Brazil Fast Food Corp operates and franchises Bob’s fast food burger chain in Brazil.  In addition, it is an operator of KFC and Pizza Hut franchises in Brazil.  An investor group led by the company’s CEO, Ricardo Bomeny, offered $15.50/share for the 26% of the company that the investor group did not already control.  The offer was withdrawn two weeks ago after the maneuver failed to attract shareholder support.

Interestingly, both the investor presentation for the going private transaction and the subsequent letter of withdrawal began and ended their commentary about the merits by referencing the macro environment.  However, this de-emphasizes the very attractive valuation of the company.

As a caveat, please keep in mind that this is an illiquid stock and does not have much volume.

The stock is trading at a modest 8.2x EV/EBIT (trailing twelve months), and just 1.1x revenues with operating margins greater than 11%.

Bob’s is Brazil’s second largest fast-food chain, behind only McDonalds, with about 640 locations.  Its chain includes more than 270 kiosks that sell burgers during Carnival (where it is the exclusive provider of burgers) and other special events.  Only about ten percent of the Bob’s outlets are company owner, with the rest operated by franchisees.

In 2007, the company entered an agreement with Yum! Brands to operate and expand the KFC brand in Brazil.  In 2008, the company acquired control of Brazil’s largest Pizza Hut franchisee, adding 14 Pizza Hut locations.  Later in 2008, the company entered an agreement with one of the leading food service companies in Chile to roll out the Bob’s brand in Chile while simultaneously bringint to Brazil the Doggis brand, which is Latin America’s largest hot dog fast-food network.  In 2012, BOBS added Yoggi’s frozen yogurt company.

Combining all of these operations, BOBS has 1,085 points-of-sale. 

The company stated that one of their primary reasons for wanting to go private is because they are an orphaned stock with limited analyst following and as such would have difficulty with a capital raise.  In addition, the company’s status as a U.S. corporation disqualifies it from favorable government loan programs in Brazil.  The company wants to invest in branding, and said that the depressed EBITDA resulting from this investment will probably not be received well by shareholders, and that was their justification for wanting to go private.

In their own words, due to the combination of macro-economic headwinds and the company’s intention to increase its investment in branding, the 74% inside ownership wanted to provide a timely exit for the 26% minority shareholders in order to “reduce the uncertainty” for those shareholder.  The presentation was remarkable for the number of times that the board members emphasized that the buy-out must be fair given the fairness opinion’s valuation, the premium over historical prices, and the dismal macroeconomic forecasts. 

Another rationale for the management buyout price was that since the minority shareholders of BOBS have always been aware that they were minority investors and that they would always be completely dependent on whether or not the controlling investors would make their shares available in a strategic transaction, and therefore the minority shareholders “would not be able to obtain a control premium for their stake should the controlling shareholders decide to not make their stock available” (49:30 into the conference call).  “This element should have been taken into consideration by minority shareholders when they purchased shares in the company.”

Needless to say, the controlling shareholders said that they would not sell to a competing transaction. 

A friend of mine mentioned this obscure stock over a year ago and referred to Bob’s as the In-N-Out Burger of Brazil.  Of course, that is just one person’s opinion and many In-N-Out fans would say that there can be no such thing.  However, even if Bob’s was the Jack-in-the-Box of Brazil, I’d suggest that 8x EV/EBIT is still too modest of a price. 

Here are a few valuation points of comparison to some well-known U.S. fast food stocks:

TTM  EV/EBIT:

BOBS                     MCD                      WEN                      PNRA                    JACK                      YUM
8.2x                        12.1x                     21.4x                     15.0x                     15.9x                     18.7x

However, earnings are not the entire story.  There is considerable brand value to the Bob’s hamburger chain and to the company’s further affiliation with the other strong brands represented by its over one thousand points of sale.  In addition, Coca-Cola has maintained an exclusivity agreement with BOBS since 1996.  This was renewed in the spring of this year at yet another increase for BOBS.

Brazil has been undergoing tremendous transformation over the last decade, and the growth of its middle class has been dramatic.  In addition, Brazil will be hosting the 2014 World Cup and the 2016 Summer Olympics.  Of course, management cited the latter two events as negatives, given the exclusive sponsorship deals awarded to McDonalds and the historical tendency of revenues to decrease during World Cup matches.  At eight times EBIT, I think there is some margin of safety that protects investors from all the worrisome possibilities of hosting two of the largest sporting events of the decade.

On November 18^th, BOBS reported third quarter results.  Keep in mind that this is a business with a $113M enterprise value valuation (the current quarter figures that were reported in R$ have been translated to $USD using today’s exchange rate of 2.38, however, the percentage change YOY is reported as if only in R$--this distorts as the Brazilian Real is a volatile currency):

• For the quarter, system-wide sales totaled $141 million, up 26% year-over-year.
• Points of sale totaled 1,085, up from 983, an increase of 10.4% YOY. 
• Revenue totaled $29.4 million, up 28% YOY.
• Operating income increased 4% to $3.3 million, while net income decreased 12% to $2.2 million.
• Earnings per basic and diluted share were $0.27, down from 12.3% YOY.  

Earnings YTD before income tax were $R 24.2 million, which gives an annualized rate of $USD 13.6 million.  This is a current EV/EBIT of 8.3x.  EBITDA was R$ 30.0 million YTD, which annualizes to a 6.7x EV/EBITDA multiple.

At the current valuation, it is a matter of investor preference how to project a valuation.  Given the recent failure of management to take this private, any paths that suggest a take-out premium or a maneuver to relist in Brazil are probably unlikely.  Therefore, it makes sense to assume that the valuation of the stock probably follows along near its current valuation levels.  However, today’s valuation more than compensates for this given the earnings yield and growth rate..  Obviously, there is some additional risk as this stock may go back to its status as “value-without-a-catalyst”, and as with all pink sheet stocks, particularly those that represent a non-U.S. business, anything can happen.   

DISCLAIMER:

This is not mean to be a buy or sell recommendation, and my firm frequently has both long and short positions in many of the securities mentioned.