ROGER’S 8/15 COLUMN IN RESTAURANT FINANCE MONITOR: THE MACRO ECONOMY, CHUY’S, THE FZT/FALCON’S MERGER
“FOLLOW THE MONEY” – August 15, 2022 edition – by Roger Lipton
Macro economic crosscurrents abound. Fed Chair, Jerome Powell and Janet Yellen (US Treasury Secretary and ex-Fed Chair) have redefined a recession, which always consisted of two negative GDP quarters in a row until it happened on their watch. The Fed Funds Rate has been moved to 2.25-2.5% and Powell is now calling a potential rate of 3% a “neutral” rate, so not too far to go, even though inflation is running at 8-9%. Recall that it took a Fed Funds Rate of 18% in 1979 to defuse the 13% inflation rate. The other part of the monetary medicine, reducing the Federal Reserve balance sheet, is now admittedly “getting off to a slow start”. Last Friday, shockingly strong employment numbers came out, at odds with (1) Amazon cutting staff by almost 100,000 in Q2 (2) Walmart laying off hundreds of corporate workers and (3) The US Treasury increasing the Q3 borrowing estimate by 143%, from $182B to $444B. Continues to look like stagflation to me.
Restaurant Stocks look cheap, as we wrote here last month, but individual situations could be a “value trap”, rather than an opportunity. For example, Chuy’s (CHUY) trades inexpensively at less than 6x trailing twelve-month EBITDA, almost entirely as a result of store level labor moving from 36.2% to 28.7% between 2018 and 2021. In comparison, full-service competitors, also affected by Covid, such as TXRH, BJRI, CAKE, EAT and DRI kept their store level labor percentage almost constant in the same period. Turns out, amazingly enough, that the number of managers, as well as hourly employees in the Chuy’s system was virtually the same in 2021 as in 2014 (about 500 and 6000, respectively), though the number of restaurants increased by 63% from 59 to 96. Could be one reason why, even after taking $53.3M of impairment charges the last several years, comp traffic trends have been consistently negative. We will pass on this opportunity.
FAST Acquisition Corp. II (FZT) is writing a new book in the SPAC space, none too soon based on current disillusionment with SPACs. Aside from the fundamental appeal of the just proposed Business Combination with Falcon’s Beyond (an entertainment/hotel/theme park company), the FZT Sponsors (led by Doug Jacob, Sandy Beall and other restauranteur/brand builders) have made structural adjustments, all materially beneficial to the public and worthy of description. SPACs, as we have written, can be unattractive because too often: (1) The Sponsors have no operating experience and the principals to be acquired are sometimes selling and/or leaving. (2) The starting valuation is years ahead of the fundamentals (3) The SPAC investors may not approve the Business Combination, and their funds may be necessary to close (4) There is downside risk if the earnings are light or late, especially when the starting point is a “plan” rather than an existing business (5) There is substantial dilution of the public shares by earnout incentives that depend on short term stock price rather than longer term results. A short-term stock move can trigger the earnout but the fundamentals, allowing for public investor liquidity, may still be far in the future. The structural adjustments of the FZT/Falcon’s merger mitigates the above negatives as follows: (1) The Sponsorship group and proposed Board of Directors have outstanding brand building credentials in the hospitality/restaurant/retail industries. Included are &vest’s Doug Jacob (co-founder of &vest), Bill Hinman (partner of &vest and former Director of the SEC’s Division of Corporate Finance), Sandy Beall (partner of &vest, founder of Ruby Tuesday’s, founder of Blackberry Farm and Blackberry Mountain) and others. The creative credentials of the “sellers” and the partnership with Melia’ Hotels speak for themselves. Furthermore, the sellers are accepting stock and staying, putting their reputations, patents, funds, property, etc. into the new venture. Lastly, an affiliate of the seller will contribute up to $60M to the new company, $20M of which is already in place. (2) The first project, in Punta Cana, Dominican Republic, opens in early 2023, within months of the Business Combination and calendar 2024, with $150M of projected EBITDA, will be little more than a year away. Melia’ Hotels will be contributing hotels already long term successful, on valuable resort real estate, as part of their contribution to the 50-50 JV, providing brick and mortar value to the new Company. Lastly, even if projects should be delayed for some reason, indications of success will not be long in coming as Punta Cana opens in early 2023 (3) The FZT/Falcon’s transaction will likely move forward, even with substantial SPAC redemptions. The projects are largely pre-funded, an affiliate of the seller will provide up to $60M, and Melia’ operating credibility and contribution of brick and mortar should provide a range of financing alternatives. (4) The risk is mitigated because brick and mortar hotels will be contributed by Melia’ as each project moves forward. In addition, half of the public’s common shares will be exchanged into an 8% convertible preferred stock. The Sponsor is also forfeiting 20% of their “promote”, to be reallocated between Private Placement and non-redeeming public investors. This effective stock dividend, depending on redemptions, will range from 6.1% to 8.1% of FZT’s $10.00 price. (5) The potential dilution from earnout shares is a non-factor because that would take place only after one year, triggered in tranches at $20, $25, and $30/share, at which point public shareholders will have already made substantial returns. In Conclusion, the new structure provides a much-improved balance between “organizers”, incoming operating principals and the public investors. There is less of a “promote” for the organizers and underwriters, the exit for the operating principals is longer term in nature and the reward vs. risk equation for public investors is far more attractive than usual with SPACs.