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Summary

  • As TAST normalizes margins from the 2012 acquisition, finishes the 20/20 remodel and executes the stated roll-up opportunity acquiring BK stores at 1-3x EBITDA, EBITDA should increase from $40m to $115m+.
  • TAST has tremendous operating leverage to increasing sales, due to temporarily high operating expenses from the recent spin-off.
  • A $67m capital raise unlocks $20m additional cash, while allowing TAST to refinance the 2015 debt at ~60% lower interest expense, generating 28.6%+ upside from this catalyst alone.
  • TAST has world-class management, who own 9% of equity, while the famous 3G Capital Partners took 29% equity stake and 2 board seats at ~$6 per share, with a 30-month lockup.
  • My estimates ignore "free option" from a 3G-driven BKW turnaround or valuation multiple expansion. If 3G is successful, a >$30 TAST stock price is not unreasonable.

Carrols Restaurant Group (NASDAQ:TAST) is in the initial stage of a growth plan set to increase EBITDA 300%+ from the current $40m to $115m+ over the next 2-3 years. Simultaneously, temporarily dynamics are hiding the "normalized" earnings power and growth. I estimate TAST trades at <5.5x 2016 run rate free cash flow. This completely excludes the "free option" of 3G's effort to improve the Burger King Worldwide (BKW) brand or multiple expansion.

The current $6.88 stock price is just slightly above where legendary PE firm 3G Capital Partners (who controls BKW) took a 29% equity stake with a 30-month lockup, and my medium term price target is $18 per share. While I believe TAST offers a low-correlation 100%+ upside over the next 18 months, I am more interested in the longer-term multi-bagger potential from a top-tier management team deploying capital at very high returns into the organic, and a virtually "endless" roll-up opportunity they are actively executing on. With multiple identified near-term catalysts and increased investor relations effort as management just attended two conferences in the last week, I expect TAST stock to re-rate to reflect the growth opportunity.

  1. As TAST finishes "truing up" the underperforming ~50% of its store base acquired in 2012 from BKW, EBITDA margins in roughly half of its stores will increase from 7% to 11%+. This will drive earnings growth, and this alone should increase the run-rate EBITDA by ~$11m.
  2. TAST's 20/20 Store Refresh is generating 15-20%+ returns, and is only 1/3rd rolled out. This will further drive earnings and revenue growth as this rollout is completed.
  3. Most importantly, TAST has $87m in cash to deploy into an "endless" and uniquely accretive roll-up opportunity. TAST is BKW's hand-chosen acquirer, and due to sustainable scale and operational advantages, is acquiring stores for 1-3x pro forma EBITDA. Pure play restaurant operators with scale trade for 7-10x EV/EBITDA in the public markets, and TAST shareholders capture this "multiple arbitrage" with each acquisition TAST makes. TAST has near-term runway to nearly double its current 560 store count, with literally thousands more stores after.
  4. TAST has tremendous operational leverage, with temporarily high operating expense due to a recent spin-off. As revenue increases, earnings will increase dramatically as TAST grows into its infrastructure.
  5. The recent $67m capital raise will unlock an additional $20m in restricted cash, while allowing TAST to refinance its 2015 debt at ~60% lower interest expense. Capitalizing the interest savings at 10x is worth an additional 28.6%+ upside to the stock from this catalyst alone.
  6. My estimates ignore the tailwind TAST will get if 3G succeeds with its BKW brand turnaround. If 3G can drive BKW sales/stores above Wendy's levels, it is not hard to derive a >$30 stock price for TAST in a few years. While my personal view is 3G will likely succeed, TAST is an attractive investment without this, and so, to be conservative, I value this at $0 and call it a "free option".
  7. Investing in TAST is an opportunity to partner with some of the best managers and investors in the world who own a lot of TAST stock. TAST has a top-tier management team of BKW "lifers" with demonstrable evidence of superior execution, who own 9% of TAST stock. TAST is also partnered with one of the best private equity firms in the world, 3G Capital Partners, who owns ~21% of TAST equity with board seats and a lockup into 2015 on its equity.

Key Risks:

  1. TAST has financial and operational leverage; while I view that as a positive to the equity, if TAST management fails miserably, the operational and financial leverage cuts both ways. I believe this risk is mitigated by the $80m in cash, with no near-term debt maturities, and rapidly-growing EBITDA.
  2. I believe TAST's current valuation ascribes zero value to a successful BKW brand turnaround by 3G. However, if 3G should fail miserably and BKW goes into terminal decline, the operational impact on TAST would be material. I view this as unlikely, since 3G is one of the best operators and investors on the planet.

I will go into the details of the earnings growth drivers and catalyst shortly, but in order to understand the opportunity, background and historical context of BKW and TAST is necessary.

Short BKW Background:

Burger King has a history of being a private equity "hot potato" for the past 50 years. As the brand changed hands, it was revived, then neglected, and then sold to a new owner to repeat the pattern. The average CEO tenure for the past 25 years has been ~2 years.

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(From 2012 Pershing Square BKW presentation)

This pattern changed in 2010, though, when famous PE firm (and Warren Buffett partner) 3G Capital Partners acquired BKW, and it has been a home run investment so far. I have followed, and invested alongside, 3G for years, and I believe they are both incredible investors and superior operators. After completely revamping the corporate business, they are now focused on improving store level economics as they improve the brand.

With each new owner and brand refresh historically, BKW sales have increased by 15-20%+. For example, the 1979 menu refresh, called "Operation Phoenix", drove sales 15%+, while the 1995 "back to basics" campaign drove a 28%+ sales bump. I expect 3G could likely exceed these historical examples over a longer time frame, providing tailwind to franchisees and restaurant economics, but I have not included this sales tailwind in my estimates or model.

Another critical aspect of BKW history for TAST is exactly how and why the BKW franchisee became extremely fragmented (creating the roll-up opportunity for TAST). In 1979, in response to a large franchisee challenging BKW corporate, BKW instituted strict rules apparently directly created to prevent corporate ownership of BKW franchises. These rules included prohibiting franchises from operating other chains, and required franchisees to live within a one-hour drive from their stores. While these rules were eventually removed, the predictable result was that during this period of BKW, the franchisee base grew to become extremely fragmented, with hundreds of small operators around the US.

As a result, despite ~7,400 stores in North America, TAST is the largest BKW operator by a wide margin, at just 560 stores. The next-largest BKW franchisee has 380 stores, the 3rd has 292, then 168, and then it drops off dramatically. The current average stores per franchisee in the BKW network is less than 10.

(From TAST corporate presentation)

The other crucial outcome of this historical reality is that the franchisee entrepreneurs building BKW in the 1979 era are now all in their 60s or older and looking for retirement. Given the fragmented ownership structure, there is a distinct lack of natural buyers for BKW franchises aside from TAST. Combined with credit markets being frozen for a few years and now BKW brand showing signs of stabilization, many BKW franchisees are simultaneously coming to market to begin their retirement and sell their businesses. This has created a large pool of sellers who are ready to exit the business for non-financial reasons, allowing TAST to acquire their stores at attractive multiples of EBITDA.

This "retirement cliff" among franchisees comes at the same time these owners are being asked to reinvest $300k per store for the 20/20 remodel.

Short TAST Background:

TAST is the largest operator of Burger King Restaurants across 13 states, with ~560 restaurants, and has been the largest BK operator since the 1970s. TAST is also the second-largest restaurant franchisee in the US, and the largest publicly traded franchisee (by store count).

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(From TAST corporate presentation)

TAST Management is Top-Notch, with a History of Shareholder-Friendly Capital Allocation, and Own A Lot of Stock

In contrast to the clown-show of many small cap management teams, TAST has an impressive group of BKW/QSR "lifers" with a successful track record of capital allocation. The average BK tenure of TAST regional directors is 27 years, and 15 years for district managers.

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(Chart from TAST corporate presentation)

CEO Daniel Accordino and CFO Paul Flanders are prime examples of this. CEO Accordino has been with TAST since 1972, started out operating 8 restaurants, then moved up the ranks to become president of TAST, and COO in 1993, when he was 42 years old. CFO Paul Flanders has been with TSAT since 1997, working at TAST for essentially his entire career. They are both good examples of one of the reasons TAST retains the best BKW managers in the country, as they can, due to scale, offer superior growth and promotion potential to young, talented and motivated managers.

TAST's board is also stacked with extremely high-quality individuals. New to the board since the 2012 BKW store acquisition is Daniel Schwarts, CEO of BKW and partner at 3G. We also have Alexandre Macedo, EVP and president of BKW North America. Macedo was head of Brahma Beer at AmBev from 2003-2007, during an epic run for that business.

TAST's management and board are clearly the "A team", and I believe could be the best franchise operating team in the country.

Since TAST has ~40 years of experience managing Burger King Restaurants, with much of their management dedicating their entire career to the business, they are exceptionally good at it. Over many years, TAST-operated Burger Kings have outperformed their peers by a wide margin on virtually any metric.

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(Charts from TAST corporate presentation)

Furthermore, TAST insiders own ~9% of TAST stock (adjusted for recent capital raise) and, with aligned incentives, have a long history of intelligent and shareholder-friendly capital allocation. For instance, they decided to spin out FRGI in 2012, and that stock has increased 350%+ since, with $1b market cap. I estimate the 2012 acquisition of the BKW stores was done at ~2.5x EBITDA pro forma, and the most recent acquisition was done at ~1.5x cash flow. Unlike 90%+ of small cap management teams I have met, this management team clearly understands math and capital allocation.

Now that you understand the context, let's go through the 6 key drivers of earnings that I estimate will triple TAST's run-rate EBITDA in 2-3 years.

Note that in my estimates and modeling, I am not going to share my quarter-by-quarter model or even try to nail down quarterly earnings to eight-decimal point precision. There are a lot of moving parts, and changes in estimates of the timing of acquisitions, remodels and speed of margin improvement all have an impact on the timing and level of earnings. Any two people who model this company will come up with two different models, and I don't want to get hung up on minutiae. Instead, I am going to present my broad view on where I believe this company is heading, along with my estimates on future levels of annualized run rate earnings. TAST is not an extremely complex business to model, and I encourage you to build your own precise model if you are so inclined.

1. Margin "true up" of BKW Acquired Stores Has Dramatic Impact on Earnings

TAST is recognized as the best BKW store operator in the US franchise network, so when BKW went to sell its poorly-performing stores, TAST was the natural acquirer and has become 3G/BKW's turnaround artist of choice. As a result, immediately after the FRGI spin-off, TAST made a transformational acquisition, which doubled its store count with some of the worst Burger King stores in the country (which was the opportunity).

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(Chart from TAST corporate presentation)

Unfortunately, since these BKW stores were barely profitable, the near-term impact on the consolidated financials has been negative, as the poor margins and sales per store are a temporary drag on the consolidated financial statements until the turnaround is accomplished. The reason for this is that Burger King has historically been focused on managing the corporate entity than the retail operations, and so, was not focused on ground-floor operational excellence. Ironically making them one of the worst operators of Burger King stores - far worse than the average franchisee.

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(Chart from TAST corporate presentation)

Had these stores been operated independently, the owners would have gone bankrupt. Per management commentary on earnings calls and investor presentations, many of these stores were operating at a loss, store managers were stealing, "suspicious" workers' comp claims were a headwind, and these stores did not have updated internal POS systems or modern infrastructure. TAST had its work cut out for itself, but the "heavy lifting" is already done, and all that is left is for TAST is to close ~15 stores with negative or break-even EBITDA and push for the last few hundred bps of margin normalization.

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(Chart from TAST corp presentation)

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(Chart from R.F. Lafferty & Co.)

The stores to be closed were part of the original acquisition plan, and are not a surprise. As part of the initial acquisition plan, TAST identified 30 stores it planned on closing. However, BKW never closed stores, and given the optics of TAST immediately shutting them down, TAST agreed to wait for a while, and negotiated short-term leases and short-term franchise agreements with BKW so closing costs will not be high.

The basic economics of this situation is that the BKW acquired stores are currently operating at ~7% trailing 12-month EBITDA margin. TAST management believes that in the near term, through a combination of closing the worst stores along with continued operational improvement, they should be able to bring EBITDA margins to within 250bps of their legacy stores within the next year. There are two reasons why near term these stores are unlikely to converge completely with the legacy margins, though. The first is that the rents per store have not been negotiated as effectively as TAST's legacy stores, which accounts for ~150-200bps EBITDA margin difference. Over a very long time (5-10 years), this will converge as leases are renegotiated, but I am not modeling that to occur. The other difference is that the sales per store are currently about 15% lower than TAST legacy stores. Some of this will go away as the worst 15 stores are closed, and I expect revenue at these stores will benefit from TAST management and the 20/20 remodel as well, but this will take time.

I estimate these BKW acquired stores will exit 2014 at a run rate of ~11% EBITDA margins (300bps discount to Legacy), with sales per store in the $1.15m area. As the 20/20 remodel is instituted on these stores, I model a 12.5% sales lift over 2 years, with an organic sales and SG&A growth rate of 3% (inflation).

With the margin "true up", I estimate these BKW acquired stores will exit 2014 at a ~$30m EBITDA run rate, while growing EBITDA in the mid-teens due to the 20/20 remodeling program.

Keep in mind that the acquired stores are largely in regions that have been awful for years. One reason the sales per store is weaker here, in my view, is that the brand has suffered a particularly poor reputation. With the combination of new management, new employees, updated menu and continued 3G brand improvement, along with the 20/20 store refresh economics, I believe longer term (5+ years), TAST will be able to narrow the margin gap between these stores and the legacy stores until they ultimately come very close to converging. I have not included this in my model, but it could add some long-term margin tailwind.

2. TAST's "Endless", Highly Accretive Roll-Up Opportunity

When roll-up opportunities are well executed and the economics are attractive, the results to investors can be impressive (see self-made roll-up prodigy Brad Jacobs for examples).

TAST is the largest player in an extremely fragmented market with many simultaneous sellers and few buyers. This structural imbalance of buyers vs. sellers means TAST can make many acquisitions at attractive prices. Due to TAST's 40 years of experience operating Burger Kings and its large scale, it has some impressive internal technology and processes for managing these stores as well. TAST is able to have real-time insight into its network of stores, with sophisticated POS data collection, labor management, production control and other technology. Combined with having the best BKW managers in the country, even relative to other high-quality BKW operators, there is typically a 250-400bps margin improvement opportunity once a store is acquired. Given TAST is one of the only natural acquirers and the best operator in the US, it can typically acquire stores with nothing wrong with them for ~4x EBITDA. With the margin improvement it can implement, which typically takes ~6 months, that brings the multiple down to 3x EBITDA for TAST. Given that high-quality restaurant operators with scale typically trade for 8-9x EV/EBITDA or higher in the public markets, acquiring them for 3x and integrating them drives tremendous value for shareholders, while simultaneously offering valuable liquidity to franchisees who wish to exit the Burger King business for retirement.

Both TAST and BKW recognize the opportunity here, and so, as part of the 2012 BKW store acquisition, TAST negotiated a "Right of First Refusal" with BKW in a 20-state region including >2,000 stores. TAST is also pre-approved by BKW for growth to 1,000 stores.

(From TAST corporate presentation)

It is also in BKW corporate's best interest for TAST to rapidly consolidate its store base, as TAST is the best-in-class operator who drives higher sales per store and higher margins. As a result, I would be surprised if BKW is not pushing underperforming stores to sell to TAST and help ensure TAST's acquisition pipeline is full.

Given TAST already has the infrastructure to support 1,000 stores, the CFO of TAST has said it would not be difficult for them to acquire and integrate 100+ stores per year. Given the current store base, this would equate to ~15-20% growth per year.

The CFO of TAST has said with a natural buyer with capital, signs of BKW brand stabilization and credit markets aren't frozen anymore, and the pipeline of deals he is seeing is significant and expected to improve, with >200 stores for sale having already crossed his desk in the past 12 months. TAST management has said they are currently in some form of due diligence on 100 stores, and they would not be surprised to close on 100 stores this year alone.

While this will take years, at 1,000 stores, I estimate TAST will generate ~$135m in consolidated EBITDA, which probably makes TAST a $24+ stock.

Now that TAST has capital in hand and is executing on this roll-up opportunity, we can see the economics, and I think it looks attractive.

In just the past few weeks, TAST has executed on 3 smaller deals:

  1. Smaller Acquisition in Indiana
    1. 4 restaurants for ~$700k
    2. Each doing $1.2m in sales, 3 should get a 20/20 remodel soon
    3. Acquired for 2x owner's stated cash flow and 1-1.5x TAST pro forma cash flow
    4. These are well-managed stores with nothing fundamentally wrong with them
    5. Unusually cheap due to unique, site-specific dynamics, but a good example of what a smart management team in a unique niche with some capital can do
  2. TAST should also close an acquisition of 20 stores in June
    1. Seller is nearly 70 years old
    2. Good operator, nothing "wrong" with these stores
    3. Half already remodeled
    4. TAST still sees 250bps of margin improvement it expects to implement
    5. I estimate these will cost ~$7.5m, or ~$375k per store, for ~4x EBITDA
    6. Going to acquire them for 4x stated EBITDA
    7. TAST CFO indicated this acquisition is a good proxy for what a "typical" acquisition it would expect to execute on could look like
  3. TAST has another small transaction of 4 stores it hopes to close on shortly as well. These will also be acquired for 4x stated EBITDA.
  4. TAST CFO also recently stated they are also looking at a couple larger transactions, so it is possible TAST could execute a few larger deals soon and accelerate this roll-up.

I estimate TAST will acquire 100 stores this year, and 110 in both 2015 and 2016. I estimate these stores have ~$1.2m per store in annual sales, and TAST can bring these up to 14% EBITDA margins, slightly less than legacy stores, in about 6 months from acquisition.

With the $87m in cash TAST now has, along with Cash Flow from Operations and modest debt increase upon the 2015 debt refinancing, I estimate TAST should be able to execute its growth plans without issuing more equity also. My estimates put TAST at 880 total stores by the end of 2016.

With 7,400 BKW stores in the US and Canada, the long-term runway for TAST is enormous and is "endless" for practical purposes for the foreseeable future.

For some reason, the sell-side analysts following TAST have not updated their numbers to include this potential roll-up opportunity, even though TAST has already raised the capital and is actively pursuing it while closing deals. As TAST executes on this opportunity and the results are apparent in the financials, I expect TAST stock to re-rate higher. TAST already has the cash, and is actively executing on this opportunity right now.

3. TAST's SG&A is Temporarily High, Creating High Operating Leverage To Increasing Revenue

TAST's operational leverage is high, as TAST is currently carrying the infrastructure and SG&A for a business much larger than what it currently has. With the spin-off of Fiesta (~250 stores), Fiesta was using TAST's infrastructure in HR, payroll, back office, etc.

Previously, TAST was receiving payments from Fiesta for this support, but now that the spin-off has been >1 year, Fiesta has developed its own internal systems and is no longer paying TAST. Since TAST execs are aiming to grow this company rapidly, instead of firing people just to have to rehire them shortly, TAST management has chosen to shoulder this cost for now and instead grow into their infrastructure.

As a result, TAST will have tremendous operational leverage off of sales increases. The basic math of adding stores for TAST relative to operating expense is that if TAST grows store count by 10%, it should grow SG&A at 1/4th that rate or lower. It needs a district manager for every 8-10 new stores, and then a regional office for every 100-110 stores. Regional offices cost about $500k per year and, to make the numbers round, I assume a district manager costs TAST ~$100k all-in. Given TAST already has the infrastructure for 1,000+ stores, I believe the execution risk is decreased as well.

4. "20/20" Store Refresh: Generating 15%+ Cash-on-Cash Returns and 20-30%+ Returns on Equity

Part of BKW's plan involves repositioning the BKW brand, and one aspect of this is its "20/20 Re-imaging" store remodel plan. The BKW store base is old, and this store refresh program has been showing great results so far. If you happen to see one of the new 20/20 BKWs, I would encourage you to check it out. I found them to be surprisingly nice, with stainless steel trim, nice seats, flat-screen TVs, bar seating, etc., and much more reminiscent of a high-end Starbucks than what you might expect from "fast food".

(Pictures of 20/20 Burger King from Corp Website and News Gazette)

The near-term financial impact of the 20/20 store refresh is ~$300k capex; the store faces a revenue headwind for 4 weeks, is completely shut down for 2 weeks, then afterward experiences a 10-15%+ sales increase in the first year. The math of this remodel program is described below. Note that TAST initially was targeting ~10% revenue increases, but now that it's done a good amount of them, it has recently stated it is seeing better results, with 100-300bps additional sales lift afterward in the following year.

(click to enlarge)

(Chart built using my own assumptions based on historic results and management guidance)

Part of the 2012 acquisition of BKW stores was that TAST agreed to remodel 450 stores. TAST has already completed 200 stores, with plans for another 250 to be done over the next 2 years. TAST remodeled 13 in Q1, while guiding to another 105-115 in 2014. By the end of 2014, TAST will have remodeled ~60% of its stores. I estimate that for TAST legacy stores, the 20/20 remodel should get it to ~$1.4m in sales per store, at 15%+ EBITDA margins.

Lastly, there are some important "free options" embedded in this 20/20 refresh program that I want to mention. These are my own speculations and not included in any of my estimates, but I think they are important enough to warrant discussion.

From the 2012 BKW Pershing Square Presentation, we can see BKW franchisees were getting 15% sales uplifts from the 20/20 refresh, with some seeing sales lifts of as much as 20%.

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(From Pershing Square 2012 BKW Presentation)

TAST, on the other hand, was initially only seeing ~10% in the first year, and another 2-3% the following year. Why is TAST seeing such lower sales increases and returns? I think the obvious answer is TAST has historically been, generally speaking, managed in a superior way, and already has above-average sales per store.

Remember, though, nearly 50% of TAST's stores were, until very recently, managed by BKW corporate with extremely poor execution, and were some of the worst-managed stores in the country. The sales per store of these stores is -10% or more lower than the "legacy" TAST-owned stores. Since, until recently, TAST was still refining the operations and hiring competent managers as part of the turnaround, TAST has not remodeled many of these BKW 2012 acquired stores as there was no need to drive traffic to stores that are poorly run. With that part of the turnaround completed, though, TAST is now moving on to execute the 20/20 refresh on these BKW acquired stores just earlier this year. Since these are not your typical TAST store, and were even worse than BKW corporate average in sales per store, I think it is very possible that these stores will see a higher-than-normal sales lift from the 20/20 refresh as TAST begins remodeling them.

Furthermore, the stores TAST acquired from BKW were not random stores scattered about, but were mostly regions of stores bought in blocks, such as the Virginia market. It seems clear to me from management discussion and the conference calls that the BKW brand has suffered in those areas. I would guess many people in those areas had a bad experience in years past, and haven't been back. Could a combination of coupons, more exciting menu, top-notch staff and an entirely new image and store front bring some of those people back?

We know that TAST's legacy stores get a 10% sales increase in the first year, and another 2-3% in the second year. The average BKW franchisee sees ~15% 1st-year sales increase. Is it possible that the worst-managed stores in the country see a 15-20%+ sales increase from the 20/20 remodel, also off a lower base, as people come back and the BKW brand's local reputation improves?

It is my speculation that we could easily see 15%+ sales increases, with a longer-term sales tailwind from executing the 20/20 store refresh program on the 2012 BKW acquired stores. It is also my speculation that the currently lower sales per store are a result of this local BKW brand damage those BKW acquired stores face. As that brand reputation is repaired over a 2-3 year time frame, the sales per store could begin to converge with the legacy stores, and that gap will decrease. I have not included these potential tailwinds in my financial models.

One other thing I think analysts are missing is: what happens when an entire region of BKWs is reimaged with 20/20 store refresh? Early indications are that the brand could hit a "tipping point" in that area, where reimaging one store can benefit sales of other stores as the brand's perception as a whole improves.

5. The 3G/BKW Corporate Turnaround Opportunity is A Tremendous "free option" for TAST

I believe TAST is an attractive investment regardless, but the continued opportunity of 3G to improve the BKW brand has the potential to be transformational for both BKW and TAST. I have not modeled in any substantial BKW turnaround, and count this as a "free option", because, quite honestly, I do not believe you need a view on this for TAST to be a very compelling investment.

That being said, so far, things are looking pretty good. BKW has refreshed the menu with some new and exciting offerings, expanded its market, moved towards less discounting, and generally seems to be making good progress (BKW stock at 52-week high).

New BKW Salads (picture from BK corporate website)

BKW Bacon Sundae (picture from BK corporate website)

BKW Regional Burgers (picture from BK corporate website)

See the Pershing Square BKW presentation or the BKW investor slide decks for a good summary of what some very smart people think is possible.

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(From 2012 Pershing Square BKW presentation)

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(From TAST corporate presentation)

This opportunity is too large for me to go into here, though, and there is plenty of public information for you to read if you are interested. I will say that BKW's sales per store are <$1.3m, while WEN is at ~$1.45m and McDonald's (NYSE:MCD) is off the charts at $2.6m average sales per store (due largely to MCD's dominance in the breakfast segment). Given conversations with BKW franchisees, TAST CFO, Wendy's (NASDAQ:WEN) operators and other QSR experts, I believe there is no structural reason BKW cannot get to $1.4m+ average sales per unit to approach Wendy's. To get much higher than that likely requires more success from corporate BKW, but $1.4-1.45m sales per BKW store could be easily accomplished with the current BKW model. Given the enormous operational leverage in TAST and BKW, however, if 3G can bring BKW sales per store to $1.5m or $1.6m+, it is not hard to arrive at a $30+ per share value for TAST stock in the outer years. I am not assuming any BKW corporate turnaround benefit in any of my models, and use a simple 3% organic revenue growth, with matching 3% expense growth to account for inflation.

6. 5/2015 TAST Debt Refinancing Value Creation for Shareholders

TAST carries very expensive debt, issued when the credit markets were less friendly than they are now. TAST also had to pay up on the debt in order to get covenant-lite terms at a time when its financials were much less clean and weaker than they will be in 2015. For a company with the credit quality of TAST to be paying 11.25% on short-term debt in today's credit markets is clearly not necessary. Furthermore, TAST's EBITDA is growing rapidly, so when 5/2015 comes, the company will be much stronger and larger than it is now. Given where credit spreads are, I believe, depending on terms and maturity, TAST should be able to refinance this debt at a 5% coupon pretty easily. This will cut their annual interest expense from $16.88m to ~$7.50, saving TAST $9.4m per year in pre-tax cash flow. Capitalized at 10x, that is worth $94m to the equity, or ~$2 per share.

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(Chart built using my SCM internally generated estimates, historic operating results and public guidance)

Alternately, I expect TAST to use the refinancing opportunity to increase debt to a reasonable 3x EBITDA level on the increased 2015 EBITDA. I estimate annualized run rate TAST corporate EBITDA in 2015 of ~$85m, at 3x $85m EBITDA, TAST would have access to $255m in debt capital, or ~$100m more than it currently has. If TAST assumes this leverage and puts that $100m to work rolling up more BKW stores, TAST management will create tremendous value. Note that TAST has accessed the debt markets multiple times in the past, and taken on leverage >3x when it made sense to do so.

One reason I believe TAST is an attractive roll-up is that with the recent capital raise, it should not need more equity to execute its growth plan. If a surprise large and highly accretive deal becomes available soon, TAST management could use equity, but with the estimates I have used, they should be able to execute their growth plan fairly easily with the $87m in cash they have, organic cash flow and a modest increase in debt in 2015 when they refinance. Management has stated as such too, calling the recent capital raise "a bridge to the 2015 debt refinancing". TAST management own ~9% of TAST stock, while 3G/BKW own 20% and have board seats, so I expect management to continue to be very conscious of dilution.

Recent TAST Results Temporarily Impacted by Polar Vortex

This last quarter, TAST stores comp'd -2.5% due primarily to the Polar Vortex, with overall 2014 sales guidance of 1.5%+ to 3.5%+. Keep in mind that stores undergoing the 20/20 remodel program are likely facing a 3-5% revenue headwind that year, due to the store being partly closed for several weeks and totally closed for 2 weeks.

(Picture from The Weather Channel)

(Picture from TAST corporate presentation)

Usually, I think management teams who blame the weather on earnings calls are using excuses, but for TAST, I think it makes sense. You can see above that unfortunately, TAST's stores were right in the middle of the most unusually cold areas, as a result, there were days with 150 stores closed, and it stated its restaurants were comping 3%+ before the weather set in. As a result, while the next quarter reported could still have some headwind from this dynamic, I expect results in 2H 2014 to rebound, and going into 2015, the comps should be fairly easy as well.

TAST Valuation: $18-20+ Per Share

With the combination of continued margin convergence on the BKW acquired stores, completing the 20/20 remodel and executing on the roll-up opportunity at levels matching management guidance, I estimate TAST will exit 2016 at $113m of run-rate consolidated EBITDA. Using peer-level valuation metrics, TAST would then be valued at $17.74 to $21.34 per share.

(Chart built using internally generated SCM estimates, historic results and management's public guidance)

These estimates are not heroic in my opinion, either. WEN's current sales per store are already in the $1.52-1.6m range and forecasted to move to $1.8m. I do not believe that forecasting BKW sales per store in 2016 at $1.17m to $1.46m is overly optimistic. 13-15% EBITDA margins given continued 20/20 remodel is also not likely to be particularly heroic; TAST legacy BKW store EBITDA margins in 2013 were already ~14.4%.

Note I am also using a 3% inflation number on both sales and expenses, so that inflation, along with 20/20 remodel sales lift, is what explains the higher 2016 sales per store relative to 2014 numbers.

To value TAST, we can look at what other restaurant operators typically trade at, and that is what the chart below displays. I also took the liberty of arbitrarily removing the extremely high-valued momentum restaurant names like Chipotle, etc., so this should be a pretty pure set of TAST peers being valued on fundamentals.

(click to enlarge)

(Chart built internally using our estimates and trailing earnings numbers based on public SEC filings)

As you can see, there is a wide range, but on average, a normal valuation for a restaurant operator is 1x EV/Revenue and 9x EV/EBITDA. As we can see, TAST trades at a ~50% discount to the mean EV/Sales and in line with peers on an EV/EBITDA basis, despite much higher expected growth and an impressive management team with $87m in cash to deploy.

At 1x EV/Sales, based on 2014 revenue guidance, TAST would be ~$13 per share stock today. Based on my estimate of what TAST's run-rate sales will be when it exits 2016, TAST is $21+ stock at 1x EV/Sales in 2 years or less.

I think given the size of the growth opportunity and the quality of management, there could be a strong case for why TAST should trade at a higher-than-average valuation. As you can see above (and remember, I removed the really highly-valued peers), we can see that restaurant operators with similar growth rates to what I expect from TAST trade at 13-16x EV/EBITDA. At 12x EV/EBITDA, based on my 2016 run rate numbers, TAST would be $36 stock… but I will stick with 9x, and if it is valued higher, then I won't be unhappy.

One could also say that the market is richly valued right now, and 1x EV/Sales is a by-product of the overall richly valued stock market? There is some truth to this, but if you look over a longer time frame, using Darden as an example, since we can build the data easily, ~1x sales for a larger restaurant operator that is well-operated has been a relatively consistent valuation for the last 14 years. From 2000-2014, the average EV/Sales for DRI was ~1x, that briefly hit a low of ~0.55x in apocalyptic 2009, and was at a high in 2002 of 1.38x. So I don't think using 1x EV/Sales valuation is unreasonable for a base case for TAST, given that is the average over the past 14 years. Some restaurant operators trade cheaper than 1x EV/Sales, but some rapidly-growing restaurant operators routinely trade at 2x EV/Sales or higher as well.

(click to enlarge)

(Chart built internally using SEC public filings)

I also think it is interesting to look at what other extremely successful investors pay for their investments. Note that in the 2012 store BK transaction, 3G took a ~29% stake in TAST equity at ~$6, when the business was smaller and financially weaker. With TAST stock currently at $6.88, investors are paying only a small premium to where 3G invested, for a much improved business. Also note that 3G/BKW took a 30 month lockup on their investment into 2015, which I think offers some insight into how they are thinking about the timing on this investment as well.

RISKS:

I view TAST as a compelling, asymmetric opportunity, but there is no such thing as a "perfect" investment, because the uncertainty of the future is what creates mispricing. Could a huge US recession negatively impact BKW in the US? It's certainly possible; I believe that would create extremely compelling valuations for TAST's roll-up strategy, and TAST already has the capital raised to execute. I also like the fact that TAST's growth strategy is primarily dependent on management execution and not necessarily a cyclical tailwind or strong economy. The margin true up, 20/20 remodel and roll-up are all different and somewhat non-correlated drivers of earnings, which I like.

TAST has, and has always been, run with some leverage on the balance sheet. Given my confidence in the management's and the board's capital allocation skills, I prefer a modestly leveraged capital structure for driving equity value. However, if they fail miserably, that leverage will exaggerate the impact on the equity in both directions.

CONCLUSION:

Some of the earnings drivers and catalysts I have outlined are near term, while some are longer term, therefore, this story will obviously not all happen overnight, and patience will be required.

I believe TAST is mispriced, because the financials are still "messy" and confusing due to the FRGI spin-off and immediate acquisition of poorly performing stores that are now in the later innings of being turned around. TAST management has not yet communicated the roll-up opportunity clearly to investors (which they are starting to do), while the short-term sales numbers have been impacted by temporarily extreme weather, along with the inherent sales headwind from the 20/20 remodels. I believe as the three drivers of earnings growth simultaneously occur over the next 12-18 months, with easy comparisons relative to last year, TAST stock will start to screen more attractively. This will help it break out of the small cap stock purgatory, where the stock is not optically cheap enough to attract the value investors but the growth has not yet become apparent to bring in the growth investors. As management tells their story to investors and the numbers support their view, I expect the stock to re-rate and perhaps double or triple.

At $6.88 per share today, TAST trades either in line or at a discount to peers, and if its growth plan is executed well, which I expect, the stock could triple in 2 years. There is additional "free option" upside if 3G is successful in turning around the BKW brand or if TAST becomes valued similar to other high-growth restaurant operators.

Over the next 12-18 months, I believe TAST has 100%+ upside as the multiple catalysts outlined above are realized, but I find the multi-year multi-bagger opportunity to be most compelling as this impressive management team aggressively deploys capital into the extremely attractive growth opportunities in front of them.

Source: Carrols: 200%+ Upside, Catalyst-Driven 'Endless' Growth Opportunity, Top-Tier Management