THE NEWS

FAT Brands, Inc. (FAT) filed an SEC Form 10 on Friday, the necessary prelude to the public debut of the “crown jewel” of their eighteen-brand portfolio, the Twin Peaks restaurant chain. As described in the document, FAT Brands plans to “spin off” to Fat Brands’ common stockholders 5% ownership of Twin Hospitality Group, owner, and operator of the chain. Trading is likely to begin sometime in December. This “monetization” strategy is being implemented to provide “price discovery” for the value of the Twin Peaks chain, more easily allowing for equity and debt capital to be raised, both general purpose for FAT Brands and specifically for the use of its 95% owned subsidiary.

BACKGROUND

FAT Brands, Inc. (FAT) purchased the Twin Peaks chain in October of 2021, when there were 84 Units in the system. Since then, the system has grown 36% to 114 locations across 27 US states, 33 company operated and 81 franchised (including 7 in Mexico), and the organization is primed to accelerate that pace, especially with the inclusion of Smokey Bones’ conversions, as described below.

Most concisely, Twin Peaks is a chain of sports bars, currently averaging 7,800 square feet, and averaging $5.4M systemwide. The chain has distinguished itself within the sports bar segment (as Hooter’s, Bombshell’s, TGI Friday’s, Bar Louie’s & Walk-Ons have all suffered to varying degrees) by growing Average Unit Volumes and generating attractive cash on cash returns. The Company suggests that the USA could accommodate 650 locations nationwide, with another 250 abroad.

SMOKEY BONES

Twin Holdings’ ownership of the Smokey Bones 58-unit company operated dinner house chain (EBITDA historically positive with a $2.8M AUV), was purchased for $30M in September 2023. The potential conversion of most locations to the Twin Peaks brand is the primary attraction, though the Smokey Brands brand could also  be grown. Smokey Bones, founded in Florida in 1999 by Darden Corp, owned in recent years by private equity, was expanded within 16 states in the eastern United States. From fiscal year 2019 to fiscal year 2023, Smokey Bones’ revenue increased from $149.1 million to $172.3 million, representing a CAGR of 3.7%, and AUVs  grew from $2.5 million to $2.8 million, representing a CAGR of 2.9%. As expanded upon below, the control of 30 or more  well located units that can be economically converted in a timely fashion, is an important tangible current  asset within  Twin Holding.

While the consolidation of Smokey Bones in the last twelve months has diluted the recent reported EBITDA of Twin Holdings, it is expected that about half of the chain will be converted to Twin Peaks, quicker and perhaps cheaper than building from scratch. The Smokey Bones locations that are not converted will be franchised, company operated, or sold for their leasehold value. Since good affordable locations are always hard to find, FAT Brands viewed control of the timing and opening of 30 or more conversions too good to pass up. Encouragingly, the first conversion, opened in Lakeland, FL in September, is initially annualizing well above $8M, more than double its volume as a Smokey Bones. Based on the sensible plan, and outstanding initial results, the acquisition of Smokey Bones could be substantially accretive, well worth looking through the consolidated short-term numbers.

TWIN PEAKS

The consumer appeal of Twin Peaks is a great deal more than its “engaging” wait staff. It is more about the made from scratch food, craft beverages including their famous 29-degree cold beer, the sports lodge experience with wall-to-wall televisions that provide curated pay per view as well as network and cable events, and seasonal events that are often coordinated with specific holidays. The Company offers game day, lunch, happy hour and holiday specials across both food and beverage items. The extensive menu and diverse price points result in a per person average spend of a modest $22.18.

The unit level economics generate strong cash on cash returns, which has in turn attracted a dedicated group of successful multi-unit franchisees that keep building. In 2023, AUVs at company operated locations were $5.0M, with franchisees generating $5.6M. About 91 of the current 114 locations (80%) were conversions, costing between $2.0 and $5.0 million, and taking nine months to complete. New construction from scratch costs between $4.0 and $6.0M and take as much as 18 months. These parameters support the appeal of the Smokey Unit conversion pipeline. While the current units average 7,800 square feet, the new domestic prototype is 6,500 square feet, plus a 2,100 square foot patio.

Based on the long-term historical results, as well as the encouraging volumes as Twin Peaks has expanded into new states, the targeted AUV in the third full year is $6.5M, with a 16% store level EBITDA margin, generating a 28.9% cash on cash return for conversions and 37.1% for new-build units. This is based on an average cost of $3.6M for conversions and $2.8M for new builds, net of tenant allowances, sale leaseback proceeds, and excluding pre-opening expenses.

TWIN PEAKS FRANCHISING

Franchisees pay a $50,0000 initial fee on the first unit, $25,000 on additional units, a 5% ongoing royalty, and a 2.5% contribution to the national advertising program. An important feature of the Twin Peaks franchisee system is the longevity, success, and continued expansion from existing franchise partners. Each current franchisee on average operates about four locations, has been a franchisee (since originally signing) for about seven years, and 73% of the 100-store development pipeline is with the existing group. Management currently targets franchise prospects who will commit to open at least three locations.

THE NUMBERS

From 2019 to 2023 Adjusted EBITDA increased from $9M to $28M, representing a CAGR of 33.2%. These Adjusted EBITDA figures represent consolidated Adjusted EBITDA Margins of 7.0% and 12.3%, an improvement of 530 basis points.

During fiscal year 2023 franchisees opened 12 franchised locations. In 2024 franchisees have opened five locations and the company opened 2 units, targeting a total of eight new Twin Peaks restaurants in 2024. Going forward, the Company is targeting 10-12 new units systemwide per year, plus Smokey Bones’ conversions. The long-term objective is to have the system 75% franchised.

As the numbers below show:

Same store sales stalled for both chains in 2023, likely due to general industry softness. At Twin Peaks they were coming off a strong post-Covid period in ’21 and ’22, and AUVs were still up 32% from ’19 to ’23. Relative to same store sales in ’24, FAT Brands has indicated in presentations to analysts that SSS at Twin Peaks were negative in early ’24, have improved steadily through the year and, though not enough to  bring ‘24 positive, are currently in plus territory.

The balance sheet as of September 29, 2024, is carrying $397M of securitized debt. FAT Brands’ management has been working toward, and the Form 10 describes, a refinancing of that debt but the new terms have not yet been disclosed.

The operating statement shown below, excerpted from the Form 10, shows that Pro Forma EIBTDA was $28.5M in calendar ’23, which included 3 months of Smokey Bones ownership. Management of FAT Brands indicated on the Q3 conference call that Smokey Bones related expenses represented the lion’s share of the YTY decline in operating margins and EBITDA.

Our conclusion, relative to the performance of Twin Peaks over the last five years, including the inclusion of Smokey Bones,  relative to the industry in general, as well as their segment, is that Twin Peaks is well positioned for sustained long term further growth. A key element is the unit level economics that have attracted a successful and still enthusiastic group of franchised partners. Subject to free cash flow from operations for new unit construction, requirements of debt service, and/or the ability to raise new debt or equity, new company operated locations could also be added to the system.

CONCLUSION

The spin off of a minority position in Twin Peaks to FAT Brands’ shareholders should be productive for stakeholders at both parent and subsidiary. “Price Discovery” of Twin Peaks should allow for both debt and equity capital to be raised at more attractive rates. Independent public ownership could also be a new source of focus for Twin Peaks’ management, resulting in even better reported numbers.

While the Twin Peaks spinoff “dividend” will no doubt be of value to FAT Brands’ common shareholders, it cannot today be determined what five percent of the Enterprise Value of Twin Peaks will be worth in the marketplace. Based on EBITDA of about $28M within calendar ’23, before the Smokey Bones “project” began to dilute the short term results, we conclude  that (ex-the “Smokey Project”)  $30-35M is the current run rate of Adjusted EBITDA. While it requires a multiple more than 13x, to provide an Enterprise Value in excess of the $397M of long-term debt, Twin Peaks Holdings has an unusually high probability of achieving its long term growth plan. The development pipeline of 100 locations, plus about 30 Smokey Bones conversions in hand, to be developed by already successful multi-unit franchisees, provide an usual degree of EBITDA visibility,  to perhaps a $50-60M run rate within several years.  It will no doubt take some time for the financial world to become familiar with Joe Hummel, CEO, and his team. We’ve been positively impressed as we’ve met them in recent years and that has been supported by our store visits as well as the facts provided above. We believe it likely that Twin Peaks will be viewed as “Best of Breed” within their full-service dining segment.

Roger Lipton