EITHTEENTH BRAND PURCHASED

FAT Brands announced last evening the acquisition of sixty one Smokey Bones Bar & Fire Grill locations, purchased from an affiliate of Sun Capital Partners, Inc. The purchase price of $30 million has been funded from FAT’s existing securitization facility. The announcement states that adjusted EBITDA is expected to be enhanced by approximately $10M, which implies a purchase price of only about three times EBITDA.

While the Smokey Bones locations were obviously not promising enough to remain within Sun Capital’s portfolio, and are projected to generate the relatively modest average of only $163k of corporate Adjusted EBITDA per store for FAT Brands, the purchase price of about $500,000 per property is relatively low for stores that are likely around 7-8000 square feet. Moreover, FAT Brands is in the unique position of owning a promising brand, namely Twin Peaks, that could likely generate closer to a million dollars of EBITDA per location, generating a handsome return on investment on conversion costs that would be a lot less than building from scratch. With currently around 100 Twin Peaks locations systemwide (growing at 15-20% annually) even 10-20 conversion opportunities within the Smokey Bones portfolio would be a material addition to the Twin Peaks development program.  The best of the non-conversion sites could be managed as an eighteenth brand and others could likely be monetized for an average of at least $500k/site. Overall, this transaction demonstrates that FAT Brands, in spite of its existing obviously high leverage, maintains adequate financial flexibility to put in place another transaction with an attractive reward/risk profile.

STEADY PROGRESS WITHIN THE PORTFOLIO

Since the second quarter earnings report in early August, a number of productive operating developments have been announced.

On August 7^th: A new development deal to bring 20 Johnny Rockets locations to Texas in the next 10 years, with the first unit to open In 2024. The franchisee, Brame Holdings LLC, is also developing Fatburger and Buffalo Express, as well as Round Table Pizza, all part of an 80 store development deal in Texas.

On August 9^th: A new development deal to open 10 Hot Dog on a Stick locations in Iraq. The franchisee, Global Vita USA LLC, is also developing Fatburger and Buffalo’s Express, as well as Great American Cookies and Marable Slab Creamery in Iraq.

On August 10^th: Three new locations of Round Table Pizza have opened, bringing the California footprint of this 65 year old brand to 340 locations.

On August 29^th: Great American Cookie returned to Orlando, with a franchisee converting another of the Nestle Toll House Café locations, the brand previously purchased by FAT Brands with this conversion intent. “The cookie chain has plans to continue its growth in Orlando with new locations set to open this year.”

On August 31^st: FAT Brands announces the opening of a co-branded Great American Cookies and Mable Slab Creamery location in Happy Valley, Oregon, the first Pacific Northwest location for both brands.

On September 5^th: Fazoli’s returned to Orlando, owned by franchisee, Keys Restaurants, Inc.

On September 20^th: Fazoli’s opened Its second location in Little Rock, Arkansas, and Doug Bostick, President at Fazoli’s, added “Our second location in Little Rock is just the beginning…”.

Roger Lipton

RESTAURANT FINANCE MONITOR – 4-15-23 – Follow the Money by Roger Lipton

A Macro-Monetary-Storm is blowing, with broad ramifications. Just over a month ago there was a “run” on Silicon Value Bank and others, requiring Fed rescue. It turns out that more than twenty years of reckless fiscal/monetary policy have unintended consequences. What a surprise! Almost all banks have purchased fixed income securities (US Treasury Bills, Mortgage Backed Securities, etc.) that when marked to market price would show an unrealized loss, in turn jeopardizing the banks’ equity. We have not heard the last of this problem – but we need not fear. The Federal Reserve has stepped in to guarantee even uninsured deposits, essentially putting in place a mechanism by which the entire US banking system can be nationalized — a long term probability. Taking into consideration the timing uncertainty, the necessary monetary accommodation will spur inflation well above the Fed’s 2% objective. Also increasing inflation is the weak US Dollar, as foreign nations increasingly transact in other currencies and diversify reserves away from Dollar denominated assets. When the USA, by way of sanctions, froze Russia’s US Dollar assets in ‘22 the “weaponization” of the Dollar created a new urgency for China and others to reduce Dollar holdings. China, Russia, Brazil and India (the BRICs), plus Middle Easterners, South Africa and others, are transacting with gold, oil, or non-Dollar currencies. It should be lost on nobody that the US is no longer energy independent, is the only important trading nation that is not increasing its holdings of gold, and is running larger trade deficits than ever. There are too many economic, political, military and even social areas of tension to discuss here, but there is trouble brewing on all fronts. Our focus is the “money” and we believe that financial strength is paramount if the US is to exert influence within the other venues.

Leverage Works Both Ways and we have written extensively on our website about FAT Brands. They have assembled, largely during Covid, a portfolio of seventeen franchised restaurant brands, financed by monetizing (for about $1B) future royalty streams. This was based on anticipated post-Covid Adjusted EBITDA of about $100M, from brands led by Twin Peaks, Round Table Pizza, Fazoli’s, Johnny Rockets and Fatburger. While the original overall interest rate was just above 7% the expectation was for a re-rating of the debt in late ‘22, reducing interest expense by perhaps 200bp or $20M annually. With only $50M of interest expense in ’23 (down from about $70M in ’22, excluding transaction costs), $100M could provide a comfortable cushion of “free cash flow”. Expectations continue to be for about 1,000 new locations, already in the development pipeline, which could increase corporate EBITDA to roughly $150M in five years or so.

However: Interest rates have spiked much higher, and, while other options exist, the re-rating of the debt will not help. Adjusted EBITDA came in at $88M in ‘22, not far from the $90-95M projected run rate, which was absorbed by interest expense and other non-recurring items, legal expenses in particular. In that regard, CEO Wiederhorn, his family still a major shareholder, has recently stepped aside as CEO and the Board has been restructured, apparently to distance the Company from Wiederhorn’s personal legal issues.

Legalities aside, which do not seem to be affecting operations, the “new age” result is that “free cash flow” is dependent on top line growth in the portfolio, fortunately moving in the right direction. Cash at Dec. ‘22 was $29M (unrestricted). $40M more was raised in January from further royalty securitization, with room for more, allowing for liquidity to be maintained while free cash flow generation moves toward breakeven. An “ace in the hole” is the ability to sell some portion of the dough manufacturing plant, which generated about $15M of EBITDA in ’22 while operating at about one third of capacity, as well as equity in one (or more) of the major brands.

Regarding the stock, FAT Brands (FAT), worth about $120M represents an equity “stub” or “option”, compared to debt of about one billion dollars. The Enterprise Value, at about 12x the current rounded $100M run rate of Adjusted EBITDA is less than some pure franchising peers with multiples in the high teens. If FAT is generating something like $150M of Adjusted EBITDA in five years, the Enterprise Value at that point could be 15-20x, or $2.2B to $3.0B. If there are still 16M shares, with similar debt, the common stock would be worth $1.2B to $2.0B or $75 to $125/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/share, or $60/share at a 5% free cash flow yield. Investors can make assumptions in terms of operating projections and more stock and/or debt being issued, but the upside is perhaps surprisingly substantial. Relative to the risk, the existing lenders seem comfortable, reportedly willing to lend more, “to help out”. The fact remains that the upside possibilities for FAT are an order of magnitude larger than the $7 share at risk.

FAT Brands’ UPDATE: THE BOARD OF DIRECTORS IS RESTRUCTURED, AS UNIT DEVELOPMENT DEALS AND NEW PRODUCTS ARE ANNOUNCED

An 8K filing on April 3^rd described a restructuring of the Board of Directors at FAT Brands. While not referenced in early March, when CEO, Andy Wiederhorn’s revised role (from CEO to strategic advisor) was announced, this move to help separate the company from ongoing legal issues seems logical. Below the listing of recent fundamental developments, we have provided a link to our description in early March of that development. We see no reason that the Board restructuring will affect the outlook for the business fundamentals.

Of the former directors, only Andy Wiederhorn and Lynne Collier remain. Five insiders (including Wiederhorn’s three sons, all with leadership positions at the Company) are joined by three independent directors; Mark Elenowitz, Kenneth Kepp, and Tyler Child. We have provided just below a link to the 8-K filing.

https://seekingalpha.com/filing/7387585

RECENT ANNOUNCEMENTS REGARDING BUSINESS FUNDAMENTALS

On April 5^th: FAT Brands’ Elevation Burger chain unveiled fresh baked Chocolate Chip Cookies and Chocolate Chip Cookie Ice Cream Sandwiches. Complimenting Elevation Burger’s hand-spun shakes and ice cream, this new offering demonstrates the opportunity to more fully utilize the dough manufacturing facility that, already generating approximately $15M of annual EBITDA, is operating far below capacity. As the release points out: “Following this rollout, we will look into similar collaborations with the other burger brands in our portfolio”.

On March 23^rd: FAT Brands’ Johnny Rockets change announced a new development deal for 20 franchised locations in Mexico over the next 10 years, on top of the 25 restaurants that debuted there in 1991.

On March 22^nd: FAT Brands announced the official launch of their newly formed 501 © (3) charitable foundation. Seeded with a $250,000 donation from the Company, FAT is obviously reaching out to serve the employees and communities within their 17 brand portfolio of worldwide franchised restaurant brands.

On March 21^st: FAT Brands’ Pretzelmaker brand opened its first drive-thru location, in Mason City, Iowa, with its Fresh Twist brand, which was launched in 2018 to fulfill breakfast and late-night options, especially aimed at small footprint locations

On March 16^th: FAT Brands’ announced a 10-unit development deal for co-branded (35 year old) Great American Cookie and (40 year old) Marble Slab Creamery locations. They will be opened in Puerto Rico over the next five years, the first two by 2024.

On March 9^th: A co-branded Fatburger/Buffalo’s Express location opened in Orland Park, Illinois by a franchised partnership including NBA athletes, Anthony Davis, Jr., Derrick Rose and Tim Hardaway, Jr. Joined by two successful African American female entrepreneurs, Toi Salter and Jackie Jackson, this partnership is anticipating further development in the area.

On March 6^th: FAT Brands announced that founder, Andy Wiederhorn would step aside as CEO and transition to a strategic advisory role in May ’23. Our website described that development per the link below:

https://www.liptonfinancialservices.com/2023/03/fat-brands-founder-and-ceo-andy-wiederhorn-to-step-aside/

We have written extensively about FAT Brands and our reports can be accessed using the SEARCH function on our Home Page.)

All reported results were an order of magnitude larger in Q3’22 vs. a year ago, largely as a result of acquisitions, also influenced by openings, higher same store sales and average unit volumes. Recall that FAT Brands now oversees a 17-brand portfolio of franchised restaurant concepts, comprised of over 2300 locations that generate $2.2B of annual sales. The five largest brands are Fatburger, Johnny Rockets, Round Table Pizza, Fazoli’s and Twin Peaks. Twin Peaks is the only brand with a material number of company operated locations, 28 out of the 92- unit current total, with AUVs above $5M and  compelling store level profits and return on investment.

THE QUARTER

Adjusted EBITDA in Q3’22 was $24.6M (up from $7.2M in ’21) with a GAAP loss of $23.4M. The material reconciling adjustments were addbacks of: Interest Expense of $24.5M, D&A of $6.9M, Share Based Compensation of $2.0M. Additional non-recurring adjustments were Acquisition Costs of $2.0, Provision for Bad Debts of $5.5M and Litigation Costs of $6.9M, the last two of which are expected to be at least partially recoverable

Management has, since late ’21, been guiding to a post-Covid run rate of $90-95M of Adjusted EBITDA with over 100 openings in ‘22, and both objectives are being met. In Q3’22, systemwide sales growth was 57% vs. ‘21, with SSS growth of 7.0% and there were 38 new store openings, the new total for ’22 expected to be 125.  For nine months, Adjusted EBITDA was $69M, and guidance of about $25M in Q4 would take it to $94M for the full year. Importantly, franchisees signed for over 180 new locations during Q3, bringing the development pipeline to over 1,000, “expected to represent a 60% increase in EBITDA over the next several years”.

THE DEBT

While management continues to work to reduce its debt service, anticipating a re-rating and a lower interest rate, a process that was expected to be well under way by now, the current volatility in debt markets has predictably inhibited this effort. While marking time in this regard, $43M of Series B Preferred Stock has been redeemed by the use of one of its securitization facilities that carries a lower rate. The savings will be material and the plan is to convert another $95M in the next two or three quarters. Fortunately: unit growth, sales growth, and efficiencies inherent in operating a multi-branded administrative platform are steadily improving operating cash flow, so the current debt structure can be serviced even if the terms are not improved. Moreover, FAT owns at least five brands that could be monetized over time in a variety of ways to materially reduce the debt. At the same time the factors above, augmented by increased cash flow from dough manufacturing should generate a steadily increasing amount of free cash flow.

THE OUTLOOK

According to commentary on the conference call, more than 90 new locations are currently under construction, with 130-150 due to open in ’23. The portfolio wide pipeline of over 1000 locations represents forty three percent unit growth and an incremental $60M of EBITDA. Regarding Twin Peaks, the single most important brand, there are over 100 locations in the franchise development pipeline, with 15-20 franchised and 3-4 company operated to open in ’23 and in each subsequent year. The newest class of stores is generating about a $6M AUV, and same store sales are running up about 13% through nine months of ’23. In the Fast Casual segment, the pipeline has 350 new Fatburger’s and Johnny Rockets. Within QSR there are over 400 restaurants, including Fazoli’s, Round Table Pizza, Great American Cookies and Marble Slab Creamery. Co-branding is an important focus, which spreads the cost of the physical facility and increases sales per square foot. There are over 100 pairings of Buffalo’s Express and Fatburger, 225 co-branded Great American Cookies and Marble Slab Creamery, and one tri-branded Fatburger, Hot Dog on a Stick and Buffalo’s Express. Non-traditional locations are also a new focus, with 13 opened in the past year.

Another important opportunity is the dough manufacturing facility that was purchased in mid’21. It generated $7.8M of revenues in Q3, $25M for nine months, and is generating about $15M of  EBITDA while operating at only 33% of capacity. The 55 acquired Nestle Toll House Café stores are being converted to Great American Cookies (GAC) and will take the manufacturing facility to 38% of capacity with materially improved cash flow. At the same time, franchisees of Nestle (to become GAC) will be able to purchase dough at 20% less than previously. More broadly relating to FAT’s multi-branded portfolio, based on $600M of total purchasing power, franchisees will be able to save 200-300 bp within their cost of goods.

THE BOTTOM LINE

The run rate of improving EBITDA and free cash flow generation should continue to build quarter by quarter, with contributions in ‘23 as follows: (1) Corporate efficiencies amounting to $2M at least (2) New franchised units open, at the rate of 5-6% per year, generating about $5M of new royalties annually (3) Higher royalty generating sales, from inflation at least, generating an incremental $2M (4) At least 2 new corporate “store years” at Twin Peaks, out of 3-4 planned openings, which should generate $2M of EBITDA, depending on timing of openings (5) Manufacturing facility, improved utilization, $3M. In total, our estimate is that total Incremental operating EBITDA phasing in during ’23 could amount to $14M. The Company has so far made no estimate, and we are not including the effect of “fill in” acquisitions, but our analysis above takes the annualized run rate of EBITDA in ’23 to about $108-110M.

Roger Lipton