CONCLUSION
The second calendar quarter was again routine from an operational standpoint. Management continues to employ a conservative strategy, managing their 18 franchised brands responsibly, open to acquisitions and still with sufficient liquidity to do so, but requiring a very reasonable purchase price and a predictable immediate cash flow benefit. While the cumulative value of FAT’s eighteen brands (and the manufacturing plant) is increasing over time, the equity is obviously leveraged to the balance sheet debt. The single most important current financial objective is to partially monetize the value of Twin Peaks, their largest and by far most valuable brand. Important as Twin Peaks is, relative to deleveraging the balance sheet, there are several other growing brands, as well as the dough manufacturing plant, each of which could be potentially worth hundreds of millions of dollars.
While industry traffic and sales trends continue to be challenging, FAT Brands has managed their portfolio as well as can be reasonably expected. At least equally important, financial circumstances have changed for the better; over the last three months and over the last three days. Within the last quarter, the necessary steps have been taken to establish Twin Peaks as an independent publicly held entity, now expected within three or four months. Within the last three days, the dramatic reduction in interest rates, likely here to stay for a while, have improved the likelihood of advantageously restructuring the existing $1.168B of long-term debt, including current negotiations relative to $400M of debt tied to Twin Peaks. At least partial relief would be welcome from the $20-30M higher annual interest expense than expected before rates ran up two years ago. Lastly, lower equity values (public and private) could provide especially attractive acquisition opportunities.
As the development pipeline builds out and Adjusted EBITDA grows to approximately $150M over the next five years, if valued at an average of 12-15x, the Enterprise Value would be $1.8B to $2.25B, providing equity amounting to $600M to $1.0B, or $35-$59/share on the current 17M shares outstanding. While 12-15x Adjusted EBITDA could be considered aggressive, the $150M five years from now could turn out to be low, with inflation taking royalties up on the existing store base, new locations contributing higher sales as well, and certain brands such as Twin Peaks could generate above average growth.
A great deal of long-term potential for equity appreciation remains in place. While the sudden downside volatility (“crash”) in equity markets is not a plus for the store traffic at their eighteen brands, none of FAT’s brands can be considered “high end”. More important, short and long term is the pending monetization of the Twin Peaks chain and the sudden lower interest rates which could reduce the debt burden.
SECOND QUARTER SUMMARY
FAT Brands (FAT) reported their June quarter last week. Results were generally as expected, with eighteen brands and a leveraged balance sheet, operating within a challenging restaurant industry. As the table below shows, Revenues were up 42.4%, largely driven by the acquisition in Q4’23 of 61 Smokey Bones stores. The $32M greater YTY loss was primarily the result of $12.7M Employee Retention Tax Credit last year, $9.5M of interest, $3.2M of additional D&A from Smokey Bones, and consolidation inefficiencies relating to the addition of Smokey Bones. Adjusted EBITDA, as shown by the second table below, was actually up YTY by 30.8%, at $15.7M vs. $10.4 M (after deducting the $12.7M ERC from the reported $23.1M).
Within the numbers, as shown by the supplemental information below, systemwide sales growth was 8.6% with 24 new store openings in Q2, same store sales down 1.6% and systemwide sales up 8.6% YTY at $614M.
CONFERENCE CALL SUMMARY
There are now 790 franchisees, operating about 2,100 restaurants, including those under construction. The Company now owns and operates about 190 restaurants across four brands, the largest of which is Twin Peaks (now with 113 locations, up from 83 when acquired 30 months ago).
In terms of new store development in Q2, 24 new locations were opened, bringing the total through 7/31/24 to 45, still expecting 120 for the year, which would be comparable to 2023. The signed pipeline of franchisee development now approximates 1,100 additional units, expected to generate $50-$60M of incremental royalties. About 20-30 of the H2’24 planned openings are international, where experienced multi-unit franchisees do not need much corporate support. Further Q2’24 progress in terms of unit expansion include: (1) Roundtable Pizza strengthening its presence in Texas with the opening of a 2nd location in San Antonio, the franchisee there planning to open up to 40 more. (2) Fazoli’s opening of a 2nd Tampa, FL location, the 6th in that state. Separately, a 3rd Fazoli’s unit in the Phoenix, AZ area also established (3) Expansion of the co-branding approach, with 50 Fatburger/Round Table Pizza units planned. The successful first unit in Texas will be followed by 12 locations in Utah over the next six years. (4) The Great American Cookie/Marble Slab Creamery combination continues to thrive with over 50 locations now in Georgia and more planned. (4) Non-traditional locations provide substantial opportunity, and Round Table opened the first of several campus locations at Stanford University, in their student union. Additionally, Royal Caribbean opened a 15th location within their ships, a Johnny Rockets unit.
Acquisitions are still being considered, but “at a price”, also aiming at inter-brand synergy, just as with Smokey Bones relative to Twin Peaks, and Nestle Toll House Café to boost the utilization of the dough manufacturing facility. That factory’s sales were relatively constant at $9.6M for the quarter, but EBITDA was up 9.3% YTY at $3.8M and utilization is still only 45%, though up from 33% at acquisition 3 years ago. Fazoli’s has recently added dessert items systemwide and plans include rollout in other casual dining and polished casual brands. As discussed previously, a modest $1.5M capex investment (plus 3.5 unused adjacent acres for further expansion) could more than double that capacity. This provides the opportunity to take the current $15M EBITDA run rate substantially higher, providing a meaningful monetization opportunity.
In the course of the discussion about General & Administrative expenses, Andrew Wiederhorn suggested that “legal expense has to end here somewhere, maybe 12 to 18 months from now, and that will be the final touch of it.” Management has previously indicated their expectation that a substantial portion of the substantial ongoing legal expenses will be covered by insurance.
THE MONETIZATION OF THE TWIN PEAKS SPORTS BAR CHAIN
There was predictable interest on the conference call regarding the planned monetization of the Twin Peaks sports bar chain, FAT Brands’ most valuable asset.
During the quarter a new Twin Peaks opened in Naples, FL, as well as in Fort Mill, SC, the fourth in that state. H2’24 development will take the current 113 locations to 125 lodges at 12/31/24. That would bring Twin Peaks’ unit growth to about 50% since being acquired about three years earlier. The Twin Peaks pipeline is especially impressive with 125 new units (without Smokey Bones’ conversion possibilities) called for over five years, bringing system-wide sales to well over $1 billion with about 250 units, 75-80% franchised at that point. It is noteworthy that the lion’s share of franchise development comes from the existing franchise network, an obvious strong testimony to the profitability and return on investment for franchisees.
AUVs at company operated Twin Peaks locations approximate $6M, with some locations, especially in Florida, in the $9-12M range. An as yet undetermined number of Smokey Bones’ approximate 61 company operated locations will be converted, at a cost of $3.5-4.0M instead of up to $7.5M for a new unit built from scratch. Plans also call for franchising the Smokey Bones brand, building it back to its previous peak of about 120 locations. The first SB to TP conversion will be in Lakeland, FL in Q4’24, with several more later in ’24, and many more in ’25 and ’26. Twin Peaks and Smokey Bones, combined, filed a “confidential” SEC registration statement to become a standalone public reporting company and that process is continuing. Part of that monetization process includes the refinancing of $400 of FAT Brands’ debt tied to Twin Peaks.
Apparently because the near-term Twin Peaks monetization is expected to partially reduce the $1.168B long term debt as of 6/30/24 and/or allow for restructuring of same, there was no discussion on the conference call of corporate liquidity. Per the 6/30/24 SEC 10Q filing: “The Company had $16.6 million of unrestricted cash at June 30, 2024 and plans on the combination of cash flows from operations, cash on hand, $75.6 million of issued but not sold aggregate principal amount of fixed rate secured notes and $104.7 million aggregate principal amount of repurchased but not re-sold fixed rate secured notes (see Note 9) to be sufficient to cover any working capital requirements for the next twelve months from the date of this report.” As we suggest in our conclusion, the sharp reduction in interest rates in just the last several days, and the sudden consensus expectation that lower rates are here to stay, may have begun to reverse FAT Brands’ poor luck of being “stuck” with higher rates than they thought would long be in place as they financed their acquisitions 2-3 years ago.
CONCLUSION: Provided at the beginning of this update