All posts by Roger Lipton

THE RESTAURANT INDUSTRY AND WORLDWIDE FISCAL/MONETARY DEVELOPMENTS – WHAT’S THE RELATIONSHIP?

THE RESTAURANT INDUSTRY AND WORLDWIDE FISCAL/MONETARY DEVELOPMSENTS – WHAT’S THE RELATIONSHIP?

Some of our readers may be wondering why, while focusing intently on restaurant industry fundamentals, we also regularly summarize worldwide fiscal/monetary developments.

It used to be that a restaurant operator, especially a single location operator, could “mind the store”, and pay relatively very little attention to money flows, governmental deficits, and inflationary trends. All you had to do was hold (and build) your market share. The broader economic trends, especially after the stagflationary nineteen seventies, were slow moving, not dramatic in nature, and affected you very little. Those trends were mere ripples in the sea.

These days, that equation still holds true, as long as you are running one or two locations, are personally meeting and greeting customers, and watching almost every meal that comes over the transom.

However, if you are a multi-unit operator, with visions of growth, the local ripples have become a broad based tidal wave, and that has been especially evident the last eighteen months. As Warren Buffet famously suggested: “When the tide goes out you find out who has been swimming naked”.

FISCAL/MONETARY AFFAIRS AFFECT RESTAURANT OPERATORS

The growing multi-unit operator cannot afford to be unaware of trends in interest rates, the availability of debt or equity financing, the trends in wages, commodities and inflation in general. That is where the study of fiscal/monetary affairs and restaurant fundamentals intersect. While a great deal of our time is spent advising restaurant companies and institutional restaurant investors, we also feel the need to protect our personal long term purchasing power by way of gold mining stocks.

RESTAURANT OPERATING TRENDS ARE REFLECTIVE OF CURRENT AND FUTURE FISCAL/MONETARY DEVELOPMENTS

It also should be noted that while fiscal/monetary developments can affect restaurant fundamentals, the reverse applies as well. Restaurants and the hospitality industry in general provide an effective window, and can (should) affect economic policy. The logic is as follows:

  • Approximately 70% of the U.S. economy is consumer driven. If consumer confidence and spending is soft, the general economy will suffer accordingly.
  • The restaurant industry, in particular, has proven for many decades to be an effective leading indicator on the economy as a whole. Meals, bought and/or consumed, away from home are an entrenched part of our life style. Since the expenditure is a relatively small ticket compared to travel spending, automotive or housing spending, computer purchases, even cell phone expenses, consumers can adjust this spending easily with frequency and average ticket. The typical family will adjust the frequency of an appetizer or dessert well before they will take a vacation (or not), buy a new car (or not) or renovate their home (or not).
  • Transparency within this industry is unique. Inventories turn weekly, so inventory building or drawdown does not affect the results, as opposed to measurement of so many elements of the GDP. An analyst following same store sales, traffic trends adjusted for pricing is not going to be badly misled. If the largest retailers on the planet, WalMart and Target, report  flat same store sales,  and Ralph Lauren or Estee Lauder (on the high end) are also troubled, you can probably conclude that the economy is not in great shape.
  • Approximately 14 million adults are employed by the retail/hospitality industry (80%-90% in restaurants) in the U.S., approximately 10% of the U.S. workforce. Wage trends, health care cost trends, and employment trends (such as adjusting weekly hours to meet ACA requirements) are significant windows into national employment trends, and inflation expectations.
  • Cost of goods (beef, chicken, seafood, paper costs, etc.) at restaurant chains approximates 30% of sales so frequent reporting, and commentary,  by publicly held restaurant chains provides a window into inflation expectations.
  • Corporate transparency is unique. Traffic trends, quality standards in terms of price/value, service at the store level, cleanliness of facilities, etc. are visible meal by meal. A visit to the mall or dinner at a restaurant chain can pay dividends. Every stock you buy may not enrich you, but will not impoverish you if you pay attention.
  • Restaurant industry is relatively recession resistant. Trite though it might be, people have to eat, meals away from home are entrenched as a lifestyle (as suggested above) and will remain so. Traffic trends and average spending fluctuate but not hugely. Well run restaurant chains, and even some that aren’t so well run, can survive over the long term. The good ones can grow spectacularly, like McDonalds and Starbucks (for decades), more recently chains like Shake Shack and Wingstop.  Overall, however, individual investments in restaurants and retail should be monitored, not “put away” long term. More companies suffer serious periodic stumbles than produce reliable results year after year. Parenthetically, our experience is that this is true to an even greater extent in retail, rather than restaurants, where an apparel company can be only as good as their latest “floor set”. Quality standards in a well run restaurant company will not normally change much on a very short term basis.

For these reasons, and more, the restaurant/retail industry is not just about burgers, tacos, or even apparel, furniture, or smart phones.  The study of retail consumer trends gives us a window into far more general economic trends.

With that backdrop, we will tomorrow provide a Fiscal/Monetary Update

Roger Lipton

NOBLE ROMAN’S (NROM) ANNOUNCES NINTH COMPANY OPERATED “CRAFT PIZZA AND PUB” LOCATION

NOBLE ROMAN’S ANNOUNCES NINTH COMPANY OPERATED “CRAFT PIZZA AND PUB” LOCATION

Noble Roman’s (NROM) announced today a lease signing for their ninth company operated Noble Roman’s Craft Pizza and Pub location, to open in Franklin, Indiana, just south of Indianapolis.

While NROM is relatively small, among publicly held restaurant chains, this forty year old brand has been re-invented over the last five years, in particular with the creation of its flagship Noble Roman’s Craft Pizza and Pub (NRCPP). Our previous write-ups, describing the Company, its history and its prospects, can be accessed using the SEARCH function on our Home Page.  As we have previously suggested, the public valuation of NROM should follow, as the Company produces  steady fundamental progress

Recall that Noble Roman’s (NROM), with the first NRCPP location, in Westfield, IN now over four years old, opened three highly successful units during 2020, bringing the current total to seven. The Franklin unit will be the second of three expected during the balance of 2021. There are three franchised locations also operating, so NROM will enter 2022 with thirteen units in their expanding NRCPP system, all within a ninety minute drive from  Indianapolis.

The latest location will be about 3,600 square feet, representing the somewhat smaller  (10-20%) version of the first NRCPPs, and this size location (costing about $750k) and including their innovative curbside “pizza valet” carry-out service,  has shown a capability of generating  annualized volumes  over $1.5M with a store level EBITDA margin at 20% or more. It is worth noting that the Pizza Valet service, introduced over a year before Covid-19, served the Company well during 2020 and should alleviate the traffic risk from any sort of resurgence concern.

The recovery from the pandemic affected 2020, including their 650 franchised non-traditional locations, and new unit growth of the NRCPP system should allow for expanding cash flow and earnings. The stock has moved up materially (from about $0.50 to $0.80-0.90) but the Enterprise Value, still under $30M, continues to be modest relative to the prospective earnings and cash flow.

Roger Lipton

FAT BRANDS CLOSES MAJOR ACQUISITION AND $350M ASSOCIATED FINANCING IN LESS THAN A MONTH AFTER ANNOUNCEMENT

FAT BRANDS CLOSES MAJOR ACQUISITION AND $350M ASSOCIATED FINANCING IN LESS THAN A MONTH AFTER ANNOUNCEMENT

We have been reporting on FAT Brands’ (FAT) progress, and its emergence as an increasingly substantial multi-branded restaurant franchisor, since January ’21, and our previous reports can be accessed by way of the SEARCH function on this website. This short update is mostly to report that their recently announced acquisition of Global Franchise Group (GLG) and the associated $350M financing has been completed in what must be record time.

On June 28th, the Company announced the planned acquisition of Global Franchise Group (GLG), which triples the number of systemwide units in FAT’s portfolio to more than 2,000, increases the number of brands from nine to fourteen, and increases the potential EBITDA by approximately 67%. Since the number of common shares to be issued is only about 20% of the common shares to be outstanding post-merger, the GLG acquisition is substantially accretive to EPS and EBITDA/share.

On July 6th, the 8-K filing reported on the finalized definitive Purchase Agreement, and the indication that the $350M in new debt would be completed on or about 7/22/21.

On July 22nd the acquisition of GLG was completed, and the completion of the $350M financing was announced this morning, July 27th.

This important acquisition was therefore completed in less than 30 days from announcement to completion, including a major financing.

To management’s credit.

Roger Lipton

FRANCHISING IS NOT THE “BE ALL TO END ALL”

FRANCHISING IS NOT THE “BE ALL TO END ALL”

There are a lot of myths that surround franchising, many of which have been embraced by restaurant operators and institutional investors alike. Some of them are briefly and broadly described below.

Myth Number One – Franchising is capable of improving the cash flow for a company successfully operating a handful of restaurants.

Not so fast. Substantial legal expenses must be incurred to register as a franchisor. Since the liability and the expenses to defend in a lawsuit can be substantial, it would be foolhardy to proceed without proper legal advice. Registration requirements vary, state by state, so that research has to be done as well.

Secondarily, just in terms of the first franchise deal, expenses by the franchisor will be incurred, indeed should be incurred, to minimize the risk of failure. If the first franchisee stumbles, it’s case closed except for potential legal liability. Those supporting expenses to get the franchise effort off the ground will likely offset most, if not all, of the initial franchise fees.

Myth Number Two – Accepting the reality of the above, if five or ten franchised units can get going, generating, let’s say $1,000,000 per location, a 5% ongoing royalty would be $50,000 annually per unit, and $250-500k of recurring franchisee income becomes real money. Marketing contributions are on top of that, but presumably would be spent as promised.

Not so fast. If you’ve got 5-10 franchised locations, with more planned, you need a supporting cast to maximize the probability of franchisee success. While it is tempting to use your existing operating personnel to support initial franchisees, you can’t afford to distract the operating personnel at your company stores too much. In addition, sites must be approved, training must take place, marketing materials and programs must be created and provided, ongoing field supervision must take place. Salaries, automotive and travel expenses and employee benefits add up pretty quickly, and you don’t want to hire a second rate staff. So even 10 franchised locations, properly supported, are not going to generate a lot of incremental income for the franchisor. Our experience indicates that something like a minimum of $1M of annual expenses, with the handful of functions described above, to properly support a franchising effort. You can calculate for yourself how many units, at your AUV, to absorb that expense, and begin to look at “free cash flow”.

Myth Number Three – Accepting Myths One and Two, the “Asset Light”,“Free Cash Flow” is really exciting when a chain gets to be hundreds and thousands of units.

This assumption is not completely flawed, but is not as foolproof as often assumed. There are any number of large franchised systems where the franchisor allowed their franchisees to “twist in the wind”, as the former’s executives enriched themselves. Just one example: A number of years ago, I was a guest speaker at a Dunkin’ Donuts (to become Dunkin’ Brands) franchisee annual conference. That conference was sponsored by the franchisee Association, not the franchisor. It was crystal clear that the franchisees were suitably glum. Their sales had been flat to down for a number of years while Starbucks had been “eating their lunch” and breakfast too. Though stores that were fifteen or twenty years old were still profitable, there were very few new stores being built, predictably, because current economics didn’t justify it. In the meantime, the Company had bought back, over five years, over ONE BILLION DOLLARS of stock, to allow for stock options and to shrink the shares outstanding enough to show EPS progress. Wouldn’t it have been nice, appropriate and productive, if a couple of hundred million dollars less had spent to buy back stock at a fully priced valuation? It could have alternatively been spent on new product development, marketing, digital ordering technology, or even a renovation fund (at a low interest rate) for the physical updating of franchised stores. The system would have been healthier in the long run, but, as opposed to the franchisees who have signed twenty year franchise agreements and store leases, most of the executives will have cashed out and moved on. Franchised systems, to remain vibrant, have to be supported. Cash flow it is, but it’s not all “free”. Let’s call it “soft capex”.

Myth Number Four – The Apparent Ease of Duplication – Customers love it. If you build it “they will come”.

There are all kinds of reasons that success at one, or even a handful, of locations might not be indicative of broader appeal. To name just a few: the early location (s) might be unique, even in misunderstood ways. The owner’s personality and physical presence, including operating expertise, might be essential. The menu might not work as well elsewhere. Occupancy Expense and Capex at future locations could change the operating economics. New locations might not be adequately researched, from a demographic or logistical (traffic patterns, etc.) standpoint.

Myth Number Five – If it is profitable for the concept’s creator, and it is not too complex an operation, there is no reason it shouldn’t be just as profitable for a hard working franchisee.

Not exactly. The franchisee has to pay a royalty plus marketing fees plus “incidental” fees. That will very substantially reduce the return on investment for the franchisee. As described in Myth Number Six below, a concept should be generating close to 20% EBITDA at the store level to provide an above average long term economic return for the franchisee. An exception would be if the franchisee is willing to “work the store”, perhaps along with family members, therefore “buying a job”, so the operational salaries can be considered additional return on capital invested.

Myth Number Six – 5% Royalty, plus 1-2% local plus 1-2% brand marketing can be expected, pretty sweet for the franchisor, especially once the overhead is covered.

The restaurant franchising industry has come a long way. What was standard, affordable and acceptable by franchisees decades ago is not so easily in the cards today. We wrote over two years ago, referenced in the link:

https://www.liptonfinancialservices.com/2019/03/the-franchisor-franchisee-economic-relationship-this-is-not-your-fathers-world/

This is not your father’s restaurant industry. In a nutshell: if a franchised store is fortunate to be generating 17-18% store level EBITDA (BTW, depreciation is not free cash), that is before local G&A, which can easily run 2-3 points. Out of 15 points, before allowing for the depreciation “reserve” fund, the franchisee is not going to love rebating half of that back to the franchisor. Not unless there is a great deal of support provided. Once the partners have gotten to know each other, after the early passion has worn off, the franchisor and the franchisee had best become good, mutually responsible, friends. 20% store level EBITDA, or more, is better than 17-18%, and will help keep the romance in the relationship.

We could go on, and would be happy to do so, with any of our readers that would like to explore the above thoughts further.

Roger Lipton

BOOK REVIEW! TILMAN FERTITTA’S “SHUT UP AND LISTEN” – COULD NOT BE MORE TIMELY

BOOK REVIEW – SHUT UP AND LISTEN

We are not in the business of reviewing books, but we are always interested in best practices of very successful restaurant/hospitality operators. That is why we periodically report on commentary by CEOs such as Gene Lee of Darden and Danny Meyer of USHG. We therefore spent an interesting five hours on a flight to LA reading Fertitta’s “Shut Up and Listen”.

You don’t build a multi-billion dollar hospitality empire over 40 years without doing a lot of things right and we feel like we have had a ringside seat since Fertitta brought Landrys’s public with twenty units in the eighties. His “easy read”, of course flattering, provides an informative description of how he navigated the macro economic cycles, as well as his management principles.  This is especially interesting since his hospitality empire is about to become publicly held once again by way of a merger with SPAC, Fast Acquisition Corp. (FST).  In preview, we admire his style, and have to be impressed with his accomplishments but our relationship with him and FST is arms length. We haven’t spoken to Tilman Fertitta in decades, and we get no royalties on book sales.

No two management styles are exactly the same, nor should they be. It comes through loud and clear that Fertitta knows what he wants and when he wants it, and we have heard numerous comments through the years that Fertitta is demanding. However, nobody  has ever described to us that his requirements have been unreasonable, and that is consistent with his self evaluation. We get the impression that he pushes nobody harder than he pushes himself. We believe it is also telling that there aren’t a lot of ex-Fertitta executives out there. Seems like he must be more than careful about whom he brings aboard and most likely rewards them pretty well thereafter.

We won’t describe here all the details, but the chapters include: Hospitality Matters, Take the Word “No” Out of Your Vocabulary, Cater to the Masses, Working Capital is Everything, The Pitfalls of Property Leases, KNOW YOUR NUMBERS, Leverage Your Strengths, Partner with Complementary Strengths, Don’t Ever Lose the Hunger, LISTEN first, Change Change Change” and the Conclusion: Don’t Choose to Quit, Keep Punching.

Aside from the above, we found especially interesting Fertitta’s macro moves, leveraging his business in the bad times, staying liquid and buying distress properties that would almost certainly recover over time. This was brilliantly employed in the crash of 08-09, and Fertitta became a multi billionaire, allowing, among other things, him to personally buy the NBA’s Houston Rockets for $1.2 billion.

The one thing that Fertitta could not foresee, however, was a worldwide pandemic that mostly shut down his basketball arena, his casinos and his 450 dinner houses. This is not good when you are carrying $4.5 billion of debt, and that is when Fertitta’s Conclusion, written pre-pandemic in 2019, “Don’t Choose to Quit, Keep Punching” kicked in.

With the pending merger of the Fertitta hospitality empire into FST, just as the new COVID variant becomes of concern, check out the book, and stay tuned.

Roger Lipton

ROGER’S 7/15/21 MONTHLY COLUMN IN RESTAURANT FINANCE MONITOR, THEIR “MUST ATTEND” LAS VEGAS CONFERENCE IS COMING UP IN NOVEMBER

FOLLOW THE MONEY WITH ROGER LIPTON – RESTAURANT FINANCE MONTIOR -7/15/21

MERGER-ACQUISITION ACTIVITY HEATS UP – WHAT’S GOING ON?

There has been a flurry of M&A activity: Panera selling Au Bon Pain; FAT Brands buying GFG Group with five brands; Famous Dave’s buying Village Inn and Baker’s Square; Lee’s Famous Recipe sold again; A Jack in the Box franchisee buying Taco Cabana; J. Alexander’s going private; the $500M IPO of Krispy Kreme and Fertitta’s multi-billion dollar SPAC transaction. The reasons include: (1) Very low Interest rates (2) P/E firms and SPACs are flush with cash and the restaurant space is always seductive. (3) The industry is recovering almost daily, so buyers sense opportunity, especially since off-premise sales provide new growth possibilities. (4) Post-pandemic it is natural for some single brand owners to have “had enough” and multi-branded operators have had ample time to decide which portions of the tree are worth pruning. With future operating margins still uncertain, there is therefore an ongoing pool of willing sellers. (5) Public valuations have recovered, providing a reference point for private valuations, all of which can be tolerated with the still low interest rates (6) The talk, by the Biden administration, of much higher capital gains taxes provides strong current motivation. Our conclusion: virtually all of the above ingredients will remain for the foreseeable future. Additionally, campaign season for the mid-term national election is already upon us. The Treasury and the Federal Reserve, openly working in tandem (violating the supposed independence of the Fed), will therefore keep interest rates low and money available. If you are a potential seller, get your power point presentation ready and, as Bernard Baruch advised, leave a little on the table for the next guy.  If you are a buyer, be careful out there. It’s not as easy as it sometimes looks, and leverage works both ways.

IN “THE ROOM WHERE IT HAPPENED” – WHY DID TILMAN FERTITTA SWEETEN THE DEAL? Outside the room, it is likely relevant that a great deal of the bloom has come off the SPAC rose. Only one of the six restaurant related SPACs has been trading above the $10 issue price and that has been Fast Acquisition Corp. (FST), which has been finalizing the proxy material relative to the pending acquisition of Tilman Fertitta’s multi-billion dollar hospitality empire (72% restaurants and hotels, 28% gaming).

Recall that shareholders in a SPAC have the right to redeem their shares at approximately the $10 issue price if they don’t approve of the suggested business combination. FST has been trading at about $12/share, normally a safe premium going into the vote. However, the possibility of deal rejection may well have been of concern to both Fertitta and the FST sponsors (Doug Jacob and Sandy Beall, most prominently), especially with the SPAC index trading down about 25% from its high earlier this year.

With even modest uncertainty Fertitta decided to sweeten and insure the deal by adding 42 additional properties, including Vic and Anthony’s,The Pleasure Pier on Galveston Island, the Mastro’s steakhouse chain and his 50% of Catch Hospitality Group. Collectively these properties generate EBITDA somewhere north of $100M, depending whether we talk pre-pandemic, the current recovery phase, or post-pandemic 2022. As a result, Fertitta will end up with 72% of the post-merger FST, up from 59% previously.

The resulting EBITDA is a bit of a moving target. In early January, 2021 his empire was strung out with over $4B in debt and apparently around $400M of pandemic depressed trailing EBIDA. Three months into 2021, there had been an already material recovery, so the original FST/Fertitta merged guidance was $648M of EBITDA in 2022. Now, 3 months later and including the additional properties, Fertitta has indicated that the prospectively enlarged company is currently (Q2’21) generating pro forma EBITDA at $270-275M for the quarter, or $800M annualized. The post-transaction Enterprise Value is estimated to be $8.6B or about 11x the current EBITDA ran rate. The new Enterprise Value/EBITDA is not materially different from the original. Importantly, however, the debt is not being increased. The merged debt will have been reduced from $4.5B to “only” $3B, from the $200M IPO raise and privately raised equity (the PIPE) of $1.2B.In The Room Where It Happened: We suspect that the institutional shareholders of FST were not adequately comfortable with $3B of debt relative to the original $648M of projected ’22 EBITDA. This transaction, originally and as adjusted, is a great result for Fertitta, who only a year ago stooped to raise $250M at 15%. With the hospitality industry now improving daily, he could afford to sweeten the deal. Sounds a lot better, relative to $3B of debt, to be running at $800M today than guiding to $648M in ’22. Tilman Fertitta is a practical man. The last thing this serial acquirer needs is to be mortgaged to the hilt just as his empire becomes publicly held once again. No doubt he said to himself: “Let’s get this deal done and move forward. Who knows what tomorrow brings?” And that’s what we would have advised.

SANITY BEGINS ITS RETURN TO THE EQUITY MARKETPLACE: We wrote last month about the high contemplated IPO price for Krispy Kreme (DNUT). The deal was completed at $17/share, down from the original price range of $21 to $24 and the stock is currently trading around $18. Of the six restaurant related SPACs that are trading, only one is materially above the issue price and Tilman Fertitta sweetened the deal materially, as described above. Bitcoin, which we have also written extensively about, is down 50% from its high of just ninety days ago and 10,000 other cryptocurrencies are suffering to varying degrees. All good things come to an end.

THE LABOR CRISIS BECOMES INCREASINGLY CLEAR

THE LABOR CRISIS BECOMES INCREASINGLY CLEAR

We wrote a little over a month ago about the labor crisis in the restaurant industry. We based our conclusions upon anecdotal information and the result of a survey done by Stephen Crichlow’s Compass Restaurant Consulting  group, which indicated that 35 % of the “past restaurant employees” are “disenchanted”. We’ve provided the June 9th at the bottom of today’s upate.

A Dow Jones article this morning quantified the above (largely qualitative) thesis further. Among other things, it said “the new job-market dynamics have left employers scrambling to find enough workers while helping many longtime cooks, servers, hotel staff and other hospitality workers to break into new lines of work, often with more predictable schedules and better pay and benefits.”

Specifically, according to the US Labor Department, the share of U.S. restaurant and hotel workers leaving their jobs hit a two-decade high in May at 5.7%. Furthermore, while the latest jobs report shows restaurants and bars adding 194,000 jobs in June, employment at such establishments remains down by 1.3 million jobs since the pandemic began. By contrast, employment has bounced back beyond pre-pandemic levels in many other sectors. Compared with February, 2020, there are now 100,000 more warehousing and storage jobs, 39,000 more jobs in management and technical consulting, 25,000 more jobs in insurance and finance. An even more dramatic indication is that Jobcase, a digital job board and social network for hourly workers, indicated that searches for restaurant and food service jobs in April were 35% lower than in 2019. Lastly, in terms of quantitative feedback, a LinkedIn analysis of hospitality oriented people who updated their profile a year ago: 79% indicated that they had moved to a new industry, well above a more typical rate of 58%.

There were lots of other anecdotal reports in today’s article, but much of it we described a month ago, in the article provided below.

There is no reason to think that the factors discussed above and below are going to abate anytime soon.

Roger Lipton

As Published on June 9,  2021

THE LABOR CRISIS IN THE SERVICE SECTOR – WHEN WILL IT RECEDE?

Everyone knows by now that there is a labor crisis in restaurants and retail and hospitality and other sectors of the service economy. Readers of this website, mostly involved in the restaurant industry, don’t have to be convinced how difficult staffing is these days. The difficulty is a result of a number of factors and nobody really knows the contribution of each element. There has been (1) a fear of catching Covid (2) the need to stay home with the kids because schools haven’t been fully opened (3) unemployment benefits providing sufficient income and (4) general disenchantment with the restaurant industry.

You don’t need us to help you weigh the first three of the four factors mentioned above, and time will solve those problems between now and September when (1) Covid will have run its course (2) the schools will have reopened and (3) unemployment benefits and supplements will have largely run out.

It is the fourth possibility that we believe is far more of a factor than has been widely accepted, especially in the restaurant industry, which is the most demanding sector within generalized hospitality. The last year or so, when restaurant crew, and managers too, were forced to “take some time off” has provided the opportunity to assess the long term attractiveness of the restaurant industry. A survey done recently by our friend, Steve Crichlow, the astute publisher and owner of Compass Restaurant Consulting and Research, indicated that 35% of the “past” restaurant employees are “disenchanted” with the restaurant industry and not planning to return. It is easy to understand why: the demands are intense, the hours can be long for management (often more than the stated schedule indicates), the pay scale is not compelling, and the scheduling does not mesh well with family obligations. You can imagine the pressure on store managers, especially at a publicly held or private equity owned restaurant chain, where every P&L line item is scrutinized for performance. You are expected to deliver consistently positive comps, at the same time produce consistently improving food and labor costs. No matter how well you perform, you are expected to do a little better next year. It’s easy to see why so many “past” restaurant employees now say they have “had enough”. Sometimes a person is too close to the trees to see the forest, too involved with day to day concerns to think about long term strategy. The past year may well have allowed for a reassessment in more cases than we have previously believed.

THE BOTTOM LINE

Nobody knows to what extent the survey referred to above will prove to be a true indication of the state of labor available to the restaurant industry. I can tell you that, here in Manhattan, when I stopped at Just Salad, a chain here in Manhattan consistently well run by my experience, at 6:30 last night it was understaffed. This morning, at “my” well normally smoothly running Starbucks, the situation was similar. The shortage is real, and the possibility exists that September ’21 will not provide relief. If I had to bet on how much labor costs, and then menu prices, are going to rise this year and beyond, I will take “the over”.

Roger Lipton

MERGER-ACQUISITION ACTIVITY HEATS UP IN RESTAURANT LAND – WHAT’S GOING ON?

MERGER-ACQUISITION ACTIVITY HEATS UP – WHAT’S GOING ON?

There has been a sudden flurry of M&A activity in the restaurant space, and we expect this to continue. Within just the last two weeks, it has been announced that:  Panera is selling Au Bon Pain, FAT Brands is buying GFG  Group that owns five different brands, Famous Dave’s is buying Village Inn and Baker’s Square, Lee’s Famous Recipe was sold again, A Jack in the Box franchisee is buying Taco Cabana from Fiesta Restaurant Group and J.Alexander’s is going private by way of SFP Hospitality. This is on top of the $500M IPO of Krispy Kreme and the multi-billion dollar SPAC transaction that is taking Tilman Fertitta’s hospitality empire public.

The reasons for all of this include:

(1) Interest rates are still very low.

(2) There is a great deal of dry powder in the hands of private equity as well as half a dozen SPACs  (sitting on a billion dollars plus borrowing power) with a time pressure to complete an acquisition. The restaurant space has always been seductive, even in the worst of times. Everybody thinks it is a simple business, which is true;  simple but uniquely demanding, especially with adolescent labor being a major part of the equation. We could write a book, and maybe we will, about the poorly conceived acquisitions  that have been made over the years In the restaurant industry,  but that doesn’t dull  the appetite of the new, often younger, players.

(3) The industry is now recovering almost daily from the pandemic, so buyers feel they can opportune the recovery, especially since off-premise sales (including curbside pickup, delivery, and digital applications) provide new growth possibilities. Beauty is in the eye of the beholder, and the buyers of the brands listed above have the financial muscle and the ego to give it a shot.

(4) The restaurant industry has been traumatized in the last fifteen months so it is natural for some single brand owners to have “had enough”. At the same time, professional multi-branded operators have had ample time to study their portfolio and decide which portions of the tree are worth pruning. Sales are returning, but a labor crisis lingers, and it is unclear how the new sales and service initiatives will affect future operating margins. This provides an ongoing pool of willing sellers.

(5) Valuations have returned to relatively high levels among publicly held chains. This provides a reference point for private valuations, which is supported also by the availability of capital at historically low interest rates. A degree of rationality has begun to return, as evidenced by the SPAC index trading 25% off its high and the lukewarm reception of the recent Krispy Kreme IPO, but there is still huge liquidity within the capital markets.

(6) The talk, by the Biden administration, of much higher capital gains taxes, 43% federal and state tax on top of that, provides a strong motivation for a potential seller to get a deal done this year. Time will tell whether, or how much, taxes will go up, but they are not coming down.

CONCLUSION

Our expectation is that virtually all of the above drivers of currently high level of M&A activity will remain in place for the foreseeable future. Additionally, campaign season for the crucially important mid-term national election is already upon us. That being the case, the Treasury and the Federal Reserve, openly working in tandem (ignoring the supposedly mandated independence of the Fed), will do everything in their power to keep interest rates low and money available.

If you are a potential seller, get your power point presentation ready and, as Bernard Baruch advised, leave a little on the table for the next guy.  If you are a buyer, be careful out there. It’s not as easy as it sometimes looks, and leverage works both ways. One last thought for would be restaurant brand builders: Every brand you own needs a really great operator to lead, by experience and example,  and they are not easy  to find. Many years ago, we met Ross Perot, who became eccentric by the time he ran for President , but, in his youth (founding and building EDS) was a spectacular leader. He had a sign above his desk which said: “Eagles Don’t Flock, You Have to Find Them One at a TIme”.

Roger Lipton

IN “THE ROOM WHERE IT HAPPENED” – WHY DID TILMAN FERTITTA SWEETEN THE DEAL?

IN “THE ROOM WHERE IT HAPPENED” – WHY DID TILMAN FERTITTA SWEETEN THE DEAL?

Outside the room where it happened, it is likely relevant that a great deal of the bloom has come off the SPAC rose. Only one of the six restaurant related SPACs has been trading above the $10 issue price and that has been Fast Acquisition Corp. (FST), which has been finalizing the proxy material relative to the pending acquisition of Tilman Fertitta’s multi-billion dollar hospitality empire (72% restaurants and hotels, 28% gaming).

Recall that shareholders in a SPAC have the right to redeem their shares at approximately the $10 issue price if they don’t approve of the suggested business combination. FST has been trading at about $12/share, which normally would be a safe premium going into the vote. However, the possibility of deal rejection may well have been of concern to both Fertitta and the FST sponsors (Doug Jacob and Sandy Beall, most prominently), particularly with the cooling off of the SPAC space, the index of which is trading down about 25% from its high earlier this year.

 With that background, and even a modest uncertainty, Fertitta decided to sweeten and insure the deal by adding 42 additional properties, including Vic and Anthony’s,The Pleasure Pier on Galveston Island, the Mastro’s steakhouse chain and his 50% of Catch Hospitality Group. Collectively these properties generate EBITDA somewhere north of $100M, depending whether we talk pre-pandemic, the current recovery phase, or post-pandemic 2022. As a result, Fertitta will end up with 72% of the post-merger FST, up from 59% previously.

The resulting EBITDA is a bit of a moving target. In early January, 2021 we wrote an article on Fertitta’s capital needs, with over $4B in debt and apparently around $400M of pandemic depressed trailing EBIDA. There has been an already material recovery in early 2021, so when the FST/Fertitta original proposal was announced a few months ago, the guidance was $648M of EBITDA in 2022. Three months later, further into the recovery and, including the additional properties, Fertitta has indicated that the prospectively enlarged company is currently (Q2’21) generating pro forma EBITDA at $270-275M for the quarter, or $800M annualized. The post-transaction Enterprise Value is estimated to be $8.6B or about 11x the current EBITDA ran rate.

The new EV/EBITDA is not materially different from the original. However, a large “adjustment” as a result of the sweetened proposal is that the debt is not being increased. Fertitta’s empire has been carrying something like $4.5B of debt, to be reduced from the $200M IPO raise and privately raised equity (the PIPE) of $1.2B, leaving a new debt load of around $3B.

In The Room Where It Happened: We suspect that the institutions currently owning FST were not adequately comfortable with $3B of debt relative to the previous $648M of projected ’22 EBITDA. This transaction, both the first  proposed and last, is a great result for Fertitta, who only a year ago raised $250M at a 15% interest rate to sustain his corporate liquidity. With the hospitality industry now improving daily, he could afford to add assets sufficient to bring the current annualized EBITDA run rate close to $800M. Sounds a lot better, relative to $3B of debt, to be running at $800M today than guiding to $648M in ’22.

 Tilman Fertitta is a practical man. Already in prospect are four additional international units, and new online gaming operations in four new states. The last thing this serial acquirer needs is to be mortgaged to the hilt just as his empire becomes publicly held once again. No doubt he said to himself: “Let’s get this deal done and move forward. Who knows what tomorrow brings?”

And that’s what we would have advised.

Roger Lipton

KRISPY KREME’S ACT TWO – TRADING NOW AS “DNUT” – NO RUSH THIS TIME!

KRISPY KREME’S ACT TWO – TRADING NOW AS (DNUT) – NO RUSH THIS TIME!

We don’t get them all right, Lord knows, but our sense a week ago that the pending Krispy Kreme IPO (again) was more than fully priced apparently had some validiity. We’ve provided below our article from a week ago. In a nutshell, the deal came at $17/share instead of within the $21-24 contemplated range. The number of shares offered remained the same as contemplated, so $125M less in company coffers was the result, no doubt leaving more debt outstanding.

DNUT started trading around noon today, slipped a few percent from the $17 issue price at first and is trading now at about $18.75/share. Almost 25 million shares have traded as this written (2pm), so that’s a lot of “interest” in a 26.7M share offering. We will read with interest, and report the highlights to our readers, as the analysts at the many underwriting firms help DNUT put its best foot forward. To be clear: we have no doubt that DNUT is here to stay, as a company and as a stock. The only question is one of valuation, depending on the fundamentals as they develop from here.  On that we are open minded.

Roger Lipton

As Published Below on June 22nd, 2020

KRISPY KREME IS BACK – FAR FROM A BARGAIN!

The preliminary filing indicated a raise of $100M, but that amount was understood to be a “place holder”.  A final prospectus, with filing price and number of shares to be sold was disclosed this morning. At the midpoint of the filing range ($22.50) the company will sell a minimum of 26,666,667 shares for net proceeds of about $565M. The ultimate raise could be 15% higher if the “green shoe” option is exercised by the underwriters. There will be 160,890,354 shares at minimum, 164,890,354 at a maximum. This would value the Krispy Kreme equity at a minimum of $3.6B. The use of proceeds is described below.

VERY BRIEF COMPANY BACKGROUND

Founded in 1937, Krispy Kreme came public in 2000 and was a hot stock for several years. However, very rapid expansion undermined the novelty effect, the Atkins diet craze may have hurt sales, the brand image was undermined by distribution points such as C-stores, and franchisees were further disillusioned by the profit the franchisor made on the distribution of product mix and donut making equipment. (Shades of TCBY!) A stabilization and building effort began in 2005, resulting in JAB Holding taking the Company private in 2016, for $1.35B.  In the preliminary prospectus filed on June 1st, there was $1.2B of debt, $350M of which was owed to JAB. Prior to the IPO, since June 1st, a new $500M term facility repaid JAB.

USE OF PROCEEDS

As presented in the prospectus filed today: “We intend to use the net proceeds that we receive from this offering, together with cash on hand, if required, to repay certain of our outstanding indebtedness under the Term Loan Facility (referred to just above), to repurchase shares of common stock from certain of our executive officers at the price to be paid by the underwriters, and to make payments in respect of tax withholdings relating to certain restricted stock units that will vest or for which vesting will be accelerated in connection with this offering, with the remainder, if any, to be used for general corporate purposes.”

It is noteworthy that the Use of Proceeds did not include repaying JAB, but a Term Loan took out JAB, then was repaid out of Proceeds. Looks a little better, we guess.

It is also worth noting that both JAB and Olivier Goudet (Chairman of the Board and CEO) have “indicated an interest”, which “is not a binding agreement”, in purchasing shares of the IPO: $50-$100M in the case of JAB and $5M for  Goudet.

THE OPERATING NUMBERS

From 2016 to 2020, Net Revenue increased from $557M to $1.122B (a CAGR of 19.1%), but a large portion of that revenue growth was generated from the buyback (for $465M) of franchised stores. Over the same period, Global Points of Access increased from 5,720 to 8,275. The GAAP loss before taxes increased from $14M in 2018 to 37M in 2019 to $64M in 2020. The Net Loss in Q1’21 was $3.1M , compared to a $11.5M loss in ’20. Adjusted EBITDA looked (predictably) better: $124M in 2018, $146M in 2019, $145M in 2020, and $46.4M in Q1’21, up from $36.4M.

The Global Points of Access grew further in Q1’21, to 9,077, up 9.6% in just three months. As presented early in the 200 page prospectus: “Krispy Kreme doughnuts are ….universally recognized for its melt-in-your-mouth experience. One differentiating aspect …is our Theater Shops with our ‘Hot Now’ light….the most awesome doughnut experience imaginable….we are an omni-channel business, via (1) our Hot Light Theater and Fresh Shops (2) delivered fresh daily through high-traffic grocery and convenience stores (3) e-Commerce and delivery and (4) our new line of packaged sweet treats offered through grocery, mass merchandise and convenience retail locations.

THE VALUATION

On a pro forma basis after the IPO, there will still be about $630M of remaining debt (net of $78M cash). Adding that to the equity value (at the $22.50 offering price) of $3.6B provides an Enterprise Value of about $4.3B. If we assume a current annual EBITDA run rate of about $185M, the Enterprise Value would be twenty three times.

For those observers that like to look at old fashioned EPS (even if it is Adjusted) Adjusted Net Income was $42.3M in calendar 2020 (compared to the $11.5M GAAP Loss), or about $0.26 on the 160M shares to be outstanding.  Adjusted Net Income in Q1’21 was about $0.11/share, up from about $.07. The offering mid-price of $22.50 is therefore about 85x calendar Adjusted Net Income and 51x the annualized Q1’21 Adjusted run rate.  We don’t know what the company or the underwriters are projecting and, if (or when) the current $185M Adjusted EBITDA run rate (and the Net earnings) can increase substantially. If so the fundamentals would obviously catch up to the valuation.

We don’t believe the outlook is risk free. When the last IPO took place, in 2000, customers were lined up for blocks around a newly opened location. Not so much today.  We suggest investors wait for a more advantageous entry point.

Roger Lipton