Description

Overview / Thesis  

• Nathan’s is an underfollowed (no analyst) microcap that owns the Nathan’s Famous brand primarily associated with hot dogs and crinkle-cut french fries. Importantly, NATH is more of a licensing business than a restaurant business as it is generally misperceived. The Company has a capital light business model with high operating leverage.

• NATH is not your typical small, undervalued company. Looking beyond the financials and multiples, I think it is important to point out that NATH is run by a management team and Board, led by Chairman Howard Lorber, that have created tremendous value, including repurchasing more shares over time than there are shares currently outstanding. This is in addition to a massive dividend payout. And each time the Company has undertaken major buybacks the shareholder return was significant in the following period.

• With that said, there is also a short-term catalyst in that the Company recently announced a large Dutch auction tender with a $36 limit. The tender was extended and expires November 16. The stock jumped above $36 on the tender news and has remained above. As the Company repurchased stock above $40 last quarter and given management’s track record, I expect an increase in the tender price, which should be a near-term catalyst. For insiders, who already own a lot of stock, to purchase 11% of the stock highlights their view on the stock.

• While I value the Company at approx. $55 per share (~35% upside), there are multiple paths for further upside including growth in its core licensing segment, higher margins from a decline in beef prices and an eventual sale of the Company.

• The stock has declined in recent months due to the Company falling out of the Russell, a fund (Steel Partners) exiting a sizeable position due to one of its funds supposedly liquidating and due to an overreaction to a debt raise which I will discuss below. The market also misunderstands the recent game-changing licensing agreement with Smithfield.

• The risk/reward is compelling with multiple catalysts to drive the price higher. I view $36 as a floor given management’s willingness to buy so much stock at that price.

Financials/valuation

• I value NATH by splitting the Company into 2 parts:  i) the long-term contractual licensing business and ii) the remainder of the business (franchise business, branded product program, company-owned stores).

• I take this approach as the licensing business drives most of the profit and it deserves a higher multiple as: the licensing business is near 100% EBITDA margin; NATH has a long-term contract with a high quality counterparty; GDP+ growth in the segment; and a licensing biz with high percent royalty revenue tends to trade at high multiples

• Applying 12x to the licensing EBITDA and a conservative 9x to the remaining business (franchises, branded product program, company stores) yields a value of approx. $55 per share, with the following optionality that could drive incremental value:

• • Beef prices have just started to decline and are on track to decline further which will increase margins in the owned stores and BPP program segments.

  • Smithfield’s recent launch of marketing initiatives for Nathan’s (e.g. Nathan’s Nascar team) could drive incremental growth across all segments.

  • Interest expense reduction: when the Company refinances in 2017 or 2018, interest expense will decline from a lower rate.

  • Capital return: The Company has been repurchasing and recently initiated a large Dutch auction tender. The Company will return cash to shareholders as it always has over time, including a $25 special dividend early this year. Since 2001 the Company has repurchased more shares than total shares outstanding.

  • Acquisition: NATH should not be public over the long term and it would fit nicely into multiple CPG companies. Chairman and former CEO Howard Lorber was not previously interested in selling but with the recent debt raise the likelihood of a sale has increased. (Kraft owns Oscar Mayer, Hillshire owns Ball Park).

   

• Currently trading at ~13.8x 2016 earnings (cash-adjusted) and ~9.2x 2016 EBITDA, NATH is also undervalued on an overall multiples basis.

Business overview

NATH is more a licensing business than a restaurant business as it is generally misperceived. The revenue is weighted to the Company’s branded product program (BPP) and company-owned stores, yet the majority of profits are in the very high margin licensing and franchising businesses. The Company outsources all manufacturing. I break down the Company into four sub-segments as follows:

1. Licensing (18% rev, 66% Ebitda): most important segment and majority of EBITDA - licenses third parties to distribute Nathan's branded packaged products to ~37,000 supermarkets, Costco, Wal-Mart, Sam’s Clubs, Target and BJ’s

• Majority of licensing revenue is an 18 year licensing agreement with Smithfield Foods who has exclusive right to the supermarket category

• “Significant marketing dollars” provided by Smithfield as part of new 18 year licensing agreement should increase sales and drive further brand awareness.

• Smithfield is working to expand Nathan’s presence in additional POS as well as widening NATH’s offering at many POS, both of which should drive growth in this segment.

2. Franchises (~5% rev, ~16% Ebitda): Licenses the Nathan's brand and know-how to franchisees operating ~243 locations in the US and 62 abroad. Collects 5.5% royalty franchisee sales

• Royalties are fairly stable although slightly declined recently due to the closing of a few franchised locations and the currency impact from the franchisees abroad.

• Increased brand awareness and pricing should drive GDP-like growth in SSS.

• Company is growing the franchise business but more focused on the BPP segment.

3. Branded product program (~61% rev, ~13% Ebitda): sells to foodservice operators at various outlets including sports stadiums (e.g. Yankees stadium), restaurants, movie theatres (e.g. Regal), train stations, airports, etc. Distributes products through distribution agreements, primarily US Foods.

• This segment has grown nicely on the top line but margins have declined as beef prices, the main cost input, have increased. Beef prices have just recently started to decline, leading to future higher margins for this segment.

• The Company has internal resources dedicated to growing this segment.

4. Company-owned stores (~15% rev, ~5% Ebitda): Operates 5 restaurants in the NYC area, including the flagship Coney Island location

• Company operated restaurants are fairly stable and have seen an uptick recently driven by higher volumes and prices.

• Increased brand awareness and pricing should drive GDP+ growth in SSS although I’m not giving them credit for that.
  
  

• NATH has high operating leverage across the company operated restaurants, franchising and licensing businesses. The Company outsources all manufacturing of food and supplies - Smithfield (hot dogs) and ConAgra (french fries), therefore very low capex requirements – maintenance capex is below $1M per year.

• NATH conducts minimal marketing outside the hot dog eating contest. As part of its recent licensing deal with Smithfield, however, Smithfield has launched a number of sizeable marketing initiatives (paid for by Smithfield not Nathan’s) which should increase brand awareness and sales across all segments

• The Company also owns the Arthur Treacher’s brand and trademarks although I give no value to this. Arthur Treacher’s is a branded seafood menu-line extension for inclusion in certain Nathan’s Famous restaurants. The Company recently entered into its first multi-unit Branded Menu Program agreement with a foodservice operator for inclusion in non-Nathan’s facilities
  
  

Other relevant points

• In terms of key risks, a further and sustained increase in beef prices is a risk although all our data suggests that beef prices are beginning to decline and should fall further next year.

• The Smithfield agreement: In 2014 the Company signed an 18 year licensing agreement for the supermarket category with John Morrell (Smithfield subsidiary) with a royalty rate of 10.8% and significant minimum payments that increase annually. The agreement also required Smithfield to commit ‘significant marketing dollars’ to the brand.

• The debt deal: the company did a dividend recap by raising $135 million of bonds. The deal was done at an outrageous 10%. My understanding is that the Company expected a lower rate and at the last minute they were offered 10% and didn’t want to pull the deal. The bonds immediately traded up to 105 so clearly the bonds were mispriced. Much of the large dividend was treated as a capital return. Ultimately, it was not a good deal but I think the negative reaction to the stock associated with the deal is overblown.

• Management/Board: Management and the board are good capital allocators (with the exception of the debt deal) and very aligned given they own approx. 32% of the stock.  Chairman and former CEO Howard Lorber himself owns 20% of the Company.

Note: We also own the NATH bonds. These bonds are also mispriced even at the current 105 price, and 8.8% yield to maturity. The bonds are essentially protected by the 18 year Smithfield licensing contract, which includes guaranteed minimum and growing annual payments for the entirety of the contract. I also considered posting the bonds.

Catalyst

• Increase in the buyback tender price

• Continued strong results, particularly in the licensing segment driven by the increased marketing spend by Smithfield

• Margins expand as beef prices decline

• Russell index inclusion in 2016

• Sale of Company