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FAT BRANDS, INC. (FAT) – NEW RESEARCH COVERAGE ESTABLISHED

FAT BRANDS, INC. (FAT) – NEW RESEARCH COVERAGE ESTABLISHED

CONCLUSION

FAT BRANDS, INC. (FAT) has come a long way over the last several years. The company has established a multi-branded restaurant franchising company, now with over $700M of systemwide sales within the portfolio’s nine brands. The units are mostly within the fast casual segment of the restaurant industry, a generally good positioning within the post-Covid convenience driven consumer economy. The performance since becoming publicly owned three years ago has been sufficient to leverage the balance on acceptable terms and, in spite of the operating challenges within the last twelve months, fresh capital has been raised and an important acquisition doubled the company’s reach. Most recently, a merger with the corporate parent simplifies the situation and provides a $100M tax loss carryforward.

The company has guided to a doubling of the 2019 pre-Covid cash flow (EBITDA) generation once post-Covid normalization takes hold. Beyond that, $12M of current cash, an apparent ability to add to existing debt arrangements and potentially refinance or improve terms on current debt should allow for further acquisitions. Though, as Yogi Berra said “predictions are always difficult, especially about the future”, aside from the normal macro concerns, the performance of FAT will depend upon (1) continued reasonable performance, supported by the corporate team, of the existing portfolio, (2) the integration of the recent Johnny Rockets (JR) acquisition, including reduction of the previous JR G&A, as shown in our operating model below (3) future acquisitions generating an attractive return. While we cannot predict the timing of post-Covid “normalization”, we expect Fat Brands to continue on its growth path, especially if the current low interest rate environment prevails. The Enterprise Value of FAT, at about $180M is about 12x the post-Covid EBITDA potential, 30%-40% less than the valuation accorded larger publicly held pure franchising companies. As FAT demonstrates the performance of its current brands and the portfolio expands further, there is room for the valuation of FAT common stock to grow as well.

COMPANY BACKGROUND

FAT Brands, Inc. (FAT) has been publicly held since late 2017, with only about two million shares publicly outstanding. Though this is about to change, 81.5% of the shares issued have been owned by Fog Cutter Capital Group Inc. Management, led by CEO, Andrew Wiederhorn, has established a platform to support a portfolio of restaurant franchising companies. The object is to spread the administrative and promotional costs, as well as using best practices to improve and build the individual brands.

Per: The most recent Investor Presentation

The two largest contributors to current FAT revenues are the first and last acquisitions, Fatburger and Johnny Rockets.

In order of purchase: Fatburger was purchased by Fog Cutter in 2003, transferred to FAT prior to the IPO in October ‘17, Buffalo’s Café and Buffalo’s Express were purchased by Fog Cutter in 2011, transferred to FAT prior to the IPO, Ponderosa and Bonanza Steakhouses were purchased in October ’17 in conjunction with the IPO, Hurricane Grill & Wings was purchased in November ‘17, Yalla Mediterranean in December ‘18, Elevation Burger in June ‘19, and Johnny Rockets in September’20. In total, FAT’s portfolio today consists of over 700 franchised locations with systemwide sales over $700M. Each concept is described in detail below.

MANAGEMENT

The founder, CEO and President is 54 year old, Andrew Wiederhorn. He also founded Fog Cutter Capital Group, Inc. After earning a B.S. in Business Administration from USC in 1987, he founded and was CEO of Wilshire Financial Services Group and Wilshire Credit Corporation. He has served on numerous philanthropic Boards, the Citizens Crime Commission of Oregon, the Economic Development Council for Beverly Hills Chamber of Commerce. He was featured as Fatburger CEO in 2013 on “Undercover Boss”, still available and worth watching on youtube. We would be remiss not to mention that Wiederhorn pleaded guilty to filing a false tax return in 1998, by way of which he violated an ERISA statute. He paid a total of $4.6M in fines and fourteen months in federal prison in ’05-’06. Over two decades removed from this obviously unfortunate episode, based on his ability to raise approximately $150M from the capital markets, Wiederhorn seems to have overcome possible doubts about his personal integrity as well as the prospects for Fat Brands.

The CFO is 47 year old Rebecca Hershinger. After earning a Business Degree from Georgetown University and an MBA from Wharton, she studied at Oxford and was an analyst at JP Morgan Chase. With Fat Brands since 2018, she was previously CFO of a publicly traded global children’s media company.

The President of the Casual Dining Division is 64 year old Gregg Nettleton, with FAT since October ’17. Prior to that he was President and CEO of an international consulting firm. His restaurant experience includes Board Membership at Black Angus Steakhouses, Chief Marketing Officer at IHOP and Interim Chief Marketing Officer at Applebee’s.

The Chief Operating Officer of the Fast Casual Division since February 2020 is 36 year old Jacob Berchtold. He joined Fatburger in 2005, out of Arizona State University, as a restaurant manager and member of the new store opening team. He has served in a wide variety of operational management positions with Fatburger company and franchised locations, in China, S.E. Asia, the Middle East and North Africa.

The Senior VP of Finance is Ron Roe, previously with Fog Cutter Capital and Piper Jaffray.

The Chief Marketing and Chief Development Officers are Thayer and Taylor Wiederhorn,  respectively, both of whom have spent over 10 years with Fog Cutter Capital, Fatburger and Buffalo’s Café/Express.

The Board of Directors is headed by Chairman, Edward Rensi, former President of McDonald’s, USA. Other Board members include James Neuhauser of Stifel Nicolaus, Turtlerock Capital, Fifth and Co. and the Bank of New England: and Squire Junger of Knight Consulting and Arthur Anderson.

STRATEGIC OVERVIEW

It is difficult for a relatively small publicly held company to build a portfolio of high quality restaurant brands, especially when there are hundreds of billions of dollars competing for attractive acquisitions. The process, of necessity, must focus on brands that seem troubled or are too small for multi-brand operators like Restaurant Brands (QSR, with Burger King, Tim Horton’s, Popeye’s), Yum Brands (YUM, with Taco Bell, KFC, Pizza Hut, Habit Burger), Bloomin’ Brands (BLMN) or privately held Inspire Brands (franchising Arby’s, Buffalo Wild Wings & Sonic). FAT, as a relatively small new competitor must deal with a lack of purchase currency: neither a large equity capitalization or inexpensive debt.

It is understandable therefore that Fat Brands, after going public in late 2017, with just a couple of brands, the most important of which was Fatburger (the first acquisition), has had to piece together a portfolio of brands too mature, not large enough, or not growing fast enough to attract a higher price from other bidders. It was on that basis that Hurricane, Ponderosa and Bonanza, Yalla and Elevation were acquired. By mid-2020, FAT had established an operating record good enough to monetize the existing royalty stream and raise capital at an acceptable interest rate to acquire Johnny Rockets (JR). JR has instantly become the “bookend” to Fatburger, between them providing the bulk of the current royalty stream and growth potential. As described further below, the post-Covid and post-JR cash flow  potential is expected to be at least a doubling of that in pre-Covid 2019. The currently liquid balance sheet plus further monetization of the royalty stream at an increasingly attractive interest rate, would allow for further acquisitions to build upon the newly enlarged base.

THE BRANDS

Fatburger – (The Last Great Hamburger Stand), was founded in Los Angeles, California in 1947. It serves a variety of freshly made-to-order, customizable, big, juicy, and tasty Fatburgers, Turkeyburgers, Chicken Sandwiches, Impossible™ Burgers, Veggieburgers, French fries, onion rings, soft-drinks and milkshakes. Fatburger has counted many celebrities and athletes as past franchisees and customers, and they believe this prestige has been a principal driver of the brand’s staying power. As of December 29, 2019, there were 163 franchised and sub-franchised Fatburger locations across eight states and 18 countries.

Per the most recent Fatburger Franchise Disclosure Document: it costs from $459K to $988K to begin operations, including the initial franchise fee of $50k. Current ongoing fees include 6%% royalty plus national ad fund of 1.9% within Los Angeles DMA or 0.95% outside of LA DMA, plus 2.0% local ads. Item 20, Page 60, shows 163 systemwide outlets (all franchised)  (79 domestic and 84 Int’l) at 12/31/19. The areas with US states with 5 or more locations are: CA (50), NV (15), WA (5), Canada (54), and China (5).  During fiscal 2019 the domestic system grew by 9 units.  

Buffalo’s Café  (and Buffalo’s Express) – Buffalo’s Café was established in Roswell, Georgia in 1985, Buffalo’s Cafe (Where Everyone is Family) is a family-themed casual dining concept known for its chicken wings and 13 distinctive homemade wing sauces, burgers, wraps, steaks, salads and other classic American cuisine. Featuring a full bar and table service, Buffalo’s Cafe affords friends and family the flexibility to enjoy an intimate dinner together or to casually watch sporting events. Beginning in 2011, Buffalo’s Express was developed and launched as a fast-casual, smaller footprint variant of Buffalo’s Cafe offering a limited version of the full menu with an emphasis on chicken wings, wraps and salads. Current Buffalo’s Express outlets are co-branded with Fatburger locations, providing  complementary concepts that share kitchen space and result in a higher average unit volume (compared to stand-alone Fatburger locations. As of December 29, 2019, there were 17 franchised Buffalo’s Cafe and 87 co-branded Fatburger / Buffalo’s Express locations globally.

Per the most recent Buffalo’s Cafe Franchise Disclosure Document: For Buffalo’s Cafe it costs from $407k to $1,009k, including the initial franchise fee of $50k, to begin operations. Current ongoing fees include 6% royalty plus 2.0% for the Creative Ad Fund, plus 2.0% local ads. Item 20, Page 60 shows 18 systemwide units (14 domestic) operating at 12/31/19, all franchised. The distribution of units is: GA (14) and Qatar (4). The system unit count was unchanged during ’19.

Relative to the co-branding of Buffalo’s Express within Fatburger outlets, it costs $36.5K to $88K to begin operations of a co-branded operation, plus the initial franchise fee of $25k. The ongoing fees are consistent with those paid by the Fatburger franchise partner. Per the FDD, “since 2012 Fatburger has permitted a total of 34 of its franchisees (in 87 locations) to also display the Buffalo’s Café marks, trade dress, and serve a limited menu relative to that described above.

Ponderosa & Bonanza Steakhouses – Ponderosa Steakhouse, founded in 1965, and Bonanza Steakhouse, founded in 1963, offer the quintessential American steakhouse experience, for which there is strong and growing demand in international markets, particularly in Asia and the Middle East. Ponderosa and Bonanza Steakhouses offer guests a high-quality buffet and broad array of affordably priced steak, chicken and seafood entrées. Buffets at Ponderosa and Bonanza Steakhouses feature a large variety of all you can eat salads, soups, appetizers, vegetables, breads, hot main courses and desserts. An additional variation of the brand, Bonanza Steak & BBQ, offers a full-service steakhouse with fresh farm-to-table salad bar and a menu showcase of USDA flame-grilled steaks and house-smoked BBQ, with contemporized interpretations of traditional American classics. As of December 29, 2019, there were 76 Ponderosa and 13 Bonanza restaurants operating under franchise and sub-franchise agreements in 16 states and five countries. There is not a current FDD for these brands, and the current stay at home economy is least promising for this portion of the FAT portfolio.

Hurricane Grill & Wings – Founded in Fort Pierce, Florida in 1995, Hurricane Grill & Wings is a tropical beach themed casual dining restaurant known for its fresh, jumbo, chicken wings, 35 signature sauces, burgers, bowls, tacos, salads and sides. Featuring a full bar and table service, Hurricane Grill & Wings’ laid-back, casual, atmosphere affords family and friends the flexibility to enjoy dining experiences together regardless of the occasion. The acquisition of Hurricane Grill & Wings has been complementary to FAT Brands existing portfolio chicken wing brands, Buffalo’s Cafe and Buffalo’s Express. As of December 29, 2019, there were 51 franchised Hurricane Grill & Wings and 2 franchised Hurricane BTWs (Hurricane’s fast-casual burgers, tacos & wings concept), across eight states.

Per the most recent Franchise Disclosure Document, dealing with domestic units: It costs from $491k to $1,088k to begin operations, including the initial franchise fee of $50k. Current ongoing fees include 6% royalty, plus 2% to nat’l ad fund, plus 2% spent on local ads. Item 20, page 63, shows 51 domestic units or int’l), all franchised plus 1 affiliated unit in FL operating at 12/31/19. The states with 2 or more locations are: AL (2), FL (36), and NY (9). During calendar 2019, the system declined by 6 units. Relative to the Hurricane BTW franchise, it varies from the above by the fact that the cost to begin operation ranges from $260k to $521k, including the $5k initial franchise fee.

Yalla Mediterranean – Founded in 2014, Yalla Mediterranean is a Los Angeles-based restaurant chain specializing in authentic, healthful, Mediterranean cuisine with an environmental conscience and focus on sustainability. The word “yalla” which means “let’s go” is embraced in every aspect of Yalla Mediterranean’s culture. Yalla offers wraps, plates, and bowls in a fast-casual setting, with cuisine prepared fresh daily using, GMO-free, local ingredients for a menu that includes vegetarian, vegan, gluten-free and dairy-free options. The brand demonstrates its commitment to the environment by using responsibly sourced proteins and utensils, bowls and serving trays made from compostable materials. Also featured are an on-tap selections of craft beers and fine wines. Originally acquired as company operated, two restaurants had been franchised as of December 29, 2019, with the intention of franchising the remaining five existing Yalla locations to franchisees and expand the business through additional franchising.

Per the most recent Yalla Franchise Disclosure Document: If a current company store is being purchased, the franchise will pay Fat Brands from $500k to $700k, depending on the existing location, which will include assets and initial franchise fee ($50k). Stores to be constructed will cost $525k to $988k, including the $50k initial franchisee fee, to open. Current ongoing fees include 6% royalty plus 2.0% to the National Ad Fund, plus 2.0% for local ads.  Per the most recent Franchise Disclosure, Item 20, Page 57 shows 7 systemwide units, unchanged in the last two years, with the 2 stores moving from company to franchisee during 2019. All locations are in California.

Elevation Burger – Established in Northern Virginia in 2002, Elevation Burger is a fast-casual burger, fries, and shakes chain that provides its customers with healthier, “elevated” food options. Serving grass-fed beef, organic chicken, and French fries cooked using a proprietary olive oil-based frying method, Elevation maintains environmentally-friendly operating practices including responsible sourcing of ingredients, robust recycling programs intended to reduce carbon footprint, and store décor constructed of eco-friendly materials. Ownership of the Elevation Burger brand aligns with our the corporate mission of providing fresh, authentic and tasty products, complementing the Fatburger brand. As of December 29, 2019, there were 45 franchised Elevation Burger locations across nine states and four countries.

Per the most recent EB Franchise Disclosure Document: It costs from $459k to $988k to begin operations, including the initial franchise fee of $50k. Current ongoing fees include 6% royalty plus 1.5% national ads plus 2% local ads.  Per the most recent Franchise Disclosure, Item 20, Page 60 shows 48 total systemwide units (27 domestic + 19 int’l franchised) + 2 Affiliates operating at 12/31/19. There are at least 2 units operating in: ME (4), MD (5), MI (2), NY (4), PA (5), VA (4) (US Total of 27), Bahrain (3), Kuwait (8), Qatar (4), UAE (3) (Int’l Total of 19). The two Affiliated units are in VA. The total number of units declined by 4 in fiscal 2019.

Johnny Rockets – Founded in 1986 by Ronn Teitelbaum in Los Angeles, originally a 20 stool counter operation on Melrose Avenue, presenting a 1940s vintage style malt shop. The first unit, featuring jukeboxes, red-vinyl booths and chrome counters, opened with fans such as Bob Hope and Elizabeth Taylor. The chain grew to 200 locations by 2007 when it was acquired by RedZone Capital. By 2013, when Sun Capital Partners bought it, there were 300 locations in 30 states and 16 countries, including more than a dozen in amusement parks and cruise ships. They typically offer lunch and dinner, featuring made to order burgers, crispy fries, chili, hand-spun shakes and malts, plus sandwiches and other items. Today, under FAT’s ownership there are 322 locations operated by 129 franchisees, having reported 2019 systemwide sales of $316M. The average royalty in 2019 was 4.3%.

Per the most recent JR Franchise Disclosure Document, dealing with domestic units: It costs from $597k to $1,189k to begin operations, including the initial franchise fee of $50k. Current ongoing fees include 6% royalty, plus 2% to a marketing fund, plus 2% spent on local ads. Item 20, page 51, shows 175 domestic units (not including cruise ships or int’l) (162 F + 13 C ) operating at 12/31/19. The US states with 5 or more units are in CA (30), CT (5), FL (14), GA (6), MD (8), NV (12), NJ (6), NY (10), PA (5), RI (5) and TX (5). During calendar 2019, the domestic system declined by 22 units (20F + 2C). Internationally: SEC filings show 177 int’l units as of 9/30/20, with the heaviest concentration in Chile, Korea, Brazil and Mexico, with units also operating in over twenty five other countries.

THE BALANCE SHEET

The company raised a total of $49M ($40M of “M-2” plus $9M of “Series B”, below) in the third quarter, which funded the Johnny Rockets acquisition and provided a $12M unrestricted cash cushion going forward. In addition to the cash, as of 9/30/20, there were current assets of $31.2M almost exactly matching $31.8M of current liabilities, long term debt, net of $1.6M current portion amounting to $78.4M. There was also (net of offering costs, OID, etc.) $13M of Preferred Stock (not including $13M to be issued in Q4 in conjunction with the Fog Cutter transaction, discussed below), along with $12.7M of equity. The long term debt is obviously substantial relative to the historical trailing EBITDA, but a great deal of it was incurred to purchase Johnny Rockets, with a cushion for a future purchase. Relative to the post-Covid expectation, including Johnny Rockets, of EBITDA in the range of $15-16M, the long term debt to EBITDA ratio drops in half to a more tolerable 5.2x. The table below shows that the weighted average interest rate on the Series 2020 notes is 8.75%. Management has noted their intention to refinance these notes at a lower interest rate in H1’21.

THE MOST RECENT TRANSACTION – MERGING FAT BRANDS WITH PARENT, FOG CUTTER

The Company announced in late 2020 a plan to merge with Fog Cutter Capital. FAT is now the surviving Company and individual shareholders of Fog Cutter own common shares of FAT with the total outstanding unchanged. Presumably to offset the elimination of the $38M receivable from Fog Cutter, each share of FAT common shareholders received .232 shares of FAT Brands’ 8.25% Series B Cumulative Preferred Stock (FATBP) which have recently been trading in the area of $16/share. The company has not yet filed information relative to the post-merger balance sheet.

The most important advantages of this transaction are (1) Fog Cutter no longer has to own over 80% of FAT to maintain its $100M tax loss carryforward, so FAT can use its stock for acquisitions (2) FAT gets the use of the tax loss carryforward  (3) The public float of FAT increases to 46% of the fully diluted shares (4) Intercompany balance sheet items are eliminated.

THE ENLARGED POST-COVID PLATFORM

It is clear now that 2020 was a lost year in terms of revenues, earnings, and cash flow progress for most restaurant companies. In spite of that, Fat Brands made meaningful progress, building on their base of brands with the Johnny Rockets acquisition as well as positioning the balance sheet for long term growth. Though we cannot predict at what point normalized post-Covid operations will be in place, our exercise is to take the 2019 platform, breaking the royalty stream down by brand, and then project forward in a reasonable fashion to the post-Covid earning and cash flow power of the FAT franchise portfolio.  In addition to the numbers shown below, it is worth noting that a total of 57 new locations  have opened across the portfolio in the first nine months of 2020, up from 52 in 2019, plus six ghost kitchens. We have, however, projected forward to a post-Covid environment assuming no growth in units or same store sales.

By definition, the projections cannot be precise, either numerically or within a timeframe. However, we have pieced together the model just below from SEC filings and investor presentations, with relevant assumptions indicated by footnotes. Our model indicates that the company conclusion that pro forma EBITDA, post-Covid with the inclusion of Johnny Rockets, could double or more from the $6.7M ($7.7M Adjusted) in calendar 2019 appears reasonable. Our most important assumptions are that the most important segments, namely Fatburger, Hurricane Grill and Johnny Rockets don’t deteriorate from their 2019 results and the G&A from Johnny Rockets can be cut from $11.9M to $6.1M annually.

 CONCLUSION : Provided at the beginning of this report