Thesis

Nathan's Famous is in the business of selling its delicious all-beef hot dogs, flavored with its secret blend of spices developed by Nathan & Ida Handwerker in 1916.  The company sells its products (mainly hot dogs, french fries, and soda) through a variety of outlets: franchised stores, company-owned stores, through other food stores, and at grocery stores via a licensed products program.  The company is run well, and has steadily increased revenue, EBIT, and EBIT margin over the past 5 years, with a sharp focus on low-capex, high-margin licensed products and branded products sales. 

Stock price is $16/share, 5.7m shares, $92m market cap, $36m net cash, $56m EV.  In FYE 2010, company did $50m revenue and $7.5m EBIT on $5m net invested capital, ex-cash.  Valuation is 7.4x EV/EBIT or 12x earnings (ex-cash balance & interest income).  The company has repurchased $16m shares in the past 3 years at an average price of $12/share.  Stock is thinly-traded at roughly 10k shares/day, so is for individual accounts only.  At 10x EV/EBIT on FYE 2011 EBIT of roughly $8m plus net cash, I think stock is worth in the low $20's/share.

Business Description

As mentioned above, Nathan's operated through a variety of channels.  Sales numbers are all for FYE 3/31/10, which company refer to as Fiscal 2010.

Franchised stores - Franchise royalties were $5m on $92m franchised unit sales.  The company has 220 franchised units in 25 states in the U.S., and 20 units in four foreign countries (15 units in Kuwait).  Franchised same-store-sales are down 6% and 7% in past two years, which is a concern insofar as it is imporant that franchises remain economically viable.  In FY 2010, the company signed master franchise agreements in China & Canada.  The company has 140 franchisees.  Foreign units are a tiny fraction of overall sales and I do not anticipate they will be a material contributor for the foreseeable future.

Company-owned stores - $12m sales, 5 stores.  These stores are all based in the New York City area, including 3 in Coney Island.  The original store in Coney Island and is host to the Nathan's International July Fourth Hot Dog Eating Contest, which has been televised on ESPN since 2004.  1.7m people watched this year, up 25% year-over-year.  This is valuable publicity for Nathan's, especially as it relates to sales of Nathan's products in grocery stores.  Fun fact: Nathan's is Mcdonald's oldest chain store customer.

Branded-products program & Branded-menu program - $25m sales.  Nathan's developed its Branded products program in 1998 as a way to sell its products through additional outlets and piggy-back on the infrastructure of other outlets selling food: Auntie Anne's pretzels, in Subways at Wal-Mart, in Foxwoods Casino, at Yankee Stadium, etc.  Sales have been growing in high single-digits over past few years.

License program - $6m sales, royalties are 3-5% of sales.  Nathan's licenses its products through a variety of channels, mainly to grocery & club stores and through the food service channel.  Sales have been growing in double-digits for past 5 years.   Nathan's is embroiled in a lawsuit with its licensee, SMG, and the matter is going to trial in 2010.  I believe this fight is over economics and will not ultimately result in a large hit to Nathan's economics.

Management & Stock Ownership

Howard Lorber, longtime Chairman & CEO (1993-2006 CEO, 1990-2006) owns 17%, Directors & Officers own 28% in total.   A number of funds own stakes in 6-8% range (Steel Partners, Dalton Greiner, Gabelli, etc).  Eric Gatoff is CEO.  He joined the company at age 33 as general counsel in 2003 and became CEO in 2007.  He was formerly a lawyer at an intellectual property firm, and from the letters to shareholders, I take it that he understands the value of the Nathan's brand and is attempting to capitalize on it through the most efficient means available.

Risks

Blowing the cash - the company has $6/share in net cash, so there is a risk they blow it.  Management's actions in the past few years (repurchases, divestiture of two small concepts - Miami Subs and NF Roasters for combined $7m in 2007-2008, focus on licensing) are positive in regards to capital allocation.  I have been able to contact management on the topic of why they are sitting on such a large cash balance.

Deterioration in Franchise sales - Franchise comps have been weak for the past two years.  This doesn't really have a big short-term impact on NATH financially, but to the extent that the concept becomes unviable, it is harmful.  Management is working on a new streamlined concept that is basically just hot dogs and fries and is lighter on required capex for franchisees, as mell as its Branded Products/Menu program wherein Nathan's products are basically tacked on to other QSR menu's.  This works due to the nature of Nathan's products (hot dogs as good add-on but not necessarily an entire concept) and Nathan's very high product recognition.

Lawsuit with licensee - see above.