FAT BRANDS INC. (FAT) TO ACQUIRE PRIVATELY HELD JOHNNY ROCKETS – WHY NAD HOW, AND WHAT IS THE OUTLOOK?

FAT BRANDS INC (FAT), led by CEO, Andrew Wiederhorn, has assembled a group of internationally franchised brands, some better known than others but all of them challenged to varying degrees in recent years. The theory is to leverage operating expertise, marketing power, purchasing scale and administrative costs over independent brands, using an asset light franchising approach (zero company operated locations). Wiederhorn is the controlling shareholder of Fog Cutter Capital Group, Inc., which owns 81% of the common stock of FAT.

The liberal use of debt and preferred stock, as outlined just below, has allowed for the current ownership of:

Fatburger, a burger chain, founded in Los Angeles in 1947, now 168 locations, including 101 co-branded

Buffalo’s, casual dining, wings and classic American platters, GA founded in 1985, now 18 locations

Ponderosa & Bonanza steakhouse, founded in 1960s, now 83 locations

Hurricane Grill & Wings, casual dining, chicken wings, FL  founding in 1995, now 49 locations

Yalla, fast casual, healthy Mediterranean, now 7 locations

Elevation Burger, fast casual with grass fed and organic burgers, 2002 founding, now 41 locations

Systemwide sales in 2019 of these 366 locations (@ 6/30/20) was $395M.

BALANCE SHEET DISCUSSION:

As of 12/31/2019 shareholders’ equity was $5.4M (including goodwill and intangible assets of $55M). Preferred A stock obligation amounted to $15.3M. The current portion of long term debt was $24.5M and the remaining long term portion was $5.2M. Due from affiliates was $26M. The current ratio consisted of $10.5M of current assets and $45.6M of current liabilities.

By 6/30/2020, the balance sheet reflected shareholders’ equity of negative $3.5M (including goodwill and intangible assets of $37M). The Preferred A stock amounted to $15.5M. The current portion of long term debt was reduced to $661k, with the long term portion amounting to $43.9M. Due from affiliates was $34.7M. The current ratio had improved to reflect $10M of current assets against a much reduced $21M of current liabilities. The previous Long Term Debt had been replaced by a face amount of $40M of “Securitization Notes”, netting $37.3M after expenses and discounts, to be repaid from royalties as received. The blended average cash interest rate is 7.75%, which reduces the total weighted average cash cost of debt to 8.49%, decreasing annual interest expense by almost $2M per year.  There is also an “Accordion” feature, allowing for additional acquisition related borrowing.

Post the second quarter, on 7/13/20 FAT raised $8.2M from the sale of 8.25% Series B Preferred Shares and warrants exercisable at $5.00/share. Subsequent to this offering FAT entered into an Agreement to redeem and cancel the remaining Series A Preferred shares. The result was equity increased by $15M, with insiders converting $3M of Series A and accrued dividends into Series B Preferred. Also retired was warrants, exercisable at $7.20, to acquire 554,065 shares.

A VERY QUICK OPERATIONAL LOOK

The first half of calendar ’20 is obviously distorted by the effects of the Coronavirus Pandemic, and the Adjusted EBITDA was a negative $361k. More importantly, the Adjusted EBITDA in calendar ’19 was $7.7M. The Company’s recent presentation talks about 41 additional Fatburger locations since acquisition, integration of Elevation Burger onto the the Fatburger operating platform, a turnaround in Hurricane Grill, from a negative 4.7% comp prior to acquisition to +6.4% in calendar ’19, including +8.3% in Q4’19. The overall portfolio store count has increased from 286 in calendar 2017 to 374 by 12/19 (including acquisitions). Most importantly, demonstrating the efficiency of the multi-brand platform, Total Costs and Expenses as a % of Revenues has come down from 97.7% in ’17 to 62.4% in ’19. It is on this basis that the Company raised $40M with their Securitization and, most recently in Q3, the additional $8.2M.

THE JOHNNY ROCKETS DEAL

This “iconic brand”, as FAT management now terms it, has over 300 locations, spread over 129 individual franchise owners, which will bring the FAT portfolio to over 700 units in total. The new systemwide expectation of over $700M implies that the Johnny Rockets locations are expected to annualize at something like $1M per store. The purchase price is $25M, which will paid for by cash on hand plus the Accordion feature of the recent securitization. FAT management stated that they expect this acquisition to allow them to double their current (in calendar ’19) Adjusted EBITDA of $7.7M. The brief audio “conference call”, with no Q&A, described how FAT can leverage their operating platform with new purchasing power of $250M annually (about 30% or so of $700M), marketing (produced and booked internally at FAT), virtual restaurant offerings, dual branding and FAT’s knowledge of “the burger business”.

WHY WOULD SUN CAPITAL SELL ?

It is reasonable that Johnny Rockets, which is, indeed, a well known brand, could be reincarnated, even if reduced in size after the pandemic, under the right leadership. However, if it is so promising, why would Sun Capital let it go for $25M, especially when FAT management says it is capable of generating $7 or $8M of EBITDA.

Our guess is that Johnny Rockets is generating no more than a couple of million dollars for Sun Capital, perhaps not much more than breaking even. Sun bought it from RedZone Capital in 2013, who had bought it in 2007. After thirteen years in private equity hands, you can bet that the energy provided by early management is long gone. It is “just a name” to Sun Capital, to be bought and sold, and the $25M can be applied elsewhere. Private equity firms always have liquidity concerns as well, so that might come into play here. If Johnny Rockets is breaking even to earning perhaps $2M for Sun Capital, Fat Brands could probably “adjust” that to a current million or two, and believe they can leverage that over a couple of years to six or seven million of EBITDA. Even if it takes longer, and amounts to only $5M, it would be a worthwhile ROI for FAT. A lot more than their cost of capital. So…..the seller is tired…..and the buyer is optimistic….and liquid enough….and that’s how deals get done.

Let’s watch.

Roger Lipton