Bye Fidelity- Restaurant Anti-Chain J Alexander To Be Spun Off Next Week

Fidelity National Financial (FNF) went on a buying spree during the crisis and snapped up an eclectic bunch of assets. The company set up a tracking stock, quite a rare breed, FNFV, in order to track the value of this eclectic group of businesses. After some prodding from Corvex Capital, the company is now in the process of monetizing these assets in order to focus on its core insurance operations. One of its recent spinoffs, Remy International, is already in the process of being acquired after being spun off at the end of 2014.

One area the company dived into was the restaurant space, but its stay will be rather short as it is in the process of spinning off both J Alexander and the American Blue Ribbon Holding company. J Alexander’s spin will be first and on September 28th FNFV shareholders as of September 22nd will receive 0.17271 shares of upscale restaurant operator J. Alexander for every one FNFV share owned. Because nothing says upscale like George from Seinfeld. The new company will trade on the NYSE under the ticker ‘JAX’ and I am sure Jacksonville residents are disappointed to see that one. Hopefully the stock performs better than the Jaguars.

The company operates three distinct restaurant brands: J. Alexander’s, Stoney River Steakhouse and Grill (which it moved over from O’Charley’s) and its new concept, Redlands Grill. Currently, the company operates 41 locations across 14 states, with 31 J Alexanders (some of these will be converted to Redlands) and 10 Stoney Rivers.

Here is how the Form 10 describes the business:

Our business plan has evolved over time to include a collection of restaurant concepts dedicated to providing guests with what we believe to be the highest quality food, high levels of professional service and a comfortable ambiance. By offering multiple restaurant concepts and utilizing unique non-standardized architecture and specialized menus, we believe we are positioned to continue to scale and grow our overall restaurant business in an efficient manner in urban and affluent suburban areas. We want each of our restaurants to be perceived by our guests as a locally- managed, stand-alone dining experience. This multiple concept strategy permits us to successfully operate each of our concepts in the same geographic market and avoid being perceived as a “chain,” which we believe is less than ideal in the upscale segment of the restaurant industry. If this strategy continues to prove successful, we may expand beyond our current three concepts in the future.

Interesting approach to dining – an anti-chain chain restaurant. Apparently, upscale eaters just don’t get excited to eat out at chains and as part of this ambivalence towards the brand, it is even converting a significant number of its restaurants, almost 50% of its J Alexanders, to its new Redlands Grill brand. The lack of brand emphasis strategy has its detractors, including Jason Knapp, but it seems to have been working as the company has recorded strong, recent financial performance:

Our J. Alexander’s restaurants have generated 22 consecutive fiscal quarters of positive same store sales growth, which we believe demonstrates the strength of that concept. We have grown theaverage weekly sales at our J. Alexander’s concept from approximately $88,400 in 2008 to approximately $107,000 in 2014, representing an increase of 21.0% over that time period. We have also grown the average weekly sales at the Stoney River locations since February 2013, even while implementing significant operational and remodeling improvements. From 2008 to 2014, our annual net sales (not including restaurants categorized as discontinued operations) increased from $137,622,000 to $202,233,000 and Adjusted EBITDA increased from $10,494,000 to $22,358,000. We generated net income of $105,000 in 2008 and $8,515,000 in 2014. For the six-month period ended June 28, 2015, our net sales were $109,275,000 and our net income was $5,514,000.

The company plans to grow by improving its operating performance and of course, by opening new locations. Interestingly, growth has been rather measured as the company added only 8 new restaurants over the past 7 years. Although seemingly modest, its plans to open 4-5 new restaurants annually starting in 2016 is positively gangbusters compared to the past.

One thing that jumped out from the Form 10 is the company’s corporate structure. Fidelity will distribute all of its shares, but a private equity firm, Newport Global Opportunities Fund, will retain its close to 11% stake in the company. The real wrinkle is in the creation of new Class B shares (really profit interests) which will be used to compensate company management and to pay its retained management consultant, Black Knight Advisory Services, which is run by Fidelity execs. Members of Black Knight include the company’s President & CEO (Lonnie Stout) along with many other of FNFV’s execs. Incentivising management with equity is one thing, but enriching the former owners and current management outside of the company is the type of related party transaction you hate to see. Here is the justification in the Form 10:

Why is J. Alexander’s entering into the consulting agreement with Black Knight Advisory Services, LLC?

A:            Our executive management team has substantial experience in the restaurant industry, particularly the upscale dining segment. The principals of the Management Consultant, most of whom who also serve as executive officers and directors of FNFV, have substantial experience in mergers, acquisitions, accessing public capital markets, managing public reporting and corporate governance, as well as extensive knowledge of our business, strategic plan, and finances. Rather than hiring additional executive management personnel with these skills or outsourcing to another consulting firm, in each case without the experience, background, track record and input on our business, we determined that using the services of the Management Consultant was the most cost effective way to provide us with these services. Factors considered included the cost savings from screening, recruiting and hiring such persons into our Company, reducing the burden on our operational management team to integrate and educate new officers or consultants, and the fact that the majority of the compensation payable to the Management Consultant is based on the performance of the Company. We describe this agreement in more detail under “Certain Relationships and Related Party Transactions—Management Consulting Agreement.”

and their compensation:

Q:            What compensation is payable to Black Knight Advisory Services, LLC as a result of its consulting agreement with J. Alexander’s, and what potential dilution to J. Alexander’s stockholders may result from such compensation?

A:            Black Knight Advisory Services, LLC will receive compensation for the services that it will provide under the consulting agreement. Such compensation will consist of: (i) 3% of the Adjusted EBITDA of the Company for each year during the term of the consulting agreement, and (ii) a grant of Class B Units of J. Alexander’s Holdings, LLC, the Company’s operating subsidiary, which vest over a period of three years from the date of grant. The grant of Class B Units will not be dilutive to the stockholders of the Company initially and would potentially become dilutive upon the occurrence of one of the following events: (a) an exercise of Class B Units by Black Knight Advisory Services, LLC in accordance with the three year vesting schedule and the subsequent exchange of such Class B Units for Company common stock, (b) the Company exceeding certain financial thresholds of profitability, after which the holders of Class B Units, including Black Knight Advisory Services, LLC, could benefit from a distribution to them, or (c) a liquidation of J. Alexander’s Holdings, LLC, each of which events are set forth in the Second Amended and Restated Limited Liability Agreement of J. Alexander’s Holdings, LLC. The grant of Class B Units to Black Knight Advisoryervices, LLC could be dilutive to public stockholders of the Company by up to 10%.

Fees of 3% of adjusted EBITDA and shares that can be dilutive up to 10% – that is more than management can earn (4.7%)! Don’t worry though, the adjusted EBITDA number excludes their non-cash compensation so they don’t get hit there. It’s really hard to believe Black Knight will be adding so much value and that an experienced business development team couldn’t be brought in for less. Seems egregious. Here is how the Class B shares work:

The hurdle amount for the Class B Units issued to our management in January 2015 was set at $180 million, which at such time was a reasonable premium to the estimated liquidation value of the equity of J. Alexander’s Holdings, LLC. The Class B Units issued to our management vest with respect to 50% of the Grant Units on the second anniversary of the date of grant and with respect to the remaining 50% on the third anniversary of the date of grant.

Vested Class B Units may be exchanged for, at our option, either (i) cash in an amount equal to the amount that would be distributed to the holder of those Class B Units by J. Alexander’s Holdings, LLC upon a liquidation of J. Alexander’s Holdings, LLC assuming the aggregate amount to be distributed to all members of J. Alexander’s Holdings, LLC were equal to our market capitalization on the date of exchange, (net of any assets and liabilities of J. Alexander’s Holdings Inc. that are not assets or liabilities of J. Alexander’s Holdings, LLC) or (ii) shares of our common stock with a fair market value equal to the cash payment under (i) above.

While there are performance hurdles – set off a liquidation value – it does seem like quite a rich deal and hard to believe in the independence of the decision makers.

The spin will end a long saga that began as a potential IPO. However, after filing a registration statement, the company’s board of directors determined that ‘due to the Company’s minimal leverage, substantial public offering costs and proceeds effectively at a 10-15% discount to the fully distributed value of the Company’s common stock, the public offering was not in the best interests of the holders of FNFV common stock, or the business.’ Basically, the market wasnt buying what they were selling and thus was born the spinoff.

The restaurant space has been an interesting and mostly successful sweet spot in the spinoff universe. Chipotle (CMG) is probably the most famous, but there have been other big winners such as the Fiesta Restaurant Group (FRGI). J Alexander has performed well recently, but the economy and the restaurant industry have also done well over the past few years. What will happen if things start to go south? Given its relatively small footprint, the success of its rebranding and slightly quicker restaurant opening schedule will have a big impact on the company’s performance. Management and its consultants are clearly incentivised to make this a winner (probably too much so) – lets see what they can deliver.

Disclosure: Author holds no position in any stock mentioned