Description

Levy Acquisition Corp is currently a $210M SPAC formed by Larry Levy the co-founder of Levy Restaurants, an international food service organization with over $1 billion in annual revenue. On March 11^th LEVY entered into an agreement to acquire Del Taco through the merger of a subsidiary into Del Taco. At current levels LEVY gives you the ability to invest in a leading Mexican QSR chain with a loyal following at ~9x ’15 EBITDA compared to comparable companies trading at an average of 16.5x (median of 17.6x) and its two closest comps LOCO & FRGI trading at 19.4x and 18x respectively. Coupled with this cheap valuation you are getting a seasoned & successful restaurant operator in Larry Levy who is personally investing ~$125M of his family money alongside the SPAC a clear signal of the opportunity he sees with this brand. This investment opportunity exists because of the fact that LEVY was previously a SPAC and these entities have little to no sell side coverage, and the official listing and closing of the deal will not occur for several months. You have several catalysts including the recapitalization which is set to occur in the middle of this month along with the preliminary proxy statement, followed by the public merger resulting in Del Taco becoming publicly traded in June. LEVY warrants are materially mispriced offering north of 300% upside compared to 23% downside for an astonishing risk/reward of ~13x.

Del Taco Overview

Del Taco is the second largest Mexican QSR in the US based on unit count but it has plenty of white space for expansion opportunity. The company is a regional icon on the West Coast with a successful and long-term track record in Southern California. Del Taco started in 1965 by a group of individuals including Ed Hackbarth & David Jameson. After experiencing rapid growth during the 1970s the founders sold the controlling interest in the company in 1976 to a group of investors who later had sold the rights to use & develop the Del Taco name throughout the United States to W.R. Grace. After expanding regionally in the 1980s the company exhibited exponential growth in the 1990s and filed for Chapter 11 in 1993. While growth stagnated in the 2000s the current President & CEO Paul Murphy joined the company in 2009 and has led the path to revitalization. At present Del Taco has grown to approximately 550 restaurants across 16 states.

John Cappasola was named the Chief Brand Officer in 2011 and the company began to address every facet of their business from their stores, to their menu, to their staff, and image. The company strategically changed the conversation surrounding it’s store form Price Value to Quality. It began with the ambience shape-up where they reimaged the stores focusing on critical guest facing elements.  100% of the company owned restaurants completed their renovation by the Summer of 2013 and 85% of system-wide restaurants have been reimaged to date. The company accelerated operational improvements, retrained their staff, created a fresh value pricing platform, renovated the menu & introduced new products, and put this all together in an advertising campaign that has started to pay dividends. The company has exhibited 10 consecutive quarters of company owned SSS-growth after the introduction of this program currently at  ~6% run-rate.

Del Taco is positioned between Taco Bell & Chipotle on the quality spectrum sitting at the cross roads of more traditional QSR & Fast Casual. They focus on fresh & high quality ingredients that are made-to-order from their kitchen. They introduced their UnFreshingBelievable® campaign which emphasizes the high quality of their food, their fresh ingredients, and the working kitchen. Their tiered menu strategy is designed to drive traffic growth & grow the average check, while enabling pricing flexibility and margin growth. Using this tiered strategy Del Taco has been able to appeal to a diverse set of preferences & budgets capturing a broad consumer base irrespective of macroeconomics. They have 3 large buckets that they consider “Buck & Under” which leverages their low price variety to drive traffic, their “Mid-Tier” which focused on meal & price point variety, and their “Premium” which focuses on freshness & quality. Simply put Del Taco offers High Quality Food at a Tremendous Value. When taking a look at the average check size Del Taco is clearly the leader in value. The average check size at Del Taco is $6.49 compared to Taco Bell at $7.20, Chipotle at $10.17 and Qdoba at $10.93. However at this price point they do offer superior value to your traditional WSR players with freshly grilled ingredients on site including a wide range of options showcasing a mix of Mexican inspired cuisine along with American classics. In an August 2014 Consumer Report Del Taco was voted #1 for fast food value across all fast food categories and the food was rated higher than Taco Bell despite it’s cheaper price point.

There is significant whitespace for growth in both the core and new markets with a nice tailwind of the growing Mexican food category. At present there are 304 company & 243 franchised owned restaurants across 16 states predominantly in the west coast along with several southern states including Texas & Florida. California is far and away the biggest region with 243 company owned and 122 franchised restaurants.  The company estimates they have the ability to reach 2,000 units which puts them at ~27% of what they view their addressable market is. Having the brand loyalty and customer satisfaction in Southern California and the South West will bode well for domestic expansion towards the Midwest and Northeast. They recently announced their move to the New England area and they plan on opening their first NJ franchise in June of 2016. Broadly speaking the Mexican Limited Service Restaurants have outperformed the broader restaurant industry with sales growing 6.1% YoY between 2012-2013 and 5% YoY between 2014 and 2013 compared to total LSR sales growing at 3.5% and 2.8% respectively.

Leading the operational turnaround and repositioned brand along with the expansion efforts is a proven & experienced management team economically aligned with shareholders. Larry Levy who will be the Chairman of the Board founded Levy Restaurants in 1978 and grew It from a Single Chicago Delicatessen into an International Food Service Company that Generates over $1 Billion Dollars in Revenue. He was awarded the 2001 Ernst & Young Master Entrepreneur of the Year Award and has spent the better part of the past 40 years in the restaurant, hospitality and real estate space. Larry has proven ability as a value added partner with deep restaurant and real estate experience focused on guiding strategic decisions and growth, enhancing marketing strategy, and leveraging his network for further strategic relationships. At 71 years old he has already made hundreds of millions of dollars in his career but is investing $125M of his family’s money alongside the SPAC a clear signal of the opportunity he sees ahead. Pro Forma for the deal Levy & his family will own ~8.5% of the company clearly aligned with shareholders. Paul Murphy is the President & CEO of Del Taco, and he has more than 30 years of restaurant experience with a focus on limited service chains and a proven track record for brand growth, strategic planning and operations. Paul was formerly the CEO of Einstein Noah Restaurant Group.

Transaction Overview

On 3/11 Del Taco signed a definitive merger agreement to merge with a subsidiary of Levy Acquisition Corp. The merged company will retain Del Taco’s name. The transaction is structured to de-risk the closing by means of a two-step process.

Step 1 Recapitalization of Del Taco (estimated Mid-March)- A $120 million investment by the Levy family and strategic investors for an approximate 46% equity ownership in Del Taco at a $500 million enterprise value before transaction fees & expenses. This investment will be exchanged for common stock in LEVY valued at $10/share at the closing of the merger.  The majority of Step 1 proceeds, including $35 million of additional senior debt, will be used to retire approximately $111 million 13% PIK Subordinated Notes and help strengthen Del Taco’s balance sheet. The remaining portion of the Levy Syndicate investment will be used to acquire common stock from current shareholders of Del Taco. The preliminary proxy statement is expected to be filed with the Sec in mid-to-late March.

Step 2 Public Merger Resulting in Del Taco Becoming Publicly Traded (estimated June)- LEVY will simultaneously enter into a definitive merger agreement for consideration reflecting the same valuation as the Step 1 investment. Upon the closing of the merger, private investors will invest an additional $35 million at $10.00 per share into the merged company, which will be used to fund the cash portion of the merger consideration. At $10.00 per share, the transaction implies an enterprise value(1) of $558 million or less than 9.0x 2015 Adj. EBITDA for the merged company. The $150M of cash in Trust after redemptions will be using according to the following waterfall: 1) Pay Step 2 transaction fees and expenses (~$22M), 2) Acquire up to $60M of incremental shares of Del Taco from current Del Taco shareholders, and 3) General corporate purposes.

Valuation

The most compelling part of the story is how cheap you create this exposure right now especially through the use of the warrants LEVYW. Pro forma for the acquisition assuming no share redemptions Del Taco will have 37.5M shares outstanding along with 12.25M warrants struck at $11.50 and an additional 975k shares to be issued subject to earn outs. Assuming no redemptions pro-forma net debt will be ~$165M, implying an EV at trust of ~$550M ($10/share). Based on 2014 EBITDA of $58M you are creating Del Taco at a multiple of 9.4x compared to QSR comps at an average multiple of 16.3x (median of 17.5x) and it’s two closest comps LOCO and FRGI at 19.4x and 18x respectively. LEVY’s AUV is lower than the peer group at ~$1.2M compared to QSR peers at $1.8M so it will likely trade at some discount. Assuming 14x ’15 EBITDA (a 2 turn discount to the broader QSR space and a 4 turn discount to its’ closest peers) of ~$60M you get a $18 stock compared to $11.14 last or 61% upside from current levels.  In a bear case scenario trading at less than ½ the multiple of the comps (8x) you get an $8.40 stock (25% downside). In a bull case scenario where it trades at a 1 turn discount to comps you get a $19.60 stock (76% upside). LOCO is a particularly interesting comp especially given  how well received the company was post IPO and I think you can see a similar path for Del Taco.  LOCO has 405 units in 5 states and is doing ~$330m in total revs. vs. Del Taco’s 546 restaurants in 16 states doing $396M in total revs.  

Warrants- The warrants are particularly interesting to take a look at and offer asymmetric risk/reward (LEVYW). There are 12.25m warrants outstanding with a strike price of $11.50. On Bloomberg it says they expire in 2018 but that is just an estimate, in the prospectus for the warrants it states they will expire 5 years after the completion of their initial business combination which would put a more accurate expiry time frame of ~June of 2020 or an additional 2 years of time value. Running a scenario analysis if LEVY were to trade at ~$18 by year end 2015 the warrants should be worth ~$7.64 vs. last sale of $1.85 or 313% upside from current levels. In a downside scenario with the stock trading at a 50% discount to peers or 9x EBITDA the warrants would be worth $1.45 or 23% downside from current levels or 13.2x risk/reward. 

Catalyst

Step 2 of the merger process will be a catalyst for the shares when Del Taco becomes publicly traded & the Del Taco name is retained. Once it begins trading you have a small cap QSR company with a 50 year track record of success, with best in class operators trading at a 50% discount to it's closest peers. This valuation discrepancy won't last long.