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I recommend a long position in Frisch’s.  I think fair value is around $40 or higher vs. today’s price around $27.50.  I also think investors will see a special dividend in the near term. The company just sold its Golden Corral business for $49mm and management has made it clear acquisitions don’t fit the new strategy and the float is limited so a repurchase isn’t ideal either.  They could sit on it but if you talk to them I think you’d reach the same conclusion that they are going to pay down debt and make a distribution to shareholders.

Up until a week ago Frisch’s operated two segments: Golden Corral and Big Boy’s.  Golden Corral (GC) is a buffet-style restaurant concept offering customers an all-you-can-eat experience at moderate prices.  (Sizzler was once a more common concept in the North East so if you ever made the mistake of eating at a one, than you are familiar with the GC concept.) 

Big Boy’s is a full service moderately priced family-style restaurant concept with drive-thru service.  Big Boy’s was born in 1946 and their claim to fame is the Double Decker Big Boy sandwich.  At year end 2011 they had 120 units, (95 owned, 25 licensed) and they own the land and building at 80 of these locations.  Today most of Frisch’s Big Boy restaurants are located inIndiana,Ohio, andKentucky.

A week ago management sold the GC business to Golden Corral’s corporate arm for $49.8mm and the divestiture was long overdue.  Starting in 1998, Frisch’s entered a series of area development agreements to open Golden Corral restaurants in severalMidweststates and I estimate they invested over $100mm since 2001 to build 30 units.  The result of the investment was marginal profitability at best and a loss at worse (after allocating corporate overhead, I arrive at a ten year aggregate EBIT value of negative $4.1mm). 

The sale of GC will add $49.8mm to cash and after accounting for $24.9mm in debt, $1.8mm in capital lease obligations, $8.9mm for an underfunded pension, and $5.2mm in cash, Frisch’s will have a net cash balance of roughly $19.4mm.  There are 4.94mm shares outstanding so at yesterday’s closing price of $27.60 the EV is roughly $117mm and Frisch’s trades for 4.7x EBITDA (4.2x normalized EBITDA).  I think a fair multiple is 7x or more and speculate the quality of the Big Boy’s franchise has been overlooked by investors due to Golden Corral polluting the P&L for over a decade. 

A little background on Frisch’s and Big Boy’s:

- Frisch’s has been publicly traded since 1960 and since then they have reported a profit every year and have paid a dividend every quarter (currently a 2.3% yield).  This performance was not a result of GC.

- Despite the Big Boy’s unit count growing from 88 units in the year 2000 to 95 by year end 2011 (8% growth), revenue has increased from $153mm to $200mm (31% growth).  This revenue growth only amounts to a 3% CAGR but it demonstrates it’s not a terrible business. 

- Big Boy’s has consistently posted EBITDA margins of roughly 14% which corresponds to normalized EBITDA of around $29mm on trailing revenue. 

- Big Boy’s has consistently earned a 9% pre-tax FCF margin which corresponds to $18-$19mm in pre-tax FCF using ttm revenue (defining pre-tax FCF as EBITDA less maintenance capex).

Note on pre-tax FCF margin: I considered maintenance capex to consist of spending in three areas; annual renovations, replacement units, and spending on dining room expansions and kitchen redesigns.  Kitchen redesigns and dining room expansions could fall under the area of growth capex but without the redesigns and expansions, it seems to me it’s possible the units would have been considered stale, and since the company reports they regularly spend in these areas, I dropped them into the maintenance capex bucket.  If you put these items in growth capex, the pre-tax fcf margin jumps from 9% to 12%.

Big Boy’s earned roughly $25mm in EBITDA in 2011 and $19mm in pre-tax FCF which implies a multiple of 4.7x EBITDA and 5.9x pre-tax FCF.  I estimate normalized values are closer to $29mm in EBITDA and $18.5mm in pre-tax FCF (maintenance capex was a little light last year) which implies multiples of 4x and 6.3x, respectively.  Currently peers trade for around 7x and historically they have traded above that.

EV/EBITDA Multiples for Peers (current multiple / avg. historical multiple)

Biglari: current multiple of 7.3x / avg. historical multiple of 8.1x

Dennys: 7x / 6.3x

Red Robin: 6.5x / 8.8x

Bob Evans: 6.4x / 7.3x

Average: current 6.8x / avg. historical multiple 7.6x

Adjusting for the GC sale and assuming a $117mm EV, at 7x $25mm in EBITDA (2011 figure) Frisch’s would be a $39 stock.  At 7x normalized EBITDA of $29mm, Frisch’s would be a $45 stock.  These targets represent upside of 42% and 64%. 

I expect the multiple to increase because going forward the P&L won’t be polluted by the ball and chain margins of Golden Corral and the profitability and consistency of Big Boy’s will become more apparent. 

While 7x EBITDA provides decent upside, I don’t think 8x is entirely unreasonable because Big Boy’s has posted industry leading margins nearly every year since 2000, so as a higher margin operator, an argument could be made they deserve a higher multiple.  Below are some tables with adjusted margins for some of their peers and Big Boy’s is consistently at the top of the range. 

In the near-term I expect Frisch’s to announce a special dividend to distribute the proceeds from the GC sale.  I’m not sure how much will be distributed but they certainly don’t need all this cash and conversations with the company support this view.  Their strategy has been to refocus on Big Boy’s and enhance shareholder value so an acquisition wouldn’t make much sense and management makes that fairly clear.  As for a repurchase, there is already a limited float and management doesn’t want to reduce the universe of potential investors even more so a buyback seems to be off the table too.  They agree they don’t need all this cash so this leaves a distribution as the likely option.

Below is a table with my target prices based on 7x-8x EBITDA using 2011 EBITDA and normalized EBITDA using ttm revenue.  2012 EBITDA will likely be within this range so I think a fair target is north of $40 (the thesis doesn’t require nailing EBITDA to a precise amount).

In summary, Frisch’s has a decent business in Big Boy’s but the P&L has been distorted by the Golden Corral operation and a decade of poor capital allocation.  With the sale of Golden Corral, Frisch’s will have a clean balance sheet and a consistently profitable restaurant that deserves to trade in-line with peers, if not above. 

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