TGI FRIDAY’S, SCHEDULED TO COME PUBLIC ON 3/26/20 THROUGH ALLEGRO MERGER CORP (ALGR) – WE ESTABLISH COVERAGE

FOREWARD:

We started our work on this situation several weeks ago, prior to the developments relative to the coronavirus and the extreme volatility in the capital markets. The transaction, as described below, is currently scheduled to be completed by way of a shareholder vote on 3/26/20. Circumstances can obviously change between now and then and we present the following analysis based on currently available information. We intend to update this analysis as appropriate.

CONCLUSION:

The TGI Fridays brand has been around for over half a century and the results the last five years have been clearly been less than their private equity owners and management would have liked. The TGIF system is about to fold into publicly held Allegro Merger Corp. (ALGR), a Special Purpose Acquisition Corporation (SPAC) that raised about $150 million in 2019. The current private equity owners of TGIF, according to the planned transaction, will be converting almost all (86%) of their equity into shares of Allegro/TGIF.

Since the restaurant industry is so transparent and it is no mystery that TGIF has not seen the best of times recently, analysts are already chiming in with (often well considered) opinions. Since we view the risks as fairly obvious, and the valuation seems to reflect most of the perceived problems, we admit to paying more attention here to what might go right than further wrong. In particular, a modest in size, but high value portion of the business, is the steadily expanding licensing business, currently generating a $13 million revenue base, truly “asset light”. Much larger in terms of current cash generation is the international franchising portion of the business (446 locations) which has been stable over the last five years and seems poised to improve. The 385 TGIF US locations (209 franchised, post the Q1’20 Company buyback) have obviously been challenged in recent years but recently recruited management is qualified by experience at TGIF and elsewhere.

Our objective view of the situation might be concisely stated as “there is a lot of low hanging fruit”. Without minimizing the job at hand, a reasonable effort on the part of this management team should at the least, stabilize, and, at best, reinvigorate the brand. From an investment standpoint, the starting valuation at conclusion of the proposed merger is a substantial discount from industry peers, especially interesting since it is based on pro forma results that could prove to be a low point.

INTRODUCTION:

There is always a story to be told whenever there is a merger of an operating company into a Special Purpose Acquisition Corporation (SPAC). Our presentation therefore will differ from our typical “corporate description”. We present the following report because this situation may well provide an investment opportunity, as well as a “teaching moment” for analysts and restaurant operators.  Rather than keep our readers, most of whom are financially oriented, in suspense, an operating summary, as provided in the proxy material, is as follows:

The TGI Fridays system, under strain since 2014, is lately beginning to show tangible signs of stabilization and improvement. As of 12/31/19 there were a total of 831 restaurants worldwide, 446 of which were franchised outside of the US and 245 of which were franchised in the US. (79% franchised after the Briad acquisition). The total corporate revenues, including royalties, are about $430M. Domestically, the systemwide AUV has been about $2.7M with an $18 average check per guest. In a nutshell, the international segment has remained relatively healthy through the tough times and it’s the domestic side that has suffered the most and theoretically has the recovery potential.

According to the Investor Presentation filed with the SEC on 2/11/20*, the post merger Enterprise Value, consisting of $275M of net debt and $200M of equity, net of balance sheet cash, will be $475 million, which is:

9.1x calendar 2019 Adjusted TTM EBITDA

8.1x projected calendar 2020 Adjusted TTM EBITDA

6.8x projected calendar 2021 Adjusted TTM EBITDA

*The most recent proxy material, filed on 3/11/20 shows trailing numbers, which we show toward the end of this report, within 1-2% of those assumed above. Readers should not be confused by the table on page 78 of the proxy which shows projections made for the sake of the Fair Value Opinion relating to the Allegro/TGIF merger. That Opinion was provided prior to the Briad acquisition, assumed capex and marketing expenses that may or may not take place, as well as presumably conservative projections of sales and profit margin progress.

There are obviously lots of adjustments and assumptions involved in a transaction of this sort, but it seems clear that TGIF has been generating something on the order of $50M of trailing EBITDA (an average of $58M, according to the proxy material), which provides an Enterprise Value to EBITDA valuation under 10x.

The valuation described just above should be considered relative to the table below showing the enterprise values (as of 3/5/20) of existing publicly held restaurant systems that are 75% or more franchised, all of which are similarly leveraged to the post-merger TGIF. We have not included in the table Wingstop (WING) and Domino’s (DPZ), which (on 3/5) were at 53x and 23.3x EBITDA respectively, which are growing steadily as “best of breed”, nor Papa John’s (PZZA) which on 3/5 was at 35.4x still depressed EBITDA results. The prices shown as of just a week ago, were already down 15-20% from their highs, and might be considered reasonably normalized. The valuations, as of this particular distressed moment in the capital markets are an additional 15-20% lower than those shown below (and are changing rapidly), but are still a premium to the starting point of of ALGR/TGIF. None of the companies shown below is “shooting the lights out” in terms of growth.  In general, they are high single digit growers, average no more than 10% annual growth in EPS and EBITDA, which could be considered a reasonable possibility for TGIF, especially coming off the depressed performance of recent years.

Details follow relative to the history, the current trends, the potential opportunities for improvement and the financial details behind the above summary. The information in this report is largely excerpted from the filed proxy material, augmented by public sources such as Google and Wikipedia.

CORPORATE BACKGROUND

The first TGI Fridays was opened on First Avenue in Manhattan in 1965, by Alan Stillman, with $5,000 of his own money plus $5,000 famously borrowed from his mother. In 1971 Daniel Scoggin acquired the rights to eight major cities. Stillman and Scoggin merged after the latter opened a highly successful new prototype in Dallas in 1972. They sold the Company to the Carlson Companies in 1975, where Scoggin remained as CEO until 1986. By 1983 there were 100 locations and the first international location opened in the UK (still the largest and most successful market for TGIF) shortly thereafter. It is interesting that the chain’s highest grossing location has historically been at Haymarket Leicester Square, which opened in 1992 in Central London. 45 licensed locations had opened in the UK by 2007 and there are 87 today. By 1989 the system was approaching 300 locations, and then tripled in size in the 25 years ending in 2014.

The next several paragraphs of history are among the most important for today’s investors:

In 2014, Private Equity, represented by Sentinel Capital Partners, and their minority partner, TriArtisan Capital Advisors LLC, paid a reported $890 million for the TGI Fridays company/franchise system, at that point generating about $2.7B in systemwide revenues.

It’s well known that investors love “asset light” companies, franchising companies in particular. Therefore, in less than two years after Sentinel took control of TGIF, by the end of 2015 the franchised percentage of the system had been increased, from about 50% (of 916 stores at 12/31/14) to a much more asset light, over 90%, by 12/31/16. Unfortunately, this form of financial engineering so often employed by private equity owners apparently  involved a poor selection of franchised partners, likely accompanied by insufficient franchisee support, and probably slimmed down attention to the remaining company stores as well. The result was the contraction of the US system from around 500 locations at 12/31/14 to 385 stores at 12/31/19. We have to interject here: it’s tough out there, but not that tough. 2014 through 2019 has shown steady, if modest, economic expansion, throughout that period. The restaurant industry probably remains overstored, but that many stores doesn’t close in a relatively short time without a serious effort 😊.

After almost five years of the above described debacle, Sentinel, for whatever combination of reasons, in 2019 sold their interest to TriArtisan (who moved up to 54% ownership) and new investor, the family office of Michael F. Price (“MFP”, now with 40%).

Importantly, Sentinel, in 2018 had recruited Ray Blanchette, previously President and COO at TGIF between 1989 and 2007, who has since brought back several others, as described below, all of whom had been successful top executives “back in the day” at TGIF.

Blanchette, in particular, has established outstanding credentials within the full service dining industry. After his previously successful career at TGIF he became CEO at Ignite Restaurant Group in mid ’07. As described in industry publications, Ignite’s primary concept, Joe’s Crab Shack, from the fall of ’08, had eighteen quarters in a row of positive same store sales. Blanchette received the “Operator of the Year” award from Nation’s Restaurant News in 2013, while Joe’s Crab Shack’s AUVs were moving from $2.1M to $3.4M under his leadership.

Blanchette, in turn, recruited John Neitzel, COO (global franchising) who was with TGIF from 1982 to 2010, Jim Mazany, COO (corporate stores) who was with TGIF from 1990 to 2005, Bill Alexander, Senior VP & Chief Development Officer, who was with TGIF from 1992 to 2003. Giovanna Koning, CFO, has been with TGIF since April ’17.

We preface the following remarks with the statement that the information provided below is assembled based on the proxy material provided to shareholders of Allegro as well as related SEC filings. We’ve tried to indicate where our commentary becomes editorial in nature.

THE STRATEGY, in summary

Before filling in the details, the strategy, in the shortest possible form, is:

• Rebuild AUVs at both corporate and franchised locations, including SSS and traffic
• Buy back and improve poorly run domestic franchised stores
• Better support and stimulate the still healthy international franchise system
• Stabilize, then stimulate the domestic franchise system
• Rebuild the social bar and alcohol beverage sales within the restaurants
• Increase licensing revenues from TGIF branded products
• Build Off-Premise sales
• Enhance Digital/Loyalty Program

MANAGEMENT

Before detailing the various initiatives, it is crucial that proven management has been brought back to the system. This team, as described above, knows the brand and has worked together before, in better times.

THE INITIATIVES

Rebuild AUVs at company and franchised locations

The following charts and commentary are excerpted from the Investor Presentation filed with the SEC on 2/11/20. As shown below, sales and traffic trends indicate that both had stabilized and moved higher in Q1’20. A skeptic could point out that it was early in the first quarter of 2020, and the better weather in the US may well have been a contributor to the improvement. On the plus side, however, the trends as far as corporate vs. franchised performance have been moving in the right direction for several quarters prior to YTD Q1’20, and it seems natural that company store results, with programs implemented earlier, would improve first.

Q1’20 System SSS were up 4.5 points compared to Q1’19. Q1’20 Corporate improvement was up 6.3 points YTY, Franchise improvement was 3.1 points YTY. Corporate stores vs franchised improved in each of the last five quarters, achieved, as described in the Investor Presentation, by “strong leadership team, operational focus, marketing/promotion support (Day of Week, TV Media Promotions, etc.”).

Q1’20 System Traffic was up 7.0 points compared to Q1’19. Q1’20 Corporate store traffic was up 11.0 points YTY. Franchise improvement was up 4.1 points YTY.

Buy back and improve previously franchised locations – It’s been done by others…successfully.

*This acquisition, called Briad, consists of 20 on the West Coast (16 in CA, 4 casino locations in NV), plus 16 East Coast locations (NY, NJ, CT, PA), increasing the company owned total to 176. Full year Briad AUV’s of $3.4M are higher than the existing company owned base.

While investors generally approve of going “asset light” and selling off underperforming corporate stores (if they can), on the assumption that a committed franchisee can operate more efficiently, and royalties can at least come close to the cash flow under corporate management, the flip side of the coin also has its logic. Why sell off your stores, your largest asset base, when they are at the low point of the cycle? If improvement is a likelihood, why not get the operating leverage for the company, and sell later at a materially higher valuation? This has been done with notable success in recent years by both Arby’s and Brinker, Int’l.

Adding to the probability of TGIF’s success with this approach: The table above shows the summary of where and when the Company has repurchased underperforming domestic stores, some of the which have once been among the systems strongest units in longstanding core regions. Noteworthy is the  heavy concentration in the Boston to NY northeast corridor and Texas.  Summarizing the geographical makeup, as of 12/31/19: 12.9% (18) of the 140 total company stores were in Massachusetts, 23.6% (33) were in NY State and 17.1% (24) in Texas. The Briad acquisition, as shown in the above table (of 36 more stores) would add 16 more east coast locations.

There are initial signs of progress in regions acquired in January ’19. Operationally and traffic wise, as described in the Investor Presentation of 2/11/20, “40-50% of existing directors of operations and general managers have been replaced over the last 4+ months.  New Management in Boston and Florida regions, acquired at the end of Q1’19, have shown “incremental growth in traffic and sales over the last several months.”

Better support and stimulate the international franchise system

The international franchise system, with 446 restaurants, is the most dominant portion of the total worldwide brand. Though the number of stores has been virtually constant the last few years, it expanded steadily under Carlson ownership and modestly even after the 2014 transition to Sentinel. This segment of TGIF activities contributed $33.3M of revenues in 2019. Considering that there is a significant pipeline of new restaurants to be built, the international activities can be considered the most predictable portion of the TGIF picture. There are 40 franchisees among the 56 countries, with a great deal of concentration in a relatively few strong operators. The top 5 franchisees operate 225 stores. On average, each franchisee owns 11.1 restaurants. All but 31 stores (out of 446) are operated by franchisees with at least 6 locations. The largest market, in the UK (with 87 restaurants) had positive same store sales (0.5%) in 2019 as well as unit growth. The second largest market is the Middle East, with 66 stores “is seeing improved performance” In 2019, after apparent weakness for unspecified reasons. There is a great deal of “white space” available In Mexico (with only 17 stores), Japan (with 14), India (9), Brazil (6), Southeast China (3), and Canada (2).  A 40 store development agreement was recently signed in Brazil, there is a signed LOI for India and Southeast Asia development with new ownership, and a development agreement is being negotiated in Mexico. There is a current total development pipeline for about 100 new units internationally, with 8-12 new countries involved, so there is the obvious possibility of a near term pickup of international unit growth. Combined with an improvement in sales trends, which also seems to be responding to the efforts of the rebuilt franchisor team, this largest portion of TGIF activities seem to have the potential for improved results.

Stabilize, then stimulate the domestic franchise system

The remaining domestic franchise system consisted, as of 12/31/19, of a still substantial 245 restaurants (209 after the 36 unit Briad sale back to the Company). This segment contributed a meaningful $28.5M of royalty revenues to 2018 results. A favorable aspect is that the locations are operated by a total of only 22 franchisees, and the top 5 groups operated a total of 174 restaurants. It can therefore be reasonably assumed that this group is fairly well capitalized and relatively effective operators. Under revitalized management at headquarters, all the “blocking and tackling” that will take place to support the domestic corporate stores can be expected to also benefit the remaining domestic franchise system. This, would presumably support higher sales and increased royalties, perhaps even encourage expansion by existing groups and attract new franchisees at some point. We should note here that the rights to operate stores in Manhattan were sold decades ago to the RIese family. Those locations do not pay royalties, are not counted in the “system”, and may or may not be operated at company standards.

Rebuild Social Bar and Alcohol sales

Almost all casual dining restaurants try to build their percentage of highly profitable alcoholic beverages. TGIF has a competitive edge in this regard, by way of its original “bartending with flair” identity. Prior management may have gone too far in terms of trying to make the concept “family friendly” and the current team is attempting to regain a portion of the original appeal. Fridays’ management team believes that the concept’s bar heritage is a key differentiator and will use its social bar strategy to reinvigorate its restaurants. Historically, alcoholic beverage sales in the dining room amounted to about 30% of revenues. Today that percentage is more like 19%, so there is obvious opportunity in this regard. The new (old) management team has already implemented new happy hour offerings in some markets (to go systemwide domestically in Q2), including $2 beer, $3 cocktails and $12 “endless appetizer” offerings with a choice of five different items. Physical changes including lighting, AV equipment and new seating are also expected to play an important part. Rebuilding alcohol sales will obviously take time, but it is consistent with the brand image, and presumably can be done at the same time as improving the food offerings.

Increase licensing revenues

Investors have to like this most “asset light” segment of TGIF revenues, which should improve the overall corporate valuation. Products such as pre-mixed cocktails, hamburger patties, baby back ribs and center of plate entrees are sold domestically. Frozen appetizers in the UK and refrigerated dips in the US are set for a 2020 introduction. Licensing revenues have grown at a 9% CAGR from 2016 to 2019 to $13 million, and are targeted, including new products, to reach $20M by 2025.

 Build off-premise sales

This area has already been an important focus, off-premise sales increasing from 7% to 13% of sales from 2017 to 2019. Delivery sales, in partnership with DoorDash, UberEats, Postmates, and Grubhub, grew 140% YTY in 2019, to $58M. The delivery segment, for all operators, has become very important, and generally has affected store level margins negatively, but this impact is leveling off throughout the industry and we believe that delivery sales through third party providers  will be less of a margin burden as competition among providers intensifies. As stated in the proxy material: “the Company is in the process of adding additional features to its delivery/off-premise platform which is expected to add incremental sales. Through it’s involvement with PF Chang’s and Hooter’s, TriArtisan is building strategic relationships with the leading third-party providers, which could improve delivery profitability and add marketing support for all three brands.” An improved effort with takeout sales will also be pursued.

Enhance digital/loyalty program

This area is hugely important for all restaurant chains, and TGIF has untapped potential in this area. They have invested $30M over the last several years, building the capability to aggregate and leverage customer data. The existing loyalty program is 60% inactive, has been primarily using email and discounts, which obviously leaves room for improvement in terms of more profitable customer engagement. In this regard, the new mobile ordering platform has been downloaded about 2M times. The plan is to deliver targeted promotions to the loyalty members and add rewards to encourage repeat behavior.  Marketing going forward will no doubt focus on the improvement in this area as well as previously discussed areas.

CONSOLIDATED TGIF MIDCO, INC. AND SUBSIDIARIES – NOTE 21 (PAGE F-57) OF 3/11/20 PROXY

The following tables sets forth a reconciliation of income (loss) before taxes and noncontrolling interest to Adjusted EBITDA for the fiscal years ended December 30, 3019, December 31, 2018 and December 25, 2017 (in thousands):

There are, by the nature of a merger of this sort, lots of adjustments, in the past, current and future. Precision is not the name of this game. We think it is most pertinent that Adjusted EBITDA averaged about $58M annually the last three years, before the Briad acquisition of 36 relatively high volume locations. The projected “base” of Adjusted EBITDA of $45.3M in the table just below (from the Investor Presentation) is very close to $44.6M in the most recent proxy material ($47.9M minus $3.3M). Management obviously expects to build upon that base, and we have talked about the various levers that could come into play. The following section outlines the contributions to the projected gains in 2020 and 2021, as presented in the Investor Presentation filed in February.

Readers can make their own judgements relative to the above assumptions. Without doubt, the coronavirus situation is affecting the worldwide economy, at the very least on a short term basis. We think the above assumptions are reasonable in a “normalized” situation and the relevant results will be achieved (or not) over time, most likely (at this point) delayed by whatever timeframe the coronavirus changes customer behavior.

CONCLUSION: PROVIDED AT THE BEGINNING OF THIS ARTICLE