CATTERTON BUYS DEL FRISCO’S (DFRG), FERTITTA BUY THE STEAKHOUSES, WHO WINS, WHO LOSES?

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CATTERTON BUYS DEL FRISCO’S (DFRG), FERTITTA BUY THE STEAKHOUSES, WHO WINS, WHO LOSES?

As of June 30th, Del Frisco’s managed 16 Del Frisco Double Eagle (DE) Restaurants, 17 Barcelona Wine Bars, 21 Bartacos and 24 Del Frisco Grilles. The AUVs in calendar 2018 were $13.3M for DE, $4.3M for Barcelona, $4.6M for Bartaco and $5.1M for the Grille.

Catterton paid $8.00 per share, providing an enterprise value close to $700MM for Del Frisco’s (inclusive of stock options, severance and change of control provisions). Tilman Fertitta, founder of Landry’s, now a huge diverse restaurant empire, has reportedly paid $300-$325M for the steakhouse side of the business, the DEs and Grille.  This leaves Catterton with the Barcelona Wine Bar and Bartaco, the two promising growth vehicles. The table following this discussion shows some summary statistics for the four concepts from calendar 2017 through the first six months of ’19. Complete comparisons are not available for Barcelona and Bartaco which were purchased during the third quarter of ’18. It is interesting, as shown in our table, that Del Frisco’s provided average weekly sales and store level margins for the two acquired concepts in Q1’19 but not in Q2’19.

The object of this exercise is to learn what we can from the “value” purchased by Landry’s, traditionally a “vulture” investor, and the remaining enterprise value that Catterton carries and is obviously hoping to build upon.

The steakhouse side of the business, at 2018 volumes with 16 DEs and 24 Grilles, is at a current run rate of about $335M.  ($213 for DE plus $122M for Grille). While store level EBITDA was 22.9% and 12.2% for the two concepts in ’18, both have run higher and Fertitta no doubt thinks he can get the margins to at least 25% and 14%, still below all-time highs. That would generate $53M at DE and $17M for Grill, or a total of $70M before corporate overhead. The incremental overhead for Fertitta’s restaurant empire would be no more than 5% of revenues (possibly closer to 3%), or $17M (possibly closer to $10M), leaving corporate EBITDA of $53M (to $60M). While we have pointed out many times that EBITDA is not free cash, the multiple of EBITDA is the most commonly used valuation measure. If the reported $300-325M is accurate, the midpoint of $312M is about 6x what Landry’s could potentially generate. It might not be the distress price that Fertitta normally reacts to, but the reward/risk for this experienced restaurant operator looks reasonable. The most prominent risks are “macro”, the general economy and the challenging traffic and cost trends within the restaurant industry. Fertitta, however, is uniquely well equipped to evaluate that aspect of the situation. Catterton might have hoped for more, but the operating trends over the last several years have not been promising. Fertitta  is  equipped to pay a “fair” price, take the risks as described above, able to layer Del Frisco’s over his much larger restaurant empire.

Catterton, after paying close to $700M for the Company, is left with about $400M at risk, and the ownership of 17 Barcelona Wine Bars and 21 Bartacos. At the current run rate, based on calendar ’18 AUVs (which is being exceeded so far in ’19), Barcelona and Bartaco are generating about $73M and $96M respectively, for a total of $169M. While we don’t know where store level EBITDA has run historically, 25% is probably the expectation and that would generate Store Level EBITDA of $42M. G&A in the case of this growth vehicle would no doubt run at least 7%, or about $12M, leaving about $30M of corporate EBITDA. The $400M of remaining investment for Catterton is therefore about 13.3X the run rate of corporate EBITDA, not a bargain but reasonable in this environment.

CONCLUSION:

Based on the public disclosures, we can understand the appeal in this environment for both Fertitta and Catterton, the operative phrase being “in this environment”.  Catterton is looking for GARP, growth at a reasonable price, which Barcelona and Bartaco provide. From Fertitta’s standpoint, even if he ends up paying 10x corporate EBITDA, and $31M (which he probably feels is a “layup”) is a lot less than the $53M corporate EBITDA outlined above, 10% cash on cash return would still be attractive relative to his much lower cost of capital. We think Catterton ends up with the larger risk, and reward, and that’s the business they are in. We don’t have access to the long-term historical results at Barcelona and Bartaco but the results, impressive as they seem, with high sales per square foot and operating margins, have no doubt had their rough spots over the years. Not every location works, labor costs are guaranteed to continue rising, rents, other operating expenses only go up, and a recession is out there somewhere… guaranteed. When Del Frisco’s was public,  when it was trading at $6-7/share, we wrote that it was “fairly valued”, considering the poor operating results at Del Frisco’s, the $300M+ of 9% debt, and the ever present risks of building out Barcelona and Bartaco. We think Catterton provided the public with a fairly priced exit, at the same time providing themselves with a promising growth vehicle. Tilman Fertitta, one of the few potential buyers able to look across the operating valley, comes away with a new “cash cow” to layer upon his existing empire. A reasonably fair deal, all around.

Roger Lipton