FAT Brands Reports Q2’23 – Comps positive, Stores Opening, Liquidity Maintained, Deleveraging Planned
Prologue: Our articles have detailed the impressive growth of FAT Brands over the last several years (available with the SEARCH function on our Home Page), as they have assembled seventeen franchised restaurant brands, with over 2,000 locations doing about $2.3B of annual sales. The billion dollars borrowed, at about 7%, was planned to be refinanced 200-300bp lower, but deleveraging as efficiently as possible now turns out to be the most practical path. In the meantime, the path to long term success is dependent on managing and building the brands by 50-60% (from the development pipeline) from about $90M of annual Adjusted EBITDA to approximately $150M. Fortunately, the operating fundamentals are positive so short-term cash flow should improve. Moreover, one particular asset, the Twin Peaks chain, seems capable of generating hundreds of millions of dollars of liquidity within the next 12-18 months with more over the long term.
CONCLUSION
Notwithstanding the current interest rate environment and the legal situation (which does not seem to be affecting operations), free cash flow, now and in the future, is dependent on fundamental progress, which is fortunately moving in the right direction. The current liquidity seems to be sufficient for the next year, and for the long term if the projected growth takes place. An “ace in the hole” is the planned IPO in 2024 of some portion of Twin Peaks, the manufacturing facility or another brand. The FAT Brands stock, now worth about $110M, represents an equity “stub” or“option”, the portion of enterprise value value above and beyond the billion dollars of debt. The Enterprise Value is therefore about 12x the current rounded $90M of Adjusted EBITDA, less than some pure franchising peers that sell for a multiple in the high teens. If FAT is generating something like $150M of Adjusted EBITDA in five years, the Enterprise Value could be 15-20x, or $2.2-3.0B. If there are still 16 million shares, with similar debt, the common stock could be worth $1.0-1.8B, or $62-112 per 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 per share or $60 with a 5% free cash flow yield. Before anticipating a stock price from $30 to $112/share, investors should consider that more shares or debt issued could dilute the potential reward. Moreover, the upside would still be surprisingly substantial and the upside for FAT is an order of magnitude larger than the $7/share at risk.
THE SECOND QUARTER – see Balance Sheet, Operating Income Breakdown and Cash Flow Below
The GAAP net loss was $7.1 million, or $0.53 per diluted share, compared to $8.2 million, or $0.60 per diluted share, in Q2’22. Adjusted EBITDA of $23.1 million compared to $29.5 million a year earlier. Adjusted net income of $3.0 million, or $0.08 per diluted share, compared to adjusted net loss of $3.1 million, or $0.29 per diluted share, in Q2’22.
Revenue in Q2’23 was $106.8 million compared to $102.8 million. Royalties were up 5%. Company owned restaurants were up 4.6%, systemwide sales were up 1.7% and revenues from the dough manufacturing facility were up 13%. Last year’s adjusted EBITDA included a $10.1 million benefit related to employee retention credits so adjusted EBITDA increased $3.7 million (19%) from the $19.4 million in Q2’22. Twenty-five new locations opened in Q2, bringing the year-to-date openings to 66 locations. Q2 openings were about 14 less than planned but 15 units have already opened in Q3, 20 more are due by the end of August and 175 locations (up 25% from ’22) are still projected for all of ’23. Most importantly, there have been signings in ‘23 for over 150 new locations, bringing the pipeline to over 1,100 new units over the coming years. As indicated above, this buildout should increase Adjusted EBITDA to about $150M annually, organically deleveraging the balance sheet.
Since the pretzel dough and cookie mix manufacturing facility is a source of increasing cash flow as well as potential balance sheet deleveraging, it is worth noting that revenues for this Georgia-based operation were up 13% in Q2. Still at only 40% to 45% of its capacity, up from 33% 2 years ago, it can potentially generate about $30M of annual cash flow and could be sold at a multiple of that. Cookies have been intrduced at Fat Brands’ Elevation Burger, beginning a roll out at Johnny Rockets and Fatburger.
Before discussing the most valuable brand, Twin Peaks, other brands have been expanding as well. During Q2 a Fatburger opened in Greater Tampa, which is the first of 4 locations over the next 5 years. Fatburger will also open 10 locations in Orlando within the next 7 years with the first location slated to open by the end of the year. Johnny Rockets has also enjoyed continued growth around the globe with new locations in Arizona, Chile, Peru, India and multiple locations in the UAE. The brand also signed a development agreement to open 20 new franchise locations throughout Texas in the coming years. Great American Cookies, now with 400 locations, continues to expand to new territories, most recently making its debut in the State of Alaska.The second Pretzelmaker drive-thru location opened in Cedar Rapids, Iowa and the drive-through model looks promising for broader useage. Co-branding is another key strategy to drive sales and leverage margins. This spring and summer, several development deals were signed to open over 30 new co-branded and franchised locations in Iraq. This deal includes 12 co-branded Fatburger and Buffalo’s Express locations, 10 co-branded Great American Cookie and Marble Slab Creamery relocations and 10 Hot Dog on a Stick locations. They will open throughout the country outside of the Kurdistan region over the next 5 years with the first unit set to open in 2024. Currently, Fatburger has 4 units already operating in the Kurdistan Region with a strong following there. Lastly, the first co-branded Fatburger and Round Table Pizza location will open shortly in Texas.
Twin Peaks is the crown jewel of the FAT Brands portfolio, without minimizing the significant value elsewhere. The Twin Peaks, now averaging close to $6M per location, has recently opened its 100th location, will end ’23 with about 115 units, up almost 40% since its acquisition in late ‘21. As previously announced, an IPO of Twin Peaks is likely in 2024. Units continue to produce industry-leading average unit volumes (with high margins), with some of the Florida locations generating AUVs between $9 million and $12 million. Twin Peaks has demonstrated its broad appeal, now operating in 27 states and 2 countries. Over the next several years, Twin Peaks plans to double its unit count to more than 200 lodges and increase the mix of franchise locations from 70% today to more than 80%. The planned unit growth is expected to increase systemwide sales to approximately $1 billion. We (at Lipton Financial Services) produced our evaluation of the potential value of Twin Peaks several months ago, a copy of which is provided below.
On the conference call, Andy Wiederhorn touched on the latest acquisition strategy. In addition to evaluating failed brands whose locations can be productively converted to Twin Peaks’ locations, they are also looking at “categories to round out our portfolio, such as salad, sandwich or coffee brands. And finally, we continue to evaluate acquisitions that will leverage our existing manufacturing capacity.”
CORPORATE LIQUIDITY
We provide the Q2’23 balance sheet, per the 10Q, below: As of the end of Q2’23, there was $30M of unrestricted (plus $26M restricted) cash. In July they sold an aggregate principal amount of $100.58 million of $105.8 million of new securitized notes with a 10% coupon rate, of which 6% is paid current and 4% is paid at maturity. In addition there is $156.1 million of marketable securities (netting to zero on the balance sheet), bonds that were issued but not sold and bonds repurchased, all of which are available for sale to third-party investors. On the conference call it was suggested that a portion of the $250M or so of total liquidity could be used to redeem preferred shares, with a resultant lower interest cost than the previous dividend obligation.
The Company, while no doubt exploring all available options to maximize financial flexibility, seems adequately prepared, while they await liquidity events such as monetizing any or all of Twin Peaks, the manufacturing facility, or other brands.
LITIGATION EXPOSURE
A question was asked, on the conference call: “Any expectations that those (legal expenses) should start to come down? Have we seen the peak? Do we think they’re going to go higher? Just your best guess, Andy?” Andrew Wiederhorn: “Yes, they are coming down. There was a lot of activity in Q1 and some of that got billed in Q2 from responding to some of the litigation and motions and meetings and things like that. We’re certainly hoping that this goes away during the balance of the year. Very hard to tell if it’s built into next year. We are pursuing claims against our insurance carriers for reimbursement of that litigation expense, and we hope to ultimately prevail on that and recover a significant amount of that.”
Our (Lipton Financial Services’) commentary, per the Q1’23 update, has not changed:
“We are not equipped to judge the validity, or predict the outcome of the legal issues in play, and we refer our readers to the discussion in the most recent quarterly 10Q and annual 10K SEC filings. The lawsuits relate largely to Andrew Wiederhorn as an individual, who has recently stepped down as CEO. As he said on the most recent conference call: “to remove the distraction of the personal investigation regarding matters from several years ago before our merger with Fog Cutter”.
“Per the latest 10Q “This lawsuit (editor’s note: one of them) does not assert any claims against the Company. However, subject to certain limitations, we are obligated to indemnify our current and former directors in connection with defense costs for the lawsuit and any related litigation, which may exceed coverage provided under our insurance policies…”
“It is apparently on this basis, as well as one of the lawsuits that includes the Company as a plaintiff, that the Company is incurring the referenced legal expenses, and management has stated an expectation that insurance will provide some portion of relief. While investors should give legal concerns their due, franchisees, as we personally observed at their seventeen brand franchisee convention last August, seemed unconcerned with this subject, viewing the Wiederhorn family with respect and even affection.”
PUBLISHED JUNE 9, 2023
FAT Brands ANNOUNCES POTENTIAL $1B MONETIZATION PLAN
Twin Peaks, FAT Brands’ largest contributor to corporate EBITDA, with a current estimated EBITDA run rate in the mid to upper $30M range, is a chain of 100 (currently about 70% franchised) “sports bar” lodges. As the Company has previously described, the unit level economics are compelling, with systemwide AUV’s north of $5.5M, “with some of our highest volume locations in Florida generating AUVs between $9M and $12M each.” We estimate that these 6-8000 square foot locations are generating a cash on cash return among the best in the restaurant industry, predictably generating a pipeline of an additional 109 locations to be built over the next several years. The chain has grown almost 40% in units since its acquisition by FAT, less than two years ago in late ’21.
The indication by FAT Brands’ management is that they would file for an IPO in early ’24, at which point the EBITDA run rate could be north of $40M, heading to $50M by the end of ’24. Comparing what we know about the unit level economics at Twin Peaks, the demonstrated credentials of their operating management, the franchise model which allows for substantial earnings leverage as the system grows, it appears to us that an Enterprise Value of a billion or more could be justified. The valuation is naturally dependent upon the state of the general market and valuations of peer franchising restaurant companies. Our model just below, built from publicly disclosed information, provides our attempt at a “realistic” estimate of Twin Peaks’ growth over the next few years.
WHAT WILL TWIN PEAKS BE “WORTH” WHEN OFFERED TO THE PUBLIC?
No two companies are the same, obviously, and current valuations within the restaurant industry, in terms of Enterprise Value versus trailing twelve month corporate EBITDA, range from multiples in the single digits for mature, slow growing chains with mediocre unit level economics to that of Wingstop (over 50x trailing EBITDA), Dutch Bros (in the mid 40s), Chipotle (about 35x), and Shake Shack (about 30x). Especially interesting right now is the pending IPO for CAVA Mezze Grill, with a contemplated valuation approximating $2 billion (trading as of 8/8 with a $5 billion valuation).
There are too many differences between CAVA and Twin Peaks to discuss here. Moreover, the biggest single difference, in terms of CAVA’s credibility in the marketplace, is that Ron Shaich, the long term “visionary” behind Panera, is Chairman of the Board and a major shareholder. Joe Hummel, long time President and driving force behind Twin Peaks is not nearly as well known, but his record speaks for itself, he is widely respected by those who know him, and (without “blowing smoke”) we can vouch for the fact that he “presents” just fine.
Management appearances aside, Twin Peaks’ unit level economics seem to be at least as good as those of CAVA, which has a 20.3% unit level EBITDA in calendar ’22 (with a big jump to 25.4% in Q1’23) and a year two targeted cash on cash return of 35%. Both companies are growing units at 15-20% rate, but Twin Peaks has an advantage in terms of the EPS leverage and potentially faster growth contributed from its successful “asset light” franchising effort. Moreover, CAVA, as promising and well positioned and managed as it is, in only the most recent quarter, Q1’23, did the corporate Adjusted EBITDA “pop”, to $16.7M vs ($1.6M), annualized to a $68M Adjusted EBITDA “run rate” that the marketplace seems prepared to pay 29x for. Adjusted Corp EBITDA in calendar ’23 was $12.6M vs $14.6M in ’22.
We need not dwell on CAVA/Twin Peaks comparisons, except to suggest that the fundamentals at Twin Peaks are as good or better than most .
