RESTAURANT FINANCE MONITOR – 4-15-23 – Follow the Money by Roger Lipton
A Macro-Monetary-Storm is blowing, with broad ramifications. Just over a month ago there was a “run” on Silicon Value Bank and others, requiring Fed rescue. It turns out that more than twenty years of reckless fiscal/monetary policy have unintended consequences. What a surprise! Almost all banks have purchased fixed income securities (US Treasury Bills, Mortgage Backed Securities, etc.) that when marked to market price would show an unrealized loss, in turn jeopardizing the banks’ equity. We have not heard the last of this problem – but we need not fear. The Federal Reserve has stepped in to guarantee even uninsured deposits, essentially putting in place a mechanism by which the entire US banking system can be nationalized — a long term probability. Taking into consideration the timing uncertainty, the necessary monetary accommodation will spur inflation well above the Fed’s 2% objective. Also increasing inflation is the weak US Dollar, as foreign nations increasingly transact in other currencies and diversify reserves away from Dollar denominated assets. When the USA, by way of sanctions, froze Russia’s US Dollar assets in ‘22 the “weaponization” of the Dollar created a new urgency for China and others to reduce Dollar holdings. China, Russia, Brazil and India (the BRICs), plus Middle Easterners, South Africa and others, are transacting with gold, oil, or non-Dollar currencies. It should be lost on nobody that the US is no longer energy independent, is the only important trading nation that is not increasing its holdings of gold, and is running larger trade deficits than ever. There are too many economic, political, military and even social areas of tension to discuss here, but there is trouble brewing on all fronts. Our focus is the “money” and we believe that financial strength is paramount if the US is to exert influence within the other venues.
Leverage Works Both Ways and we have written extensively on our website about FAT Brands. They have assembled, largely during Covid, a portfolio of seventeen franchised restaurant brands, financed by monetizing (for about $1B) future royalty streams. This was based on anticipated post-Covid Adjusted EBITDA of about $100M, from brands led by Twin Peaks, Round Table Pizza, Fazoli’s, Johnny Rockets and Fatburger. While the original overall interest rate was just above 7% the expectation was for a re-rating of the debt in late ‘22, reducing interest expense by perhaps 200bp or $20M annually. With only $50M of interest expense in ’23 (down from about $70M in ’22, excluding transaction costs), $100M could provide a comfortable cushion of “free cash flow”. Expectations continue to be for about 1,000 new locations, already in the development pipeline, which could increase corporate EBITDA to roughly $150M in five years or so.
However: Interest rates have spiked much higher, and, while other options exist, the re-rating of the debt will not help. Adjusted EBITDA came in at $88M in ‘22, not far from the $90-95M projected run rate, which was absorbed by interest expense and other non-recurring items, legal expenses in particular. In that regard, CEO Wiederhorn, his family still a major shareholder, has recently stepped aside as CEO and the Board has been restructured, apparently to distance the Company from Wiederhorn’s personal legal issues.
Legalities aside, which do not seem to be affecting operations, the “new age” result is that “free cash flow” is dependent on top line growth in the portfolio, fortunately moving in the right direction. Cash at Dec. ‘22 was $29M (unrestricted). $40M more was raised in January from further royalty securitization, with room for more, allowing for liquidity to be maintained while free cash flow generation moves toward breakeven. An “ace in the hole” is the ability to sell some portion of the dough manufacturing plant, which generated about $15M of EBITDA in ’22 while operating at about one third of capacity, as well as equity in one (or more) of the major brands.
Regarding the stock, FAT Brands (FAT), worth about $120M represents an equity “stub” or “option”, compared to debt of about 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. If FAT is generating something like $150M of Adjusted EBITDA in five years, the Enterprise Value at that point could be 15-20x, or $2.2B to $3.0B. If there are still 16M shares, with similar debt, the common stock would be worth $1.2B to $2.0B or $75 to $125/share. More conservatively, if free cash flow of $50M were to represent a hefty 10% free cash flow yield, the stock would sell at $30/share, or $60/share at a 5% free cash flow yield. Investors can make assumptions in terms of operating projections and more stock and/or debt being issued, but the upside is perhaps surprisingly substantial. Relative to the risk, the existing lenders seem comfortable, reportedly willing to lend more, “to help out”. The fact remains that the upside possibilities for FAT are an order of magnitude larger than the $7 share at risk.