FAT Brands, Inc. announced last week that founder and CEO, Andy Wiederhorn will step aside as of May 5th, transitioning to a new role as “outside consultant and strategic advisor”.
Having followed, and written of, FAT Brands’ emergence as a franchisor of seventeen restaurant brands, the largest, and likely most promising, being Twin Peaks, we are surprised but not shocked.
Wiederhorn, over several years including the heart of Covid related disruptions, creatively assembled a collection of growing franchising brands, including Twin Peaks, Round Table Pizza, Fazoli’s, Johnny Rockets and Fatburger, the brand he started with. This assemblage was accomplished by borrowing over $900M long term, securitized by the royalty streams. The expectation, and the reported results in calendar ’22 ($88.8M of Adjusted Corporate EBITDA), support the Company’s previous estimates that these brands would generate upwards of $90M of Adjusted Corporate EBITDA, once Covid ran its course.
It should be noted that the $88.8M of Adjusted EBITDA in ’22 was after adding back almost $19M of legal expenses, incurred dealing with a variety of legal actions. While management has indicated that some portion of the legal expense reported could be covered by insurance, the Company has accrued them to date. As discussed by Wiederhorn, on the most recent (February 22nd) conference call:
“SEC investigations are never good for shareholders just because of the cost. And we are — we made significant progress in terms of responding to the inquiries that we received related to the government investigation. I don’t think that there’s much more to respond to. I think that, hopefully, we’ll be able to see some sort of resolution as we finish the year. These things go slow. They can take years, as you know. But hopefully, we’ll see the legal expenses shrink here significantly. We do have opportunities for insurance defense coverage and recovery for some of these things but none of that is reflected in our financials. We haven’t seen insurance companies write checks yet, although we firmly believe that we’re covered under our policies. And we are pursuing recovery against those carriers.
“So you know how that goes sometimes where you have to actually file an action or commence arbitration and mediation to get coverage. We have done all those things. And we think that we will move it along nicely because there is also — it is not just the government investigation. We also have 2 derivative cases outstanding. Remember, in Q3 of last year, we settled 1 shareholder class action case which was good to get behind us to save further legal fees. But we’ve had plenty of discovery and things like that in the 2 derivative cases. We hope that those cases will be resolved during this calendar year and to get all this legal expense to go away once and for all.”
The implication we derive from this announcement is that Wiederhorn and his Board of Directors have concluded that his reduced role might facilitate an earlier resolution of the legal matters than would otherwise be the case.
While it remains to be seen what management adjustments will be made, calendar ’23 has already been described as a “consolidation year”, with the major brands performing well and the royalty stream expected to grow nicely. As we have previously described in our update as of February 27th, the cash position seems adequate to service the debt while the major brands expand and the royalty stream grows.
In terms of further risk to FAT stock at this point, we would be concerned if (1) lenders were somehow disillusioned and putting an unanticipated pressure on the Company or (2) there were further legal issues against the Company that would cause expanded, rather than reduced, legal exposure. Regarding (1) there seems to be no indication of that and the Company seems able to continue meeting their obligations to lenders. Regarding (2) from Wiederhorn’s commentary, as provided above, on February 27th, there has been no indication to that effect.
Based on the information available, we do not believe that Wiederhorn stepping aside, should be construed as an important negative at this point and this action appears to have a productive logic behind it. Since he and his affiliates continue to be major shareholders of FAT Brands, in his absence as day-to-day CEO, his strategic guidance will likely continue to be available, as stated.
Without question, FAT Brands common stock, (FAT), worth about $120M represents an equity “stub” or “option”, compared to the debt of close to one billion dollars. The Enterprise Value, at about 12x the current rounded $100M run rate of Adjusted EBITDA is less than some pure franchising peers with multiples in the high teens or even higher. This can be considered justifiable, in the context of the shorter operating history of the “new” FAT Brands, as well as the legal “hair” on the situation. It is also obvious that leverage works both ways. On the positive side, the business seems to be going well and the pipeline of stores to be developed seems capable of creating an additional $50-60M of Adjusted EBITDA over the next five years. If FAT is generating something like $150M of Adjusted EBITDA, the Enterprise Value at that point could be 15-20x, or $2.2B to $3.0B. If there are still 16M shares outstanding, and the debt were the same, the common stock would be worth $1.2B to $2.0B or $75 to $125/share. From a more conservative standpoint, if free cash flow of $50M were to represent a hefty 10% free cash flow yield, the stock would sell at $30/share, with a 5% free cash flow yield at $60/share. Investors can make their own assumptions in terms of the possibility of the Company accomplishing its projections, and/or the likelihood of more stock or debt being issued. The bottom line remains that the upside possibilities are an order of magnitude larger than the $7.50/share at risk.