the Vitapaks in late 2014-early 2015 were not sustained due to lack of in-store promotion/marketing including by sales associates, which led to the inventory glut. Clearing any remaining aged inventory and turning around the vitamin business is now GNC’s top priority in 2016. This will involve new promotional and marketing efforts and training sales associates to refocus their efforts. GNC attributed the incremental underperformance at franchise locations to lack of participation in some of GNC’s new corporate initiatives including new promotions and not fully adopting its expanded assortment initiative. GNC added ~500 SKUs to ~1,000 lower-volume stores during 2Q15 which helped performance, but the Company planned to expand this initiative in 2016. It appears the Company has had more difficulty reaching the next batch of franchisees; inventory is a major investment for franchisees given the relatively small store format, and some have been reluctant to invest in expanding their assortment. The Company hopes to improve this with incentives and discounts. GNC will repurchase aged/expiring inventory from franchisees where necessary.

Lowered Outlook

Despite management’s suggestions that the current issues are temporary, their revised earnings outlook suggests the 1Q16 issues could persist. In February, GNC expected flat to +1.5% SSS and flat retail product margin for the full year 2016 with EPS of $3.15-$3.35 versus $2.60 in 2015. Following the 1Q16 announcement, GNC lowered its EPS guidance for 2016 by a hefty $0.35-$0.45 to $2.80-$2.90, “assuming sales trends in the first quarter of 2016 continues for the balance of the year.” This forecast excludes refranchising gains.

CEO Mike Archbold noted on the 1Q16 conference call that the Company does not expect the recent gross margin hit to persist but that out of caution they are “not setting [investors] up for any other [negative] surprises this year.” This message seems somewhat inconsistent. Clearly the recent underperformance points to lack of internal controls over inventory management and financial forecasting. The Company has yet to find the right blend of marketing/promotional activity and product mix, especially at franchise stores. But any success with new initiatives or cessation of the recent headwinds should provide meaningful upside opportunities. In the following sections we detail the competitive environment and some of the major risks and opportunities GNC faces.

Assessing Negative Industry Risks

The nutritional supplement industry is principally regulated by the 1994 Dietary Supplement Health and Education Act (DSHEA). DSHEA sets a fairly low hurdle for any dietary ingredients that have been “present in the food supply as an article used for food” without being “chemically altered,” and requires “evidence of safety” for any product that has been altered. The FDA has been taking a more active role in recent years and legislative activity should be monitored, but the $38 billion-plus nutritional supplement industry has a powerful lobbying arm and there has been no real major incremental legislation for over 20 years. However, as discussed near the beginning of this report, GNC has faced a barrage of negative headlines over the past year and half, with GNC shares reacting (we would say overreacting) sharply at every turn. In response, GNC has tried to cooperate with both regulators and industry participants to improve standards.

The first major industry news event in the past couple years occurred on February 2, 2015, when the New York State Attorney General’s office sent cease and desist notifications to GNC and three other major retailers (Target, Wal-Mart, and Walgreens). The NYAG alleged that 79% of herbal supplements sold by GNC and several other major retailers were found not to contain the labeled ingredients or to be adulterated with other ingredients upon DNA testing. The defendants and industry trade groups fought back against these charges, and the NYAG’s DNA barcoding method was exposed to be highly unreliable for extracted/processed supplements. Just one month later, in March, GNC reached an agreement with the NYAG to implement more stringent testing standards (DNA testing at source) than required by the FDA—over the objection of industry trade group Council for Responsible Nutrition or CRN, which did not support the higher testing standards. In a

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rapid reversal, the NY AG also publicly admitted that “GNC’s herbal supplements were produced in compliance with FDA regulations requiring the use of current good manufacturing practices.” 2

GNC has not yet been able to resolve the October 2015 Oregon AG lawsuit as quickly, and the case remains in the courts system. But GNC’s liability in the Oregon case appears somewhat limited as all the products in question were supplied by third parties under vendor warranties guaranteeing FDIC compliance; they were not subject to FDA bans and were subsequently removed from stores; and it is debatable whether Oregon has legal jurisdiction over federal/FDA enforcement issues. Products with the ingredients in question comprised less than 1% of GNC sales. In terms of the recent Department of Justice mass suits in November 2015 (117 civil and criminal complaints), GNC was not directly targeted. It is also worth noting that according to Nutrition Business Journal research, industry participants who were targeted for adulteration/health issues account for only <0.5% of industry sales.

GNC is also working to introduce stronger botanical raw materials Good Manufacturing Practices (GMPs) standards industry-wide. This includes full traceability and DNA testing of ingredients prior to extraction and standards would be independently certified annually. GNC is building an industry coalition of 80+ retailers, manufacturers, distributors, etc. to promote these best practices and rebuild consumer confidence as negative publicity threatens to impact sales across the industry. GNC’s initiatives are in the early stages and wil l require some additional capital expenditures going forward. But if the Company can successfully implement industry-leading standards in its supply chain over time, this could translate to market share gains and brand value/pricing power in the face of quality control concerns in the broader industry.

Reducing Cyclical Exposure to Diet Products

GNC’s sales mix has evolved over the past decade to reduce reliance on diet products. The diet product segment includes a wide variety of products intended to help weight conscious consumers meet their goals, including pills, shakes, bars, meal replacement shakes, energy boosting tablets, and “cleanse” products. Historically, this business has faced more risk as the latest fad weight loss products went into and out of style. Furthermore, diet products have faced the most scrutiny over health claims and safety risks in recent years. For example, the supplement Hydroxycut generated 5% of GNC sales in 2008 before it was recalled in 2009. Likewise, in November of 2013, GNC discontinued sales of products that contained DMAA, an ingredient which the FDA had previously called into question. It is estimated that products with DMAA accounted for up to 6% of GNC sales in early 2013.

We believe GNC has significantly de-risked its exposure to this segment over time. Diet products accounted for just under 12% of total sales in 2015, down from 20% of total sales in 2004 and 27% in 2001. Additionally, GNC has chosen to focus more on meal replacement (e.g. Total Lean line), which is less cyclical and less exposed to FDA risks.

Evolving Sales Mix ($MM)

2011 2012 2013 2014 2015

VMHS $ 542.6 $ 624.6 $ 663.6 $ 649.1 $ 626.6

Sports Nutrition 621.8 686.2 764.9 759.8 778.8

Diet Products 139.6 192.3 198.8 193.9 201.4

Other Wellness 99.7 105.9 92.1 110.6 108.5

Total U.S. Retail Revenue $1,403.7 $1,609.0 $1,719.4 $1,713.4 $1,715.3

Outlook, Competitive Challenges and GNC’s Response

Without a doubt, in recent years GNC sales have faced meaningful headwinds from the burgeoning negative publicity shone on the industry as well as the recall of “fad” diet/bodybuilding pills. However, we believe the recent hiccups are principally reflective of Company-specific—and correctible—issues more so than a permanent industry decline. The nutritional supplement industry, GNC included, has experienced bouts of negative publicity and recalls for decades. Yet the industry has achieved an impressive long term record of growth in the U.S. with sales expanding at an ~5%-7% CAGR. Long-term tailwinds also remain favorable 2 http://www.ag.ny.gov/press-release/ag-schneiderman-announces-agreement-gnc-implement-landmark-reforms-herbal-supplements

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including an aging population (the elderly are over-indexed to vitamin and supplement sales) and the obesity epidemic. It is also notable that while GNC peer VSI has seen a slowdown in sales since 2013 as well, VSI’s SSS have remained positive (+2.8% in 2014 and +0.1% in 2015).

Responding to Retail Competition: Pricing and Innovation

GNC has long held a reputation for relatively high prices. We have not necessarily viewed GNC’s premium pricing model completely as a negative, as it reflects the Company’s brand power and it has allowed the Company to generate best-in-class operating margins (mid-teens versus 7% at VSI and high-single-digit industry averages). However, the proliferation of supplement-selling competition has been an ongoing story since at least the turn of the millennium and the competition continues to expand. VSI, Wal-Mart, Target, Whole Foods, Kroger and other high-end grocers and pharmacies are among the larger competitors that have expanded their assortment over the past decade, particularly in vitamins. As illustrated in the following chart, it does appear GNC may have overreached on pricing in some areas, particularly vitamins.

GNC Estimated Vitamin Price Premium vs. Competitors (%)

Source: Bloomberg, Piper Jaffray

We believe the negative pricing perception (and in some cases, reality), is a real issue for GNC. The new management team appears to be taking the issue to heart; GNC began initiating a new pricing strategy in early 2016 aimed at addressing the Company’s uncompetitive pricing perception. This includes identifying and offering everyday lower prices on major “known value items” (KVIs) that have an oversized impact on consumers’ value perception. This should help drive more traffic to the store and maintain customer loyalty, which hopefully leads to additional purchases of higher margin products. The Company expects the impact of the KVI initiative to become evident later in 2016 into 2017. GNC is also experimenting with more periodic, unrestricted BOGO 50% (buy one, get one 50% off) offers.

E-Commerce

E-commerce is the elephant in the room for nearly all retailers, and GNC is no exception. GNC faces a long list of online competitors from mass retailers like Amazon and Wal-Mart to VMHS businesses like Puritan’s Pride, Vitamin Shoppe, and Bodybuilding.com. GNC does not separately report GNC.com e-commerce sales and instead lumps them into its Retail segment and includes them in retail sales and SSS figures. This is not unusual for a retailer, but it makes segregating bricks-and-mortar retail SSS from e-commerce challenging. The Company does intermittently provide updates on e-commerce results. E-commerce revenue declined 7.5% in 1Q16 with traffic down 21% but conversion rates up nicely. This compared to growth of 6.4% in 4Q15 although management stated operating income dollars declined in 4Q15 due to price competition and marketing spending. E-commerce is obviously more competitive, and the Company has been adjusting pricing at GNC.com accordingly including price matching on more commoditized items.

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Somewhat to our surprise, management recently noted that e-commerce represents only ~6% of GNC’s overall business. We believe this actually speaks to the client-driven, high-touch nature of GNC’s business model. A large portion of customers come to the store looking for advice on how to meet their general needs. Additionally, while clearly not reaching the retail-driven level of, say, fresh produce, we suspect to a meaningful extent the relatively “consumable” nature of GNC’s products supports the retail channel versus online. Certain product lines (e.g. vitamins) face greater online competition.

Loyalty Program

The scale of GNC’s loyalty program has long been cited as a competitive advantage, with 6.5 million Gold Card customers paying $15 for annual membership. These members generated 79% of Company sales in 2015. The Company has made several changes to the card over the years, including offering a free membership period in mid-2013 and later transitioning from offering Gold Card member discounts during the first week of every month to consistently offering member discounts throughout the month. Now the new management team at GNC is exploring new changes to the membership program. Possible changes could include moving from a “pay to play” system where participants pay upfront annual fees to participate in the reward program, toward a free everyday loyalty card with rewards driven by product spend or tailored to individual purchasing habits. GNC is still in the testing phase and does not expect any initiatives to impact financial results before 2017. The long-term impact of an updated loyalty program may or may not be terribly meaningful for GNC in the long run, but there is some precedent. Changes to the loyalty program drove high single-digit SSS growth in mid-late 2013. Other retailers such as Starbucks have also had major success in driving customer loyalty and traffic through loyalty/payment mobile apps.

Innovation and SKU Expansion

GNC’s small store model and relatively limited SKU (avg. ~2k/store) offers attractive economics for both GNC and franchisees. Some may see this as a competitive concern as other stores are offering wider selection (Vitamin Shoppe closer to 7K SKUs but implementing a SKU reduction plan). On the whole we believe GNC’s strategy makes sense; there is a good case against SKU overkill/excessive choice from both an economic and a customer satisfaction standpoint. Other burgeoning retailers like Traders Joe’s have had success with a “fewer, better” strategy. Furthermore, a key component of this strategy is GNC’s focus on unique, branded products. GNC directly manufactures ~30% of its product and sells ~50% under private label (GNC) brands (higher in vitamins).

While GNC may be fine with a more limited SKU, finding the right product mix and continually introducing innovative products are still essential strategies for success. GNC has cited failure to get enough newer/differentiated products into stores recently and is implementing a “Fewer, Bigger, Bolder” product strategy focused on innovation. Innovation is a significant driver of Company sales, and the lack of “third party product innovation” was blamed for poor results in 2014. This continued in 2015 and the regulatory pressures may be hindering third-party innovation for the foreseeable future. But if another “blockbuster” product emerges, this could create meaningful upside. GNC is not anticipating this and is stepping up efforts to develop its own proprietary product innovations. GNC attributed a roughly +1% SSS lift to new proprietary products introduced in 2015—net of cannibalization—and +0.55% in 1Q16. GNC also recently noted that new products and expanded assortment activities are driving “significant positive increases in categories that make up 40% of our sales.” Of note, probiotics sales increased 36% in 2015 and the sale of natural and plant-based proteins increased 72% in 2015 but still accounted for <2% of sales. But as noted, recently the Company has been running into some issues in getting franchisees to expand/optimize their inventory. If GNC can make progress here and in stabilizing the vitamin category over the upcoming quarters, this bodes well for turning around the recent SSS declines.

Free Cash Flow & Financial Position

GNC has produced remarkable free cash flow growth and return of capital to shareholders since its IPO. Free cash flow grew at a 24% CAGR from $105 million in 2010 to $309 million in 2015. Free cash flow growth has continued unimpeded in recent years despite the revenue deceleration; during 2015, FCF increased 32% and was up 42% on a per-share basis to $3.67. Free cash flow growth from 2010-2013 was principally driven by the underlying profit growth as well as a reduction in interest expense as leverage declined and GNC negotiated more favorable interest rate terms on its debt. Over the past two years, FCF has incrementally benefited from

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improving working capital and a reduction in capex in 2015 (capex was elevated in 2014 related to the construction of a new distribution facility).

Obviously, continued FCF growth will be more challenging going forward given the recent operating performance trends. GNC’s preliminary 2016 cash flow forecast (provided in February 2016) was for operating cash flow to remain comparable to 2015 levels with ~$20 million in incremental capex related to new in-store and technology initiatives. This translated to FCF guidance of ~$3.60/share at the beginning share count. Management did not update their cash flow forecasts on the 1Q16 conference call, but obviously the weaker sales/profitability outlook will have a material impact on FCF in 2016.

Free Cash Flow and Capital Deployment Since IPO ($K)

2011 2012 2013 2014 2015 1Q16

FCF $113,230 $185,281 $189,199 $233,330 $308,706 $131,783

FCF/Share (Avg. DSO) $1.10 $1.77 $1.94 $2.57 $3.67 $1.80

Share Repurchases 61,634 359,990 309,255 283,226 479,799 218,900

Avg. Price $27.58 $37.99 $47.24 $42.46 $38.65 ~$29

Dividends/Share – $0.44 $0.60 $0.64 $0.72 $0.20

GNC’s post-IPO return of capital program has been no less impressive than its free cash flow growth—at least purely in terms of magnitude. GNC has spent $1.7 billion to repurchase 44.9 million shares since its IPO through 1Q16, producing a net reduction in shares outstanding of ~44%. Unfortunately, as is all too often the case, the timing of GNC’s share repurchase activity leaves much to be desired. Following the recent declines, GNC’s average purchase prices since the IPO (~$38/share) stands ~56% above the current share price. GNC pulled forward its anticipated 2016 share repurchases into 1Q16 in order to take advantage of the share price volatility early in the year. The Company spent $219 million (including $18 million settled in April) to repurchase 7.6 million shares (10%) at an average price of $28.81. This first looked like a wise move as GNC shares approached $36 by late April—until the disastrous 1Q16 earnings release on April 28. This is a bit of a head-scratcher, and seems to suggest management was blindsided by the 1Q16 earnings miss. The Company retains $208 million in share repurchase authorizations, but currently does not expect to make meaningful additional repurchases during the year as they refocus on debt reduction. Management has previously suggested they would like to maintain their current credit rating (BB+), which implies additional share repurchases may be off the table through at least 2016. GNC also initiated a dividend in 2012 and has raised it annually since then, most recently hiking the quarterly payment by 11% to $0.20/share (3.3% yield) beginning March 2016.

GNC has held a relatively high leverage for many years, reflecting its past private equity ownership as well as the leverage-supporting nature of its business model. GNC reported $61 million in cash against $1.54 billion in long term debt at March 31, 2016. Absolute debt levels have risen modestly in recent years as GNC returned capital in excess of cash generation to shareholders, but leverage (debt to EBITDA) remained between 2.3x-3.3x from 2011-2015. With the recent earnings decline, leverage has increased to 3.7x TTM EBITDA (including convertible debt at full principal value) and we project leverage to slightly exceed 4x by year-end 2016 assuming no incremental share repurchases. GNC’s senior credit facility has customary covenants which have not been disclosed recently but were set at 4.25x EBITDA after March 2013 per GNC’s IPO filings. In the most recent 10-Q GNC disclosed, “We are currently in compliance with our debt covenant reporting and compliance obligations under our Senior Credit Facility and expect to remain in compliance during 2016.” GNC’s preferred metric of adjusted debt to EBITDAR rose to ~3.9x which is at the top end or above management’s long-term target range. CFO Tricia Tolivar commented on the Company’s 1Q16 earnings call,

“What we’ve been communicating is that we’re going to maintain our current credit rating. So that is a fairly broad range when you look at leverage. I don’t – where we are right now is 3.9 [adj. debt to EBITDAR] and I would believe that’s certainly at the top-end of our range and that we’ll come down from that going forward.”

As noted and based on CFO Tolivar’s commentary, we expect this increased leverage will restrict GNC from incremental share repurchases in 2016. However, it is important to emphasize that we do not believe

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GNC’s current debt load is overly burdensome. As illustrated in the following table, GNC has run at high leverage levels since 2007 tracing to its private equity days. GNC’s low cost of debt and high interest coverage should allow the Company to run at current leverage levels comfortably. GNC’s debt principally consists of a senior credit facility including a term loan facility ($1.2 billion outstanding) and a $300 million revolving credit facility ($133 million outstanding). The term loan facility matures in March 2019 and the revolver comes due in September 2018 (recently extended from March 2017). Importantly, the senior credit facility features a very low cost of debt (linked to LIBOR) with a current average interest rate of only 3.25% on the term loan facility and 2.7% on the revolver. In August 2015, GNC also issued $287.5 million of convertible notes due August 2020. These notes were opportunistically placed by GNC; the notes feature a 1.5% interest rate and are now far out of the money with a conversion price of ~$66/share. GNC’s interest coverage ratio (EBITDA to interest expense) was a very healthy 8.8x in 2015. We project interest coverage to remain close to 8x in 2016 with free cash flow covering interest expense by more than 3x.

Leverage & Interest Coverage Ratio

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

2007 2008 2009 2010 2011 2012 2013 2014 2015

Deb

t &

In

tere

st

($K

)

0

2

4

6

8

10

12

Levera

ge &

In

tere

st

Co

vera

ge

Total Debt Interest Expense Net

Interest Coverage Gross Leverage

Even projecting the 1Q16 trends persist throughout the year and into 2017, we estimate GNC could generate ~$170 million in FCF during 2016. While this is a decline of ~45% from 2015 levels, it still translates to ~$2.45 per share (current share count) or an enticing 10% FCF yield at the current share price. Assuming GNC’s recent sales trends persist into 2017 creating modest incremental operating de-leveraging, FCF should still grow beyond 2016 as the material cash flow benefits from the store refranchising strategy flow through. Absent any incremental share repurchasing (holding the dividend steady), this should allow GNC to de-lever fairly rapidly post-2016.

Valuation & Conclusion

GNC shares were a top performer in the first few years following their April 2011 IPO, rallying from the $16 IPO price to north of $60 by late 2013. This was driven by a potent combination of positive same store sales trends and accelerated new store openings. However, GNC shares have been extremely volatile in the subsequent two-plus years as quarterly results have frequently disappointed and industry headwinds have approached gale force. GNC shares plunged 29% on April 28, 2016 following the latest quarterly disappointment, placing shares more than 50% below their August 2015 highs and at levels not breached for an extended period since 2011.

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GNC TTM P/FCF (LHS) and EV/EBITDA (RHS) Since April 2011 IPO

Source: FactSet

Following the recent declines, GNC shares trade at historically low multiples. On a TTM basis, GNC is currently valued at ~9.5x P/E, under 6x P/FCF and approximately 7x EV/EBITDA. This compares to post-IPO medians of 22x FCF and 10.7x EV/EBITDA. Without a doubt, these backward-looking valuation metrics can be misleading; the environment has become more competitive domestically in recent years and GNC may be approaching saturation in terms of the domestic footprint. Internationally, economic declines in emerging markets have halted growth and are unlikely to improve soon. High levels of regulatory/headline noise and a lack of blockbuster new products are likely to be ongoing issues as well. But even projecting the disastrous 1Q16 earnings trends persist throughout 2016, we estimate GNC trades at just 10x 2016E P/FCF or 9x 2016E P/E.

We also continue to believe a comparison to Vitamin Shoppe is a worthwhile exercise. VSI is much earlier in its growth stage (758 stores, although new store growth has slowed to ~5% per annum) but in our view GNC has a more attractive business profile with a large international franchise business and a growing domestic franchise business. Other advantages we see include GNC’s more recognizable brand, smaller store format (lower cost, higher ROI to build-out the footprint), larger manufacturing business with a higher penetration of private label products (~50% vs. ~20% at VSI), and a more attractive product mix (lower exposure to specialty/dietary products at 12% vs. 24% at VSI and higher exposure to more stable sports nutrition products at 45% of revenue). We believe these advantages are evident in GNC’s superior operating margins—in 2015, GNC recorded operating margins of 15.8% in the retail division and 14.9% overall vs. 7.0% at VSI. Yet as illustrated in the following table, GNC trades at a wide discount to VSI on both a P/E and P/FCF basis. GNC trades at a modest premium on an EV/EBITDA basis which reflects GNC’s debt load.

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GNC vs. Vitamin Shoppe (4/29/16)

Company Fiscal Period Price

Market Value

Enterprise Value

Enterprise Value/

EBITDA

EV/ EBITDA

FY1

EV/ EBITDA

FY2

Price to Earnings

Actual

Price to Earnings

FY1

Price to Earnings

FY2

Price to FCF Actual

Price to FCF

FY1

Price to FCF

FY2 EBITDA Margin

GNC 03/31/16 24.36 1,665.4 3,145.4 6.88x 6.84x 6.59x 9.52x 8.30x 7.75x 5.40x 7.92x 6.64x 17.3%

Vitamin Shoppe 12/26/15 27.37 664.2 772.5 5.77x 5.18x 4.83x 15.12x 11.93x 10.93x 36.43x 9.61x 9.64x 10.6%

Source: FactSet estimates, 4/29/16

In estimating GNC’s intrinsic value, we have made an effort to utilize relatively conservative projections for 2016 as well as the long term. We assume SSS trends to continue at 1Q16 levels through the rest of the year, producing diluted EPS of ~$2.80 in 2016—at the low end of GNC management’s recently-revised forecast of $2.80-$2.90. Beyond 2016, we estimate SSS (both Company-owned and franchise) remain flat in 2017 and do not reach a normalized level of 2% until 2019. We also project net domestic store growth (Company-owned plus franchised) slows to <50 per year going forward versus management guidance of ~125/year. We project international store growth (net) stays at just 50 per annum compared to 200-plus prior to the recent hiccups in some emerging markets.

While the near-term picture is cloudy, GNC is in the early stage of implementing several strategies to improve performance. Operational changes include implementing a revamped pricing and marketing strategy, updating a loyalty program, destocking aged inventory to be replaced with proprietary and innovative products, and better incentivizing franchisees to fully participate in these initiatives. If any of these strategies take hold, GNC’s turnaround could come sooner, and be of greater magnitude, than we anticipate. This is aside from the most substantial change: GNC’s effort to transition ~1,000 Company-owned stores to franchises in the coming years and—further aided by focusing on the franchise model for new store growth—to move from just a 23% franchised store base domestically to ~50% in 3-4 years. While we project there will be some GAAP earnings and long-term free cash flow lost in the transition (despite management claims that it will be essentially profit-neutral), we believe this negative will be far outweighed by the increased stability and higher ROIC of the new model.

GNC Key Assumptions Summary ($K)

2014 2015 2016E 2017E 2018E 2019E 2020E

Co. Owned Stores (ending) 3,497 3,594 3,459 3,189 2,829 2,469 2,469

Retail (co.-owned) SSS (2.8%) (1.6%) (2.5%) 0.0% 1.0% 2.0% 2.0%

Retail Segment Operating Margin 18.0% 15.8% 13.8% 13.3% 13.1% 13.2% 13.2%

Dom. Franchised Stores (ending) 1,070 1,084 1,254 1,549 1,943 2,337 2,356

Dom. Franchise SSS (3.3%) (2.1%) (5.0%) 0.0% 1.0% 2.0% 2.0%

Franchise Segment Operating Margin 36.4% 35.9% 36.0% 35.4% 35.5% 35.5% 35.1% Total Revenue $2,613,154 $2,639,212 $2,581,298 $2,483,212 $2,397,785 $2,324,823 $2,365,881

EBITDA $495,849 $450,344 $391,579 $367,082 $366,211 $370,066 $401,613

margin 19.0% 17.1% 15.2% 14.8% 15.3% 15.9% 17.0%

Free Cash Flow* $233,330 $308,706 $168,179 $208,625 $233,828 $247,519 $197,891

Dividends $57,491 $59,648 $57,493 $55,054 $53,731 $50,694 $47,142

Share Repurchases 283,226 479,799 218,900 0 125,000 150,000 200,000

Net Debt/EBITDA (ending) 2.4x 3.2x 4.0x 3.8x 3.7x 3.5x 3.4x

*FCF includes refranchising proceeds

Given GNC’s leveraged free cash flow financial model, we believe the Company is best valued on a free

cash flow basis. This factor also helps account for the free cash flow benefits associated with the store refranchise strategy; free cash flow should accelerate from 2016 to 2019 as the store refranchising strategy frees up working capital and produces an incremental gain on sale. Including these gains, we estimate GNC should generate close to $1.1 billion in free cash flow over 5 years between 2016-2020 or >$900 million incrementally beyond FCF already generated in 1Q16. This translates to ~$13.50/share (current share count) in

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incremental cash flow or ~55% of GNC’s current market cap. Assuming GNC takes a full 4 years to implement its refranchise strategy, the Company will not reach a new “steady state” free cash flow level until 2020. At this point, a relatively re-risked GNC should be able to garner a premium multiple. At a 15x P/FCF multiple—which is still well below GNC’s historical average of 22x—we estimate GNC’s intrinsic value could reach $54 per share in 2020. Inclusive of dividends (held at the current $0.80/share annual rate), this translates to an impressive 138% total return upside or an IRR of approximately 20% over close to 5 years.

GNC Estimate of Intrinsic Value – 2020

2020E ($MM)

FCF $198

multiple 15x

Intrinsic Equity Value $2,968

Diluted Shares Outstanding 56.8

Intrinsic Value per Share $52.28

Implied Upside 115%

Plus Dividend Generation $3.80

Implied Total Return 130%

IRR @ 12/31/20 20%

Given GNC’s free cash flow dynamics over the next few years due to the store transition, GNC’s capital return policy could be a potential catalyst for incremental intrinsic value creation. In our base case scenario, we assume GNC de-levers through 2017 and does not resume share repurchases until 2018. We project GNC to repurchase ~$475 million between 2018-2020 (avg. price ~$36) while still de-levering to 3.4x net debt/EBITDA by year-end 2020. At this stage, GNC’s de-risked business model should more comfortably support balance sheet leverage; were GNC to re-lever to 4x EBITDA, we estimate GNC could spend upwards of $900 million (in excess of 50% of the current market capitalization) on buybacks over the next 5 years in addition to maintaining the dividend (3.3% current yield).

Finally, we would not dismiss the possibility that GNC becomes an acquisition target at some point—particularly if the Company can show signs of stabilizing sales. Multiple hedge funds with activist bents hold sizable stakes in GNC, and the new management team appears vulnerable, having already disappointed investors on multiple levels. As AAF discussed in our initial report on GNC in June 2014, the Company has previously been acquired 4 times including 3 trips through private equity owners, and the leveraged free cash flow statistics discussed above could elicit LBO interest once more. For reference, we would note that GNC was last acquired by Ares Management and Ontario Teachers’ Pension for 11.2x trailing EV/EBITDA in 2007. While GNC might not garner the same takeout multiple in 2016, the current trading multiple (<7x EV/EBITDA) leaves plenty of upside even assuming a substantially lower takeout multiple.

Addendum: GNC Exploring Strategic Alternatives

As we prepared to send this issue to print, on May 2nd GNC announced that its board had commenced a review of strategic and financial alternatives to increase shareholder value. According to the release,

“The review will include a thorough evaluation of the Company’s current operating plan, as well as potential value maximizing alternatives such as accelerated refranchising strategies, capital structure optimization, partnerships and other value-creating collaborations, or a potential sale of the Company.”

GNC has hired Goldman Sachs as financial advisor and Wachtell, Lipton, Rosen & Katz as legal advisor. The announcement followed discussions with a range of (likely irate) shareholders and GNC does not plan to discuss the matter further until the board has reached a decision or is otherwise obligated to disclose information. In short, we view this announcement as a major positive step in response to an extended period of underperfomance/volatility and what was likely a barrage of shareholder complaints post-1Q16 earnings with the looming threat of an activist campaign. GNC shares’ initial response (+6.8% on May 2nd) appears far too muted,

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in our opinion, considering we already saw large upside to intrinsic value and a range of alternatives could catalyze incremental value realization. Below we provide commentary on each of the possible strategic alternatives mentioned.

Sale of the Company

GNC has a long history of private equity ownership (4 private sale transactions including 3 private equity owners since 1987) and as noted, at the current share price we believe the Company could again draw the interest of private equity firms. However, GNC’s debt load could be a hurdle. We believe the Company’s strong free cash flow profile plus its low current cost of debt could easily support an LBO, in theory. But a key issue would be whether private equity could maintain a relatively low borrowing cost while adding leverage. Additionally, regulators have opposed LBOs at >6x leverage, which limits the initial debt financing ability. On the other hand, GNC’s refranchising strategy—particularly if accelerated—could allow GNC to rapidly de-lever in an LBO transaction. In our quick-and-dirty LBO analysis, we estimate a leveraged buyout at $34/share could generate a fairly attractive 21% IRR with a year-end 2020 exit. Assumptions include 6x leverage initially with an average cost of debt of ~8%, an accelerated refranchise strategy, and an exit multiple of 20x FCF (giving credit for the higher proportion of franchised stores) on 4x leverage. Any operational improvement, incremental debt funding/lower cost of debt, or additional store refranchising could add to the upside.

In our view, the bigger uncertainty surrounding a potential LBO is whether GNC can stabilize comparable store sales within the next couple quarters. This may be an ambitious goal, and private equity firms tend to be easily spooked by poor near-term performance. The supplement industry is also in the bull’s-eye of regulators and attorneys, which could further deter would-be private equity purchasers.

Partnerships & Other Value-Creating Collaborations

The meaning of this is somewhat unclear to us, but presumably it references M&A. Vitamin Shoppe and GNC have been the subject of merger speculation since at least 2014. Vitamin Shoppe has also drastically underperformed the market over the past year, and activist investor Carlson Capital (9% stake) has been engaged with VSI and recently won a board seat. As noted, GNC’s CEO was formerly the COO of VSI. Potential benefits of a combination could include closing stores and boosting pricing power, purchasing and manufacturing synergies, and cutting G&A. However, we are somewhat skeptical of the deal benefits given GNC currently trades at a material discount on most estimates; the brands are somewhat differentiated and we prefer GNC’s business model; and mass merchants and e-commerce arguably present far bigger competitive challenges to GNC than VSI.

Franchising

GNC only franchises 23% of stores domestically and will still be at just 50% franchised in 3-4 years under the current plan. This leaves plenty of room for a faster refranchising strategy. Given the relatively low cash costs of a GNC store and their still-healthy margins, we do not believe the Company would have too much trouble finding more franchise partners. As discussed, much of the lost profit margin from refranchising can be countered by freeing up capital and producing more stable free cash flow, which should result in a significantly higher earnings multiple. Some of the other risks from accelerating the franchise model include loss of control over retail store quality/management and difficulty implementing new policies. Obviously, GNC has already been experiencing some of these issues recently. But we would note that these issues are relevant to any franchise model, and a growing number of retailers have implemented far higher franchise-driven models while maintaining the brand image/store performance. Finding quality franchisees and developing a robust quality control team are essential—but far from impossible—tasks. A faster refranchising strategy would also give GNC more capacity to repurchase shares in the near-to-medium term at what appear to be highly attractive levels. In our view, this may be the most attractive—and most plausible—strategic alternative for GNC.

Capital Structure Optimization

We read this to mean adding incremental leverage to repurchase shares. While we find the IRR prospects of incremental share repurchases extremely compelling at the current levels, GNC is already edging closer to its covenants and could have difficulty raising incremental debt at reasonable rates. No previous statements from management have suggested they are comfortable with additional leverage. Alternatively, a dividend cut combined with deploying all free cash flow toward share repurchases would make sense (tax

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efficient and potentially high IRR). But most management teams tend to treat the dividend as sacred and the likely initial market response (negative) could frighten the board from taking such action.

Risks

The Company’s primary risks include, but are not limited to:

Failure to stabilize or reverse ongoing negative same store sales trends

Additional pricing pressure and margin declines associated with mass merchant and e-commerce competition

Inability to execute domestic and international refranchise and expansion plans

Excessive debt, breach of debt covenants, and/or higher interest rates on debt

Loss of the Rite-Aid relationship (recently extended through 2019)

Ongoing negative media headlines regarding the efficacy of nutritional supplements and vitamins

Shifting fads in health awareness amongst consumers

Outstanding litigation and increased regulatory risk domestically and internationally that could result in fines or limit the suite of products that GNC sells

Failure to satisfactorily conclude the review of strategic alternatives

Analyst Certification

Asset Analysis Focus certifies that the views expressed in this report accurately reflect the personal views of our analysts about the subject securities and issuers mentioned. We also certify that no part of our analysts’ compensation was, is, or will be, directly or indirectly, related to the specific views expressed in this report.

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GNC HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands)

ASSETS March 31, 2016 Dec. 31, 2015

Current assets:

Cash and cash equivalents $ 60,999 $ 56,462

Receivables, net 126,898 142,486

Inventory 562,868 555,885

Deferred income taxes 10,926 10,916

Prepaid and other current assets 49,701 27,114

Total current assets 811,392 792,863

Long-term assets:

Goodwill 646,343 649,892

Brands 720,000 720,000

Other intangible assets, net 117,158 119,204

Property, plant and equipment, net 224,818 230,535

Deferred income taxes 3,358 3,358

Other long-term assets 34,476 38,555

Total long-term assets 1,746,153 1,761,544

TOTAL ASSETS $ 2,557,545 $ 2,554,407

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

Accounts payable $ 208,666 $ 152,099

Current portion of long-term debt 4,550 4,550

Deferred revenue and other current liabilities 154,586 121,062

Total current liabilities 367,802 277,711

Long-term liabilities:

Long-term debt 1,536,390 1,444,628

Deferred income taxes 305,453 304,491

Other long-term liabilities 58,076 59,016

Total long-term liabilities 1,899,919 1,808,135

TOTAL LIABILITIES 2,267,721 2,085,846

Stockholders’ equity:

Common stock 114 114

Additional paid-in capital 917,005 916,128

Retained earnings 1,094,550 1,058,148

Treasury stock, at cost (1,715,121) (1,496,180)

Accumulated other comprehensive loss (6,724) (9,649)

TOTAL STOCKHOLDERS’ EQUITY 289,824 468,561

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 2,557,545 $ 2,554,407

Copyright © Boyar’s Intrinsic Value Research LLC. All rights reserved www.BoyarValueGroup.com

Asset Analysis Focus is not an investment advisory bulletin, recommending the purchase or sale of any security. Rather it should be used as a guide in aiding the investment community to better understand the intrinsic worth of a corporation. The service is not intended to replace fundamental research, but should be used in conjunction with it. Additional information is available on request. The statistical and other information contained in this document has been obtained from official reports, current manuals and other sources which we believe reliable. While we cannot guarantee its entire accuracy or completeness, we believe it may be accepted as substantially correct. Boyar's Intrinsic Value Research LLC, its officers, directors and employees may at times have a position in any security mentioned herein. Boyar's Intrinsic Value Research LLC Copyright 2016.

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