FOLLOW THE MONEY – NOVEMBER 15th, 2024
THE MACRO MONEY SITUATION
Post the recent election, we believe the streets will be safer, the border will be more secure, and the Middle East will (likely) be less volatile. However, relative to the money which this column follows, there will be no material change. There will still be US debt of $35.945 trillion and climbing, with annual interest blowing through $1T since $10T annual financing of (old and new) current 3.1% average debt continues. It can’t be pushed down because that would ignite inflation again, and can’t be raised much because $1T of interest is “basta”. Expenses can’t be cut much because untouchable entitlements, defense and debt interest are about 75% of the $6.7T (and rising) US budget. DJT Trump’s first administration built upon the debt and deficits (pre-Covid) and he has made enough promises to ensure more of the same. While the Musk/Ramaswamy cost cutting initiative could bear fruit, it will take several hundred billion of savings just to offset the ongoing rise in interest expense in just the next twelve months. This represents about 18% of the discretionary part (25%) of the US expense budget ($6.7 trillion), after entitlements, defense & debt interest). You can handicap that likelihood as well as I.
As evidenced by the optimistic spirit at last week’s RFDC in Las Vegas, a lift in consumer spending, for the short term at least, can be expected. However, a continuing depressant on economic growth is the worldwide debt burden, unprecedented in magnitude in the absence of a world war.
THE FAT BRANDS’ SPINOFF OF TWIN PEAKS
FAT Brands (FAT) may be the most interesting case study within the restaurant industry, having assembled, with the help of $1.2B of securitized debt, eighteen restaurant brands. FAT filed an SEC Form 10 recently, describing a partial (5%) public spinoff of their “crown jewel” brand, Twin Hospitality Group, operator of the Twin Peaks sports bar chain. This “monetization” strategy will provide “price discovery”, easing the capital procurement process for both the parent and its 95% owned subsidiary.
FAT Brands, Inc. (FAT) purchased Twin Peaks 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, including 33 company operated and 81 franchised. These sports bars currently average 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 and others have stumbled) by growing AUVs and ROIs. The Company suggests that the USA could accommodate 650 locations nationwide, with another 250 abroad. Not to be overlooked is the $397M of securitized debt that is currently in place.
While the consolidation of 58 company operated Smokey Bones, purchased in September, 2023, 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. 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.
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. Twin Peaks’ strong unit level economics has 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, which have historically cost more than “from scratch ($3.6M vs. $2.8M), but take roughly half the time at 9 months. The repetitive Smokey Bones conversions could improve on the historical “one-off” locations. 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.
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. 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. 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.
While the Twin Peaks “dividend” will no doubt provide value to FAT shareholders, it cannot today be determined what 5% of Twin Peaks will be worth in the marketplace. 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, the growth “story” provides investment appeal. The development pipeline of 100 locations, plus about 30 Smokey Bones conversions in hand, to be developed by already successful multi-unit franchisees, points to perhaps a $50-60M run rate of EBITDA within several years. It will no doubt take some time for the financial world to become familiar with Twin Hospitality Group, but we believe the Street will be impressed with CEO, Joe Hummel & Co., and that Twin Peaks will likely be viewed as “Best of Breed” within their experiential dining segment.
Roger Lipton
