ARK RESTAURANTS (ARKR) – NO COOKIE CUTTER HERE, BUT THE CURRENT VALUE AND THE ADDITIONAL POTENTIAL SEEM SUBSTANTIAL
Ark Restaurants represents one of the few investment opportunities in the small cap restaurant space for significant appreciation over the next few years. Unlike most restaurant stocks that are trading at valuations that significantly discount their future, Ark’s current valuation gives almost zero credit for the large amount of optionality embedded in their business model and Meadowlands Racetrack investment.
THE REINVENTION OF ARK RESTAURANTS
Ark Restaurants is a unique restaurant company with a 37 year operating history that focuses on large, one-of-a-kind restaurants located in such landmark locations as Bryant Park in NYC and the Sequoia in Washington D.C. The company also operates restaurants in Alabama, Florida, New Jersey and Nevada. The restaurants typically have 200-500 seats (an Olive Garden has about 250 seats) and require specialized management skill to operate efficiently. As of January 2, 2021, ARKR owned and/or operated 18 restaurants and bars, 17 fast food concepts.
In fiscal 2020, as a result of Covid 19 related shutdowns, sales declined 34% and the company lost $7.7M. In 2019 the company generated $7M in free cash flow and paid a $1 per share dividend (the company paid a $1 per share dividend since 2010). As the economy opens back up, the company expects to reach cash flow breakeven by at least Q3, 2021.
The purpose of this report is not to analyze these results, but to highlight several value creating strategies that could drive the stock price significantly higher in the next two or three years. We are going to focus on two specific areas. The first is the company’s strategy of acquiring restaurants and the land (or secure 20+ year leases, possibility with right of first refusal). The second is their 7.45% ownership in the New Meadowlands Racetrack LLC. We believe these strategies could result in a share price in excess of $30 per share in the new few years. We believe management’s interest is strongly aligned with outside shareholders due to it 40% ownership of the company. It should also be noted that Michael Weinstein is 77 years old and the average age of the other eight directors is 73 years old, including four 77 years old or older.
Brief Summary of Earnings Power and Liquidity
In 2019 Ark generated $10.6M in cash flow and approximately $7M in free cash flow. The company was using the FCF to make approximately $3M in debt amortization payments and $3.5M in dividend payments. We believe that the cash flow of the company in 2022 could be similar. The company should be able to service its debt without difficulty. While the timing of the resumption of the dividend is unclear, the company will have the flexibility to either reinstate a dividend or accelerate debt pay down.
As of Q1, 2021 (ending 12/31/20) the company had $11M in cash and $41M in debt, of which $15M is PPP loans. The company has applied for $4.1M in forgiveness and anticipates applying for an additional $7-$9M in forgiveness. The company also anticipates receiving $3.4M-$3.8M in tax refunds this year. Excluding the debt associated with the PPP loan that is expected to be forgiven, the company’s net debt position should be closer to $12M-$15M once all the tax refunds are received. The company has stated that it believes it could be cash flow positive within the next 6 months.
How the Acquisition Strategy Creates Significant Value
In response to losing over $6M in EBITDA due to lease expirations over the last 6 years, CEO Michael Weinstein has been replacing this lost cash flow by acquiring properties where they own the building and the land (or have a 20+ year lease).
As a result of wage law changes in New York and Washington D.C. in recent years, the company’s payroll expenses increased by over 300bps so Mr. Weinstein embarked on a diversification strategy to reduce the exposure to these states, increasing activities in Alabama and Florida. Since 2014, the company has spent approximately $34M acquiring restaurants in Florida and Alabama. These acquisitions have increased revenue from these two states to over 40% of restaurant revenue. Not only does this strategy reduced exposure to lease expiration and wage hike risk, but it also increases long-term value by sustainable cash flow improvement.
The acquisition criteria are straightforward but are designed to improve the chances of long-term value creation. The basics of the criteria are as follows:
One-off, non-branded restaurants to reduce competitive bidding. Acquire restaurant buildings and land for 4-6X cash flow, alternatively with a lease of twenty years or more with a purchase right of first refusal.
- Mostly cash purchase (typically owners are 70-90 years old) to reduce buyer pool.
- Preferably a restaurant with 200-1000 seats with complex operations.
- Located in areas (i.e coastal locations) that have limited ability for new construction.
- Opportunity to increase sales and profitability through professional management.
2020 Example: Blue Moon Fish Company, Lauderdale by the Sea, FL. – Voted “Best Waterfront Dining in Fort Lauderdale by Zagat”
In December 2020, Ark acquired the Blue Moon Fish Co. near Fort Lauderdale, FL for $2.8M. The company paid $1.8M in cash and issued a four-year note in the amount of $1M with a 5% coupon. A lease which expires in 2026, has four, five-year extension options. The rent payments are approximately $360K per year (6% of revenue) and increase approximately 15% as each option is exercised. The restaurant produced approximately $6M in pre-Covid revenue and $1M cash flow. Management believes there is a strong possibility that capacity can be expanded.
2020 Example: JB’s on the Beach, Deerfield Beach, FL
In 2019, the company purchased JB’s on the Beach in Deerfield Beach, FL for $7.04M. In January, 2020, the company exercised its right-of-first refusal to acquire the land, building and parking lot associated with the restaurant for $11M (original offer price was $18M). The original agreement required the company to fund a $3M deposit, but Ark contributed its rights and interest to a new unaffiliated entity which funded the entire $11M. At this point, Ark continues to operate the restaurant and negotiations continue in terms of the real estate development.
2016 Example: Rustic Inn, Jupiter, FL.
No longer in Ark’s portfolio, the company took over the restaurant, then called the CrabHouse, in 2014, for $250k. They then spent $750k for renovations, reopening in January, 2015 as the Rustic Inn. Ark exercised its right of first refusal in October, 2016, for $5.2M, at the same time selling the same property for $8.25M, which generated a net gain of $1.637M, obviously an admirable return on their $1M investment in just a couple of years.
Another Example, with Dramatic Value Created
Another of the four properties currently owned is the Rustic Inn in Dania Beach, FL that was acquired in 2014 for approximately $7.7M. The acquisition was financed with an original bank loan of $6M, of which $3.7M is remaining. The seller was a 94 year old owner/operator. At the time of purchase the restaurant was generating $1.5M in cash flow. Since the acquisition the restaurant has increased sales 15-20% (through price increases and better management) and increased cash flow pre-Covid to $3.5M. Among other things, cash flow was increased through the combination of a reduction of 400-500bps in food costs, as well as the operating leverage on sales increase. These improvements effectively reduced the purchase multiple to a little over 2x cash flow.
At this point, Ark has the financial flexibility to leverage the cash flow if they like, with a sale/leaseback. This potential transaction, providing a $1M rent to the purchaser, for example, could generate something like $10M in proceeds, still leaving the Company with $2.5M of annual EBITDA.
THE MEADOWLANDS -RETURN COULD BE VERY SUBSTANTIAL
In 2013, the company made a $4.2M investment in the New Meadowlands Racetrack LLC (NMR). Over time the company has increased its total investment to $5.1M for a 7.4% fully diluted stake. Additionally, in 2014 the company loaned NMR $1.5M by way of a 10 year note. The principal and accrued interest currently totals $1.78M. The managing partner of NMR is Jeffery Gural, who owns the casino Tioga Downs and a racino at Vernon Downs in New York. Hard Rock International has an equity stake in NMR and a long-term agreement for future development at the Meadowlands.
ARKR has also secured the exclusive right to operate the food and beverage concessions (excluding a new Hard Rock Restaurant that could be built on-site) at the new raceway grandstand and casino. ARKR already has a relationship with the Hard Rock as the operator of food courts for them at two casinos in Florida.
New Jersey’s mobile sportsbooks produced more than $359 million in revenue in 2020. The Meadowlands has been the primary beneficiary of the legalization of sports betting in the state, with a 52% market share of sports betting in New Jersey in 2020. The Meadowlands partners are FanDuel and Pointsbet, rumored to be in the frontrunner to partner with the world famous Las Vegas Westgate SuperBook. Other advantages of the Meadowlands include the fact that it is only six miles away from New York City and is one of only two active sports books in the country within walking distance of an NFL stadium.
New York lawmakers have recently agreed to legalize mobile sports betting. Lawmakers considered and rejected a budget provision that would have permitted up to three additional casinos in downstate areas, including New York City. Licenses for that area are on hold until 2023. While the Meadowlands could see an initial decline in sports betting (an estimated 20%-30% of NJ revenue comes from New Yorkers), the consensus among industry players is that New Jersey casinos will benefit in the long run.
In fact, Mr. Gural was pleased with how the New York sports betting bill turned out. He was quoted in the Wall Street Journal as saying, “It’s the dumbest thing I’ve ever seen. I consider this a gift to New Jersey and to me at the Meadowlands, and my only regret is that Andrew won’t be around to see this totally fail.” In the past Mr. Gural has been quoted as saying “I think the best hope for The Meadowlands is to get a casino. Once downstate New York gets them, hopefully we would then get them, which would create a lot of revenue. I do think, long term, that we will get a casino.” While the New York lawmakers did put the possibility of three new land-based casinos on hold until 2023, this does not change the long-term attractiveness of the Meadowlands as a land-based casino. In addition to the large increase in revenue from sports betting, the Meadowlands racetrack has seen a 61% increase in handle over the last 10 years. Mr. Weinstein’s decision to invest in NMR seems to point to a potentially substantial long term payoff to shareholders one way or another.
WAYS TO WIN WITH THE MEADOWLANDS
Current investment in NMR is profitable
Even without a casino at the racetrack, the NMR partnership is profitable. On the Q4 2019 earnings conference call, Mr. Weinstein stated that ARKR’s share of the cash flow was around $800K. However, since it is carried on the balance sheet at cost, and not being distributed to the company, it cannot be counted as income. We believe 2020 attributed cash flow could be similar, if not higher, so this imbedded value continues to build.
Important Equity Stake in New Casino Development
The ultimate reward for shareholders would be the approval of a casino at the Meadowlands. As discussed above, the timing of such approval is highly uncertain. However, we do believe that approval will occur in the future. A simple analysis shows the potential value creation that could occur for shareholders once that happens.
Jeff Gural has estimated a Meadowlands casino could generate $800M-$900M in revenue. For reference, in 2016, the Borgata in Atlantic City had revenue of $812M and EBITDA of $212M. MGM sold the Borgata to MGM Growth Properties for $1.175B in consideration.
Example of Hypothetical Meadowlands Casino:
- Casino cost $1B
- Debt to equity 60/40 –
- ARKR prorated share of equity contribution $25-$35M
- ARKR expenditures for restaurants $55-$65M
- Funding – many possibilities – returns discuss below are non-leveraged by Ark
- Company could execute more sale-leasebacks to fund some of the cash
- Normalized cash flow could also help fund expenditures
- Outside investors have expressed interest in the project.
- Per the Q4 2020 conference call:
“And in the last two weeks, I’ve gotten two calls. …….very wealthy groups, one a family office with some $4 billion. And another one…….not involved in the restaurant business but sees the opportunity. And both of them have said that they would like to partner up with us if we saw anything that was attractive. I know one of the group has gaming interest and sort of would like to buy Ark stock, either a convertible preferred or something that converts into Ark stock because they’re not only looking at the capability of us to acquire other restaurants, but they really got their eye on the Meadowlands to own a piece of that through us.”
Potential Value Creation
We believe that the single most likely scenario is that NMR buys out Ark’s equity interest, with Ark retaining foodservice opportunities at the site. The majority partners may want to takeout its minority partners to simplify the operating structure. It is difficult to project a value, under this scenario, but we believe the payoff to ARKR would be substantial.
Should the current partnership structure prevail and the Casino get built with Ark remaining a 7.4% equity partner, we suggest that the new Casino could do a minimum of $1B in revenues and generate $200M of EBITDA. Ark’s 7.4% interest in that EBITDA would be worth about $14.8M annually.
Without considering the degree to which Ark could leverage their total gross investment of $90M, inclusive of building the restaurants, one could create a matrix of values with revenues from $1.0 to $1.5B, and multiples of EBITDA between 6x and 10x. A minimum expectation of $1B in revenues, $200M in project EBITDA, and a valuation of 6x, would generate a value for ARK of about $90M, almost exactly matching their gross investment, but without considering the value of operating restaurants.
Possible, based upon the population density in northern New Jersey, is revenues closer to $1.5B and $300M of EBITDA. Ark’s share of project EBITDA would be $22.2M, worth $133M at 6x, net after debt to ARK of $43M or $12.28/share. At a 10x multiple, Ark’s share would be worth $222M, or $37.71/share net after debt.
The range of expectations and values just above are substantial, and exclude the value of Ark’s right to manage the restaurants at the new casino, in which they have invested $50-60M. Assuming those restaurants generated EBTIDA of $10-12M, only a 20% ROI, a 6x multiple on that would be $60-$72M or $17-$20/share.
The range of expectations goes from zero for the project as a whole but $17-20/share for the right to operate the restaurants, to a value as high of $37/share for the project plus the $17-20/share for the restaurants. These are obviously very substantial possibilities, and are provided not as specific projections, but an indication that the long term potential is large relative to the current price of Ark common stock.
CONCLUSION: Provided at the beginning of this article
Prepared by: Roger Lipton and Tim Heitman