We have written extensively over the last several years about FAT Brands (which readers can access using the SEARCH function on our HOME PAGE).
Their 17 brand portfolio of restaurant franchises was mostly assembled during Covid-19, financed by almost one billion dollars of 30 year royalty securitizations, with an average interest rate of about 7%. The funds were raised based on pre-Covid (2019) economics, on the assumption that fees and royalties would normalize once Covid ran its course, which has essentially proved to be the case. Based on the portfolio as assembled, projections made over a year ago called for post-Covid adjusted EBITDA of $90 -95M. Though Q1’22 was affected by the Covid Variant and a number of Q4’22 openings slipped into Q1’23, Adjusted EBITDA came in at $88.8M, not far off early estimates.
CONCLUSION
We will discuss below the details of Q4 and calendar ’22, and expectations for ’23 and beyond. In prologue, it is obvious that a company with long term debt amounting to 10-11 times the current run rate of Adjusted EBITDA has to be prepared to adjust to a dramatically higher interest rate environment. More specific to FAT Brands, management had high hopes of having their debt “rated” sometime in calendar ’23, saving as much as 200 basis points, or almost $20MM per year. The brands are fortunately performing well, and the 7% interest rate represents a reasonable rate in this environment, but a sharp reduction of interest expense is not likely in the short term. Improvement in free cash flow will therefore be more dependent on the brand performance over time than a reduction of interest expense. Fortunately for all stakeholders, those parameters are moving in the right direction.
While not underestimating operational requirements, management’s broad financial concerns are (1) managing cash while providing adequate support to the various brands and (2) implementation of a long term deleveraging strategy. .
In terms of the first, cash on hand at 12/31/22 was $54M ($29M unrestricted). In January, per an 8-K filing, the Company increased cash by securitizing $40M more of the GFG notes. Calendar ’23, demonstrating positive same store sales so far, with 150-175 openings scheduled, should push Adjusted EBITDA to the area of $98-103M. In addition to higher fees and royalties, G&A efficiencies (e.g. the absence of a $2M national multi-brand convention, as in ‘22), and increased utilization of the manufacturing facility should contribute as well. The existing securitization facilities allow for added borrowings, with $48M more available as in January, as brand royalties increase. Part and parcel of cash management will be allowing for a scheduled 1% increase in rates during Q3 and Q4 of ’23 and amortization of note principal starting in Q3’23, amounting to $15M in ’23 and $30M in ’24, continued payment of common stock dividends and the contemplated redemption of preferred stock. While these cash requirements are substantial, $69M of unrestricted cash as of 1/31, further borrowing power within existing securitization facilities (Per description of GFG Notes in 10K, about $48M face value still available after taking down $40M in January), and management’s demonstrated financial acumen should allow for effective balance sheet management. At the end of the day, if the brands perform, this concern eases steadily over time.
In terms of the long term deleveraging strategy, FAT Brands’ 17 brands generated $88M of royalties in ’22 en route to $88.8M of corporate Adjusted EBITDA. The most obvious monetization “targets” appear to be the dough manufacturing facility (now generating about $15M of EBITDA (operating at one third of capacity) or their most valuable single brand, Twin Peaks, which generated over $25M of EBITDA in ’22 and should be able to grow by at least 15% annually for the foreseeable future. Some portion of the equity in certain brands, or the manufacturing facility could substantially reduce the debt obligations at some point in the next several years, while retaining the lion’s share of the royalty stream. Though the obligations are substantial, the brands are worth a great deal as well. Moreover, if they continue to perform well, their value will increasingly outstrip the debt.
Looking beyond the obviously complex GAAP (and even Adjusted) results of the last three years, historically eventful inside and outside of the Company: One way or another there seems to be the potential for corporate EBITDA to grow over the next five years to the area of $150M without a meaningful increase in long term debt. With free cash flow at that point in the area of $50M, if there are still only 16M shares outstanding, a conservatively valued 10% free cash flow yield would support a stock over $30/share. To be sure there are a great number of moving parts, operational and financial, but FAT Brands continues to provide an attractive reward/risk profile over the long term.
RECENT REPORTED RESULTS
There was a great deal of progress, in Q4 and for calendar ’22 as a whole. As provided in the Company’s Q4 Earnings Supplement:
The good news, as presented above is that same store sales were up 6%, 140 stores were opened, portfolio systemwide sales were $2.2B, and domestic average AUVs have been steadily increasing. For all the above reasons, as discussed below, franchisees are planning to open 150-175 new stores (on a base of 2300) and the total signed pipeline calls for 1,000 new locations.
While noting the progress as described above, GAAP accounting at this highly leveraged company was not as flattering, Including a number of large writeoffs, mostly non-cash and in most cases expected to be non-recurring. The GAAP net loss for Q4 was $70.8M, or $4.29 per diluted share, compared to $19.6M or $1.38/share in calendar ’21. The full year showed a GAAP loss of $126.2M vs. $31.6M in ’21. The table below shows the reconciliation from GAAP earnings to Adjusted EBITDA. Looking at the full year, which we consider most instructive for the future, bad debt expense, share based comp, refranchising loss, impairment losses (totaling about $50M) are non-cash and should be largely non-recurring. Litigation expense is expected to be lower and some portion could be covered by insurance.
THE CONFERENCE CALL
Per CEO, Andy Wiederhorn’s commentary on the quarterly conference call.
With 140 units opened in ’22, 44 were in the fourth quarter, in spite of supply chain headwinds, permitting and construction delays. During 2022, 110 new franchise development agreements were signed, representing a total of 372 new stores. Included were 86 Fatburger/Buffalo Express locations, 61 Fazoli’s, 56 Round Table Pizzas and 50 Twin Peaks. There was also a 10 store agreement for Johnny Rockets in Israel. The current 1000 unit pipeline represents 43% unit growth and should generate an incremental $60M of adjusted EBITDA, which would bring the securitized debt leverage ratio down to about 7x EBITDA. 26 new locations have opened already this year, anticipated to be 150-175 for the year. Q1’23 should come in between 50 and 60.
Twin Peaks, the most substantial, and the most dynamic brand within the portfolio, has grown from 80 to 96 units in just over the year that it has been owned. There should be 18-20 new units in ’23, which will be about 40% growth over two years. New Twin Peaks are “seeing AUVs north of $6 million and some locations in Florida are generating between $9M and $12M each”.
Co-branding is another growth strategy, including tri-branding. Hot Dog on a Stick has been added to Fatburger/Buffalo’s Express in L.A., Fatburger and Round Table Pizza will be joined, as well as Johnny Rockets and Hot Dog on a Stick. There are now more than 200 co-branded locations, mostly Fatburger/Buffalo’s Express and Marble Slab Creamery/Great American Cookie.
A new effort has been established to place brands in non-traditional locations such as airports, universities, amusement parks, hospitals and stadiums, a market with great opportunity.
The dough manufacturing facility did $33.5M in sales, with$15M of EBITDA, operating at only at 1/3 of capacity. Filling that plant with Fat Brands’ portfolio products, as well as contract manufacturing for others could conservatively double the current EBITDA. Wiederhorn talked about the potential value of the dough manufacturing facility as well as Twin Peaks. “If the manufacturing facility goes from $15M EBITDA to $30M, at 10 times it could be worth $300M”. Twin Peaks, the way it is performing, and growing, “could be a $700M to $1 billion brand in a number of years”
In Q4’22, $43.2M of Series B preferred stock was redeemed by way of one of the existing royalty securitization facilities, at an improved interest rate, and “we are actively working towards the redemption of the $92M of preferred issued in connection with the acquisition of GFG and Twin Peaks. In addition, we are pursuing the rating and/or refinancing of our different securitization facilities.”
In response to a question about various corporate expenses, Wiederhorn responded that “we hope that those (legal) cases will be resolved during this calendar year and to get all this legal expense to go away once and for all.” “Bad debt expense is really the reserve for the employee retention tax credit….we’ve received the money in most cases and yet we fully reserve for it but that’s what it is… it’s just the reserve for the tax credits.” “The impairment loss…if the interest rate environment moves against you…and it’s related to your cost of financing……as Ken (Kuiick, CFO) said, approximately $60M of the $70M loss for the quarter was non cash.”
In a conclusion of sorts: Wiederhorn provided: “So we really have some key liquidity events out there in 2 years, 3 years, or 5 years that are very interesting to shoot for, and that’s really what we’re focused on right now. We don’t feel compelled to buy another brand because we have so many great brands, so much pipeline already out there with additional stores signed up, paid for, ready to be opened by the franchise groups. Only if it makes strategic sense to drive the manufacturing facility or to drive the sports lodge business are we going to really make an acquisition that’s material.
“And it doesn’t mean there aren’t little bolt-on things here or there that makes sense. Like I said, we don’t have a salad concept or a coffee concept or a sandwich concept. That would be good to have in the portfolio but it is not something that’s critical right now and not something in this interest rate environment that we feel compelled to borrow money at a higher rate. We want to de-lever right now and, unless it’s very strategic, we’re going to execute by growing out that pipeline organically first.”
CONCLUSION:
Provided at the beginning of this report.