Imvescor Restaurant Group (TSE: IRG)

“Oh man, I love this business, I have the luckiest career of anyone that I can imagine. I have two kids, and I constantly tell them that what you’ve got to do is find the things in life that you’re passionate about and do it. I’ve been lucky enough to find something that I’m passionate about – because it’s people. It’s different. It’s not cookie-cutter. It’s competitive, and I like that competitive aspect. It’s always going to be new.”

Frank Hennessey, CEO Imvescor Restaurant Group (RestoBiz Interview)

Investment Highlights:

-3-year strategic plan (announced April 2015) has led to turnaround and 9 straight quarters of SRS sales growth, with 4.9% SRS growth in the most recent quarter.

-Sale of Commensal manufacturing operations on Dec 1 2017 for $4.2M now means Invescor is a purely asset light franchisor.

-CEO Frank Hennessey is an expert operator and Adam Wyden of ADW Capital is a young highly motivated cornerstone shareholder.

-An almost debt free balance sheet provides opportunity to relever and create platform for acquisitions or become the acquisition target.

-The business can earn north of 23M in operating EBITDA in FY 2018 with the turnaround complete and business at an inflection point.

Brief company history: Founder Bernard Imbeault acquired Pizza Delight in 1969 and slowly built it into a recognized brand in Atlantic Canada over many decades followed by the acquisition of Mike’s in 2004. A successful IPO in 2004 led to a few years in an income fund structure (2004-2009). Newly public with ambitious plans, further fundraising led to the purchase of Scores and Baton Rouge with Imbeault stepping away from day to day duties in 2007. In 2011, high debt levels and a tepid economic recovery led to a liquidity event and recapitalization led mostly by Fairfax ($15M equity and $10M in debt). In 2013, Fairfax exited their investment. Continued weakness in system sales and the recapitalization led to the board considering strategic alternatives which eventually led to the hiring of Frank Hennessey as CEO in September 2014.

Business description: Imvescor is an asset light franchisor in Eastern Canada, primarily Quebec & New Brunswick. Its brands include Pizza Delight, Toujour Mike’s, Scores, Baton Rouge and the recently acquired Ben & Florentine. As of Q3 2017, the company had 255 franchised and 7 company owned restaurants.

Business Model: Company makes money by charging an initial franchise fee of 30 to 60k and an ongoing royalty of 3 to 6% of gross sales. It also licenses products under its brands to be sold by 3rd parties. It has the No.1 pasta sauce in Quebec which is priced 70% higher than other pasta sauces and roughly 20 skus in marketplace.

The Turnaround: When Frank Hennessey was appointed as CEO system sales of $410 million in 2010 had fallen to $377M in 2014. Finance and administration was immediately moved from Moncton to Montreal. Subsequently key hires included Tania Clarke (formerly of Keurig) as CFO, Vincent Dugas (formerly of Sysco) for acquisitions and Robert Longtin (formerly of Boston Pizza) for business development. In April 2015 Imvescor announced its strategic plan to transform its brands over the next 3 years with fiscal 2018 goals of 14-18% revenue growth, SRS of 3-5%, 10 net new restaurants & $20M+ of EBITDA. To do this management sought to simplify and standardize service & training, purchasing, G&A Optimization & communication. In addition, they sought to revitalize the menu, food culture, marketing and introduce a $5.5M Restaurant Rejuvenation Plan (RRP). The objective was to increase SRS, franchise profitability, leverage shared services, and improve shareholder returns. So far 51 restaurants have been renovated with a goal of over 100 by FY 2018. Franchisees have invested $15.6M thus far, with IRG investing $2M alongside. Some results include a 22% reduction in SKUs, 42% reduction in vendors, 67 renegotiated leases, & $10M saved for franchises. This had led to the 9 straight quarters of SRS growth, Q4 2017 (reported on Dec 19th) will make it 10.

Going forward:

The major legwork is behind Imvescor and I expect the effects of the RRP to keep paying dividends going forward. In addition, at least 50 more stores are still to be renovated.

Capital Allocation: Imvescor closed a deal at the end of Feb 2017 to acquire the Ben & Florentine breakfast/lunch concept, founded in 2008, for $25M ($17.7M upfront and $7.3 earn outs). This acquisition included 40 locations and $35M of system sales with opportunities for sharing services due to Imvescor’s Quebec entrenchment. In Q2 2017 (Imvescor’s Fiscal year starts in November so Q2 is Feb to April) Ben & Florentine contributed $2.8M of revenue and $600K of EBITDA. Annualizing this number shows Imvescor acquired Ben & Florentine for approximately 10x EBITDA. This acquisition has some real potential. It gives Imvescor more access to the growing breakfast segment and as at Q3 2017 they have already added 6 more locations.

Frank Hennessey has stated that for acquisitions he has 3 things he looks for: First, the target must be a franchise or franchisable. Second, the target should be of a size that enables Imvescor to gain operating leverage on their G&A or be a concept which has strong and immediate growth potential and third, Imvescor must always act responsibly as it relates to valuation. He has also stated a desire to acquire in Ontario but wants to see how the introduction of the $14 minimum wage plays out. Hennessey’s ability as an operator is undeniable but he does not have a Stanley Ma-like record of acquisitions, so some execution risk exists. Some estimates peg the full service restaurant segment at $25B of sales in Canada. Conversations I’ve had with analysts suggests there are at least 100 potential acquisition candidates floating around Canada. In the U.S. you can find many private equity sponsors and large players scooping up concepts in a competitive environment. In Canada, you basically have MTY and Cara in a duopoly as far as acquisitions go. Imvescor is uniquely positioned to become a 3rd player in this highly fragmented field. It is also ¼ of the size of the other players so smaller deals will move the dial more.

Invert, Always Invert: If Imvescor does not go on an acquisition spree, there is always a chance they become the acquired. Say they earn 23M of operating EBITDA in FY 2018, add to that roughly $10M in corporate G&A and expenses allocated to the franchise segment that can be eliminated by an acquirer. Apply a 10x multiple to $33M in operating EBITDA and you get $330M in EV. Debt will probably be minimal or nonexistent by then so it is all equity. That’s 30% above current prices. Stanley Ma will probably not pay up as he is quite disciplined in the multiples he is willing to pay but one can always hope. Cara is more likely to pay if you consider what they paid for St Hubert.

Key Players:

Frank Hennessey (President & CEO): Ex Darden, Cara, Harvey’s exec who has developed a reputation as a turnaround artist. Turned around Bento Sushi (2010-2014). Over his tenure sales grew by 50% and EBITDA by 150% in less than 3 years. Is using a similar playbook at Imvescor. I have read a few earnings calls transcripts and he seems to focus on the long term. For example, he does not give short term guidance. He understands the business inside out. He stresses the core tenets of price, quality, value & ambience as the keys to success in this industry. The only major negative is that he owns almost no stock but stock options instead.

Adam Wyden: Columbia Business School MBA and son of Oregon Senator Ron Wyden, Adam Wyden started a hedge fund (ADW Capital) in his parent’s basement in 2011 and has had an impressive CAGR of 31% net so far. He has been involved in Imvescor for years with some purchases going as far back as 2011. In August 2016, along with Camac Partners, ADW Capital sought the sale of Imvescor by writing this letter to the Board. No sale happened. Fast forward to November 2017 and Wyden has increased his stake now to 12% of Imvescor. Now, why would an individual who encouraged a sale increase their stake to 12% of a not too liquid stock? In a phone call I managed to organize with Wyden, without giving too much away he reiterated many of his views from his Value Investor Insight interview in March 2017 (belief in the turnaround, potential for further acquisition, 2018 EBITDA estimate, etc). My view is that in Wyden, fellow shareholders have a highly motivated partner who also understands the name inside out and is not afraid to engage with management if focus were to be lost.

Valuation:

Assumptions & Inputs:

-MTY trades at 12.8x EV/EBITDA and Cara Operations at 10.9x, using an average of these 2 I will apply a multiple of 12x to Imvescor FY2018E Operating EBITDA.

-As at the last quarterly report (Q3 2017 ended July 30 2017), net debt was $15.2M. Assuming the $4.2M from the Commensal sale will be used to pay down debt, Net Debt will be reduced to approx. $11M. With debt to EBITDA below 1 Imvescor can pay off the remaining balance by end of FY2018 barring any acquisitions.

-The increase in revenue from FY 2014 to FY2015 is due to the fact that Imvescor temporarily assumed responsibility for the manufacture of some Trattoria di Mikes products as the manufacturer was in bankruptcy proceedings. The drop from FY2015 to FY2016 is due to the ending of this arrangement and the listing of Commensal as discontinued operations

-Higher franchise revenue in FY2018 due to a full year of contribution from Ben & Florentine vs 8 months in FY2017. In addition, there should be north of 50 Ben & Florentine’s vs the 40 at acquisition and continued strong SRS sales closer to the 4.9% recorded in Q3 2017.

-Corporate Expenses as a % of revenue returning to FY16 levels in FY18 (15%) due to the fact Ben & Florentine will be fully integrated and shared services can be leveraged.

-0.3M DSUs, 1.78M options @ $2.27, 60.5M shares outstanding. Dec 5th, 2017 closing price of $4.08 for fully diluted shares outstanding of 61.6M.

-Dividend yield: 2.2%

-Operating EBITDA: EBITDA + RRP – Discontinued Operations + Acquisitions costs – Change in Onerous Contract Provisions + Reorganization Costs + Shareholder Proposal Costs.

-There are some reservations about focusing on operating EBITDA as a metric but in a business model that is this asset light issues are less egregious.

Risks:

Ontario Minimum Wage: With the introduction of the $14 minimum wage on Jan 1 2018 in Ontario it is difficult to estimate the impact it will have on the restaurant industry. Franchisers like Imvescor are less exposed than the actual restaurant owners but the environment might lead to franchisees becoming unwilling to invest in current restaurants and obtain more franchises. Imvescor is further protected with its locations being concentrated in Quebec where the minimum wage is $11.25.

Quality Assurance & Health Concerns: In this industry, brand equity can suffer greatly if a customer falls seriously ill due to a bad meal. 2 years after Chipotle’s E-coli issues the company has still not recovered. This is always a concern. Shareholders can take some solace in the fact that Frank Hennessey earned his chops in supply chain and quality assurance at Cara.

Low insider ownership: Insiders own almost no shares and only have exposure through options which is less than desirable. As of the most recent AIF directors and executive officers were listed as owning 139,000 common shares which is less than 0.25% of shares outstanding. On the flipside, this becomes an advantage as individuals like Wyden are capable of instituting change if management does not deliver on the potential of the company.

Recommendation: In conclusion, I believe Imvescor is a buy at these prices. The turnaround is almost complete and the seeds planted will keep bearing dividends in the years to come. There is also potential in the M&A space, whether as an acquirer or an acquirer. Finally, management is strong operationally and you have the possibility of change being effected if they do not deliver.

Note: Imvescor reports on Dec 19th and conference call is on the 20th. I think it would be a very interesting listen. Tune in.

Links: Frank Hennessey interviews in Les Affaires & Resto Biz , Adam Wyden Value Investor Insight Interview , Imvescor Investor Relations , Imvescor Earnings Call Transcripts , Sell Side Research from GMP and Acumen Capital. ADW Q12017 Letter to Investors, Cara Investor Relations , & MTY Investor Relations

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