Investors hungry for a four-star experience at a reasonable price should consider a bite of FAT Brands.
The restaurant franchiser, which owns and develops dining concepts such as Fatburger and Ponderosa Steakhouse, went public in a Reg A+ offering last year. Like almost all Reg A+ stocks, FAT has traded poorly since listing, down nearly 30% from its October initial public offering price of $12 a share.
But it would be a mistake to lump FAT in with its underperforming Reg A+ brethren. While many Reg A+ companies need major breakthroughs and new financing to make their dreams reality, FAT has a plan to boost profits with clearheaded, highly-accretive acquisitions – and the financial muscle to pull it off.
Consider the M&A economics. In an interview with RegAResearch, FAT CEO Andrew Wiederhorn said that a typical restaurant concept he acquires may have revenue of, say, $4 million – mostly from franchise fees. Due to heavy costs from functions like accounting, human resources, and a corporate headquarters, the concept would have just $1 million in earnings before interest, taxes, depreciation, and amortization.
Such a capital-intensive model makes an ideal target for FAT. Since so many of the centralized costs are redundant, about two thirds of a restaurant concept’s overhead can be eliminated. “We can keep $3 million of the $4 million of revenue as EBITDA,” Mr. Wiederhorn says.
And the execution process is quick. Virtually all of the duplicate costs can be eliminated within a few months, according to Mr. Wiederhorn.
The icing on the cake: FAT has successfully used “cross selling” to boost revenue when it acquires new brands. The strategy is to have one restaurant introduce items from sister concepts, bringing new choices to customers and more fees to the company from franchisees.
All that makes it easier for FAT to find acquisitions that benefit shareholders right away. To illustrate, take the example of last year’s acquisitions of Hurricane and Ponderosa. The combined cost was $23 million, and the company says the assets would earn a combined $7.4 million in EBITDA, adjusted for cost synergies.
For simplicity, assume the company could complete two similar acquisitions in 2018. Even with a relatively high cost of capital of approximately 13.6% under the company’s current fundraising effort, and a tax rate of 25% (which could be much lower given the benefit of some accumulated net operating losses), the $7.4 million of EBITDA would translate to an increase of $3.2 million of net income.
One potential worry is whether the company can continue to find such accretive deals. But Mr. Wiederhorn points out that there are significant barriers to entry: only a franchisor with a multibrand rollup platform like FAT’s can generate such robust cost synergies. For many other buyers, a deal like Ponderosa – which was struggling to generate top-line growth – would be unappealing.
In 2018, Mr. Wiederhorn expects to execute one or two more deals, broadly comparable in size to the recent acquisitions. At the same time, he says he won’t rush into a spending spree and will be careful to digest new concepts at a prudent pace.
What’s more, the company should benefit from some industry tailwinds. As the economy gets back on track, wage growth should put more money in customers’ pockets. Millennials also dine out more frequently than previous generations and FAT has been quick to partner with third-party innovators like UberEATS and GrubHub that reach a delivery audience.
Adding appeal to investors who want to generate income, the company sports a healthy dividend that yields nearly 6%. Mr. Wiederhorn says that the company has enough cash to pay the dividend while also pursuing acquisitions.
The company expects non-GAAP cash earnings per share, which reasonably includes some upfront payments from new franchisees, of $1.10 this year. Analyst James Anderson at R.F. Lafferty, meanwhile, forecasts EPS of $0.84. Splitting the difference in forecasts, company trades at about 8 times 2018 EPS. At that price, investors should take the opportunity to fill up on the shares before the real crowds start showing up.
