Capital

Restaurants and SPACs

This may come as a shock, but 2020 will probably live long in our collective memory.

“Why??”, you might ask. “It’s not like my job just sorta moved in with me while I was moonlighting as an unpaid schoolteacher and training to become a freelance epidemiologist.”

I know. It was a snooze-fest.

That is, of course, unless you just cannot get enough of esoteric financial machinations – and, let’s be honest, whom among us…

2020 will obviously live on as the Year of the SPAC.

For the uninitiated, those requiring a quick refresh and those who’ve spent the past year obsessing over more trivial matters…

SPACs??

A SPAC – or special purpose acquisition company – is a non-operating shell company, that exists solely to raise money via initial public offering (IPO), in order to use those funds to acquire an existing company. Once the acquisition is complete, the entities are merged, and the resulting company continues to trade publicly, under the acquired company’s name.

SPACs offers units (shares of common stock, and warrants) to investors, via traditional IPO, typically at a price of $10 each. Investors then have the option of exiting their investments prior to an acquisition, either by selling on the open market or redeeming units for a piece of IPO proceeds held in a trust. Those that stick around enjoy the upsides and the risks associated with the underlying business of the acquired company.

Given their monumental spike in popularity, one might conclude that SPACs are financial engineers’ latest flavor of the month. However, SPACs have existed for more than 15 years. The timing of their “discovery” and widespread deployment by corporate movers and shakers is surprising only in that it took so long to arrive.

COVID-19 upended life and business as we know them, and triggered a doomsday scenario for countless businesses – namely restaurants. It’s worth noting, however (as I have here, at some length;) that most restaurants’ very existence, even in the best of times, is a constant struggle. While COVID thrust thousands of eateries into a desperate life-and-death battle, it largely just exacerbated challenges inherent to the industry.

Even in the Before Times, a number of prominent names in the dining space were on the brink of collapse. For years, beleaguered brands clung to life through investments and debt provided by financial sponsors and private investors. In many cases, these companies wound up in the portfolios of private investors and buyout firms. With the financial markets riding a vaccine-fueled wave of optimism (on the heels of 2020s less easily explained market surge), shareholders are seizing upon opportunities to exit these investments, quickly and at a guaranteed price. Enter the SPAC.

In essence, SPACs represent a means by which shareholders can take companies public, without the financial and regulatory burden of a traditional IPO – obligations that were met during the SPAC’s IPO process. As an added bonus, while a traditional IPO calls for valuations to be determined, over time, based on a variety of factors (the sentiments of bankers and investors, previous financing rounds, recent, comparable offerings, etc.), a SPAC merger locks in a price at the time of the agreement.

In 2020, 248 SPAC IPOs generated gross proceeds of approximately $83 billion. This was nearly half of all IPO proceeds. These marks not only dwarfed 2019’s records – deal volume was up 320%, and proceeds jumped 525% – but, according to Deal Point, topped the totals of the previous five years, combined.

Of course, that record has already proved ridiculously short-lived. In less than four months, 2021 has already seen more SPAC IPOs (308, or 76% of all IPOs) than in any previous year have already raised nearly $100 billion (64% of all IPO proceeds). In fact, according to data provider SPAC Analytics, 2021 has already accounted for 32.6% of all SPAC IPOs and 39.4% of all SPAC proceeds. EVER.

Typically, a SPAC’s value to outside investors lies in the confidence that an experienced and savvy management team is bargain-hunting for quality assets. A market the likes of which we saw in early- to mid-2020, in which valuations were depressed, is an ideal backdrop. However, with the markets repeatedly brushing aside any specter of vulnerability, the current environment is more fraught. These are days seem far more suited for those looking to cash out their winnings and leave the tables than to shrewd discount shoppers.

Vroom, VROOM… FAST Wastes Little Time

Several months ago, we highlighted FAST Acquisition Corp. (NYSE: FST), which began trading on the New York Stock Exchange in August 2020, following a $200 million IPO. Headed by Ruby Tuesday founder Sandy Beall, &Pizza board member Doug Jacob, &Pizza and Qdoba Mexican Grill Chairman Kevin Reddy, and former CEO of José Andrés’ ThinkFoodGroup Kimberly Grant, FAST’s stated goal was the acquisition of an “iconic” fast food or fast-casual brand “with strong drive-through/takeaway business and the potential for international expansion… with annual earnings before interest, taxes, depreciation, and amortization (EBITDA) of up to $150 million, and enterprise value in excess of $600 million.”

On February 1, 2021, FAST Acquisition confirmed plans to acquire Fertitta Entertainment for a staggering $6.6 billion, or 9.25x Fertitta Entertainment’s estimated 2022 EBITDA of $648 million. Fertitta Entertainment – solely owned by Tilman Fertitta, who also owns the NBA’s Houston Rockets – is the parent company of Landry’s, which owns more than 500 restaurants under the Bubba Gump, Chart House, Del Frisco’s, Mastro’s, Morton’s, and Rainforest Café brands. Anyone looking to snap up some iconic dining names would be pleased with that portfolio.

However, the fate of this mega-deal will ultimately rest on a trip to the casino(s). Of far greater consequence than Landry’s impressive dining portfolio are Fertitta’s five land-based Golden Nugget casinos (two in Southern Nevada, and one each in Louisiana, Mississippi, and New Jersey) – whose $4.6 billion net debt comprises the lion’s share of the deal’s enterprise value – and its i-gaming business, Golden Nugget Online Gaming (NASDAQ: GNOG). GNOG went public in December, via its own merger with a SPAC, Landcadia Holdings II, which is backed by Fertitta and investment bank Jefferies.

As part of this transaction, FAST will acquire 46% (31.35 million) of GNOG’s shares and assume control (79.9%) of the business’ voting rights. It’s worth noting that GNOG has been profitable in New Jersey for the past five years, and grew revenue by more than 60% in 2020, and is expanding (as online gaming does) into new states.

The deal, Fertitta’s fourth SPAC, also calls for (“assuming no redemptions”) the SPAC itself to contribute $200 million in cash in a trust, with institutional investors committing $1.2 billion of PIPE (private investment in public equity) financing, at a price of $10 per common share. Once the deal is completed (slated for Q2 2021), Fertitta will remain the Chairman, President, and CEO, with an ownership stake of 60%, valued at $2.12 billion. PIPE investors will own 35%, with FAST sponsors holding 1%, and the remaining 4% going to public investors.

From FAST’s perspective, this deal is quite the swing for the fences. An anticipated ~$600 million pursuit of casual dining assets has culminated in a gaming play of more than ten times that amount. It’s an abrupt deviation from the intended path and one that disproportionately tilts the odds in favor of Fertitta, who fared so well, in fact, that barely six weeks after announcing a $6.6 billion deal, he got the band right back together to launch the $200 million, Fast Acquisition Corp. II. “Fast II” will target hospitality businesses, including restaurants, hotels, and other “adjacent verticals” such as amusement parks and entertainment venues.

Trust in Tilman??

Despite public affirmations of his wealth and liquidity in the face of the pandemic, the onetime “world’s richest restaurateur”, took out a nine-figure “lifeline loan” with a near-consumer-credit-card interest rate. This, of course, came less than three years after he financed virtually all of his $1.75 billion purchase of an NBA team through a $1.42 billion bond issue, assumption of $175 of existing debt, and a $275 million loan… from the guy who was selling him the team… all while his businesses had less than $300 million in cash on hand.

It’s not great.

From an investor’s perspective, neither is the fact that nearly 85% of the seemingly impressive $22.5 million operating profit for Golden Nugget’s physical casinos over the first nine months of 2020 was attributable to interest expense, with pre-tax income coming in at just $3.4 million.

Consider also that the deal’s presumed crown jewel, GNOG, was itself once financed by an interest-only loan, with an interest rate exceeding 12%. Since GNOG went public, that rate has fallen to 6%, though the Company still had a debt load exceeding $140 million – over 80% of its $171.7 million in assets. As with Fertitta’s terrestrial gaming assets, once financial machinations (interest and other expenses) are taken into account, GNOG’s 2020 operating profit of $24.5 million evaporates, leaving a pretax loss of $39.4 million.

High Stakes

It’s entirely possible that casinos, whose shares have rebounded handsomely over the past year, in some cases to all-time highs, will continue to churn out above-market returns.

It’s also possible that Fertitta’s assortment of dining brands, often situated in office- and tourist-heavy locales, thrive in an environment in which: a) many affluent office workers are still working from home; b) in some cases never to return to physical offices full-time; and c) business travel (and accompanying expense accounts) are still largely non-existent.

And yes, as gambling is legalized across the nation, an established, growing player in the space is undoubtedly an attractive asset. It would, however, be preferable if that, the most attractive element of a ten-figure transaction, was not debt-laden, and facing increasingly fierce and less leveraged competition.

It’s entirely possible that all of this goes exactly to plan. Of course, it’s important to ascertain that that plan is not for a new crop of investors to fund the other guy’s escape hatch.

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