Summary

• Chanticleer is my top pick in the hot restaurant sector, trading at an 80% discount to peers.
• The current rights offering should be a game changer for Chanticleer because it could allow the company to turn profitable next quarter.
• The company is in hypergrowth mode with year-over-year quarterly revenue growth exceeding 400%.
• Chanticleer is trading at a .5 price to sales ratio, well below the 3.8. peer average.
• Chanticleer is expanding its presence in the very profitable better burger space, which should add significantly to the company’s bottom line.

I have been aggressively buying shares of Chanticleer Holdings (HOTR) based on the company’s year-over-year 473% quarterly revenue growth, potential near-term profitability, and ridiculous level of undervaluation. The results of the just completed rights offering will be announced early next week and could provide a powerful catalyst for shareholders.

This company is completely under Wall Street’s radar, and should provide more than a 100% return.

Acquisition strategy could turn Chanticleer profitable next quarter

Chanticleer has been acquiring hidden gems in the restaurant sector, and this strategy could generate profitability next quarter. Chanticleer is following a similar growth strategy that Opko (OPK) successfully implemented; growth by acquisition. I first covered Opko when it was trading at $4, and it is currently trading at over $14, primarily as a result of Dr. Philip Frost well-managed acquisition strategy.

Chanticleer is trading at an 80% discount to peers and if the current acquisition plans are finalized next week, this $2 stock could be valued above $15 within 12 months.

Chanticleer’s business

Chanticleer owns and operates multiple restaurant brands including Hooters, American Burger and Just Fresh. The Company owns all or part of the Hooters franchise rights to develop and operate Hooters restaurants in South Africa, Australia, Europe, and the Pacific Northwest. But it’s the better burger segment that really has me interested in Chanticleer.

Chanticleer is conducting a game changing rights offering

With the goal of preserving the company’s $18 million in NOLs, Chanticleer offered shareholders the right to buy shares at $2. This offering is intended to raise the cash needed to make accretive acquisitions. The currently planned acquisitions will significantly grow Chanticleer’s top line revenue, and could take the company to profitability, almost immediately.

The results of the rights offering will be announced early next week, possibly as early as Monday, and positive results should be a strong catalyst for the share price.

Better burger restaurants are the holy grail of profitability

If the current rights offering is successful, which will probably be the case, Chanticleer will buy all The Burger Joint restaurants, including 80 franchises under agreement. This will significantly increase Chanticleer’s presence in the very profitable $2.4 billion better burger space. If you haven’t been to a better burger restaurant yet, you’re in for a treat, because the burgers, fries, and milkshakes are a league above most fast food restaurants.

But what I really like about this space is that the profit margins are much higher than most fast food restaurants. In general, the expenses are about the same as a typical fast food restaurant, however you are paying slightly more for some ingredients. In other words, organic beef is more expensive than nonorganic. But here’s the kicker; you’re able to charge 3 times what a typical fast food restaurant charges, hence the better margins.

It’s a much improved business model over the traditional fast food restaurants, and because of the superior food quality, the better burger restaurants in my neighborhood are usually packed with lines out the door. On top of that, these restaurants are now trendy, which only magnifies the growth and profitability potential.

Chanticleer is severely undervalued when compared to peers

One of the best ways to value companies is to use a price to sales ratio. McDonald’s, the gold standard in burger territory has a price to sales ratio of 3.3. Shake Shack’s price to sales ratio is 4.97 and Zoe’s is 3.9. Chipotle has a price to sales ratio of 4.9. On the other end of the spectrum, we have Wendy’s which has a price to sales ratio of 1.9. The average price to sales ratio for all these companies is 3.8.

It should be noted that Shake Shack and Zoe’s are reporting losses. Zoe’s just reported a net loss of $10 million for 2014, compared to a net loss of $3.7 million the previous year. Even though these 2 competitors are losing money, they are given very healthy valuations based on substantial projected future profits.

Chanticleer on the other hand currently has a price to sales ratio of .5, and a forward-looking price to sales ratio of .2. When you consider that Chanticleer could be profitable next quarter, this level of undervaluation looks even more ridiculous.

What’s fair valuation for Chanticleer today?

Chanticleer is currently valued at $16 million. If we include the value of Chanticleer’s 3% controlling stake in Hooters of America, which should be worth at least $4 million in cash when the sale is concluded later this year, that gives Chanticleer an effective valuation of $12 million. But in order to keep all estimates conservative, we will use the $16 million number.

That’s for a company that should generate at least $45 million this year if there are no acquisitions, and with acquisitions and new restaurant openings Chanticleer could generate at least $68 million this year. That’s an insane level of mispricing with a forward price to sales ratio of .2. Remember, the average price to sales ratio for the top companies in this sector is 3.8. It’s almost unheard of to see a price to sales ratio as low as Chanticleer’s but it provides a tremendous investment opportunity.

I estimate Chanticleer’s 2014 revenue to be at least $25 million. If we use a discounted price to sales ratio of 2.8, which is 25% below the 3.8% peer average, that would give Chanticleer a fair valuation of $70 million. Keep in mind $25 million for 2014 is conservative, because most analysts are projecting greater than $30 million for the year.

With a fair valuation of $70 million, and 8 million shares outstanding, Chanticleer should be trading for $8.75 today if it were valued 25% lower than its peers. That’s over 3 times today’s shareprice. Talk about mispricing! Even if Chanticleer’s shareprice were to double, that would still be an extreme level of undervaluation when compared to peers.

What would Chanticleer be worth by year-end with no acquisitions?

If Chanticleer makes no acquisitions this year, it should generate at least $45 million for 2015. With a price to sales ratio of 2.8, that would give Chanticleer a valuation of $126 million.

To keep the estimates conservative, let’s assume that the share count is increased from the current 8 million to 10 million. With a fair valuation of $126 million, Chanticleer’s share price would be $12.60. But that’s a worst-case scenario, because in reality, Chanticleer will most likely make accretive acquisitions which will bring the revenue significantly higher.

What would Chanticleer be worth by year-end with acquisitions?

If the rights offering generates $8 million, that would increase the share count to 12 million shares and would allow the company to complete all current acquisitions including the opening of about 3 new Hooters locations. I estimate with the current business and revenue from planned acquisitions and new restaurant openings, Chanticleer should generate at least $68 million this year, and that’s not including the sales of Hooters of America which should bring in an additional $4 million to $5 million.

Just to be clear, when Chanticleer sells its 3% controlling stake in Hooters of America, it will still own all its Hooters restaurants and franchises, the 3% controlling stake was a separate investment in the parent company.

With $68 million in recurring revenue, and a 2.8 price to sales ratio, Chanticleer would be fairly valued at $190 million. With 12 million shares outstanding, that would give Chanticleer a shareprice of $15.86. When we include the Hooters of America sale, the share price would be even higher.

Which is the most accurate price target, $12 or $15?

By early next week, probably Monday, we will know the results of the rights offering, and just how much cash Chanticleer raised. If very little cash was raised, the $12 price target will be more accurate because there may be no immediate acquisitions. If $8 million or more was raised, all acquisitions and restaurant openings should be priced into the model, and a $15 price target is realistic. If only $4 million is raised, the price target will be $13 to $14, because the acquisitions will be smaller in scale.

Who cares about price targets, Chanticleer is worth $8.75 today

I bought shares in the low $2 range, so even if Chanticleer only reaches today’s fair valuation, which is $8.75, that’s more than a 3X return on my investment. If the share price goes to $12 or $15, that will be great, but as far as I’m concerned, that simply an added bonus.

Chanticleer’s impressive revenue growth

Take a look at these revenue numbers, and you will see why I have invested in Chanticleer:

·      Q3 2013: $1.6 million

·      Q4 2013: $3.3 million

·      Q1 2014: $5.8 million

·      Q2 2014: $6.9 million

·      Q3 2014: $9.1 million

3^rd quarter 2014 restaurant revenue was $9.1mn, an increase of 473.5% year-over-year. Restaurant EBITDA stood at $0.9mn, an increase of 1040% year-over-year. These are numbers generally seen by companies trading at a premium, not a discount.

If all acquisitions and new restaurant openings are completed, a high level of growth will continue and Wall Street should begin to take notice.

Acquisitions could make Chanticleer profitable this year

The biggest advantage the planned acquisitions will give investors is that Chanticleer could become profitable as a result of the acquisitions. In fact Chanticleer could be profitable as early as Q2 of this year because all revenue is accretive, and applicable immediately following the transaction.

One important element that tips the scale to profitability is the increase in the number of high-margin better burger restaurants that Chanticleer will own following the acquisitions.

When you include the sale of Hooters of America, of which Chanticleer controls 3%, that should add another $4 million-$5 million to Chanticleer’s bottom line, which would push the company into monster profitability in Q2. That’s assuming the Hooters of America sale closes by Q2.

Chanticleer will also benefit from economy of scale. The fixed costs will be distributed over a larger number of revenue producing restaurants, thus increasing profitability for the business as a whole.

When Chanticleer reports profitability, or better yet gives profitability guidance, we could see a revenue multiple of 4X or 5X, similar to Zoe’s or Shake Shack. That would take that Chanticleer’s shareprice well beyond $15. Remember, when a company transitions to profitability, it often trades at a premium when profitability is combined with spectacular growth.

Rave Restaurant Group provides the best comp to Chanticleer

Rave Restaurant Group (RAVE) provides an excellent comp, with $44 million in annual revenue, no earnings, and a valuation of $140 million. Rave is growing much slower than Chanticleer, with Q4 2013 revenues of $10 million which grew to $11 million in Q4 of 2014. That’s only a 10% % year-over-year revenue increase. Compare that to Chanticleer’s 473% year-over-year growth.

Rave is being given a price to sales ratio of 3.2. With Chanticleer’s superior revenue growth, one could easily make a case that Chanticleer deserves a much higher price to sales ratio than Rave.

Restaurant stocks have provided significant returns

Restaurant stocks don’t carry all the glamour of the tech world, but they have been performing well for years. This sector is especially hot right now, because with the strong economy, people are eating out in droves, and restaurants are raking in revenue.

Alsea provides an interesting comparison because it is similar to Chanticleer in that it started out with just a few restaurants in its portfolio and a shareprice of $3. Management executed well, primarily by bringing American cuisine abroad and shares hit $48. Domino’s Pizza used a similar strategy, and shares went from $5 to $70. And of course most Cramer fans are aware of Chipotle’s 1000% rise in 4 years.

Why is Chanticleer so undervalued?

The primary reason is that Wall Street hasn’t caught on to Chanticleer’s phenomenal growth rate, and ridiculous level of undervaluation. Shake Shack has gotten all the publicity, while Chanticleer has remained under the radar. That will change at some point, probably sooner rather than later as a result of the current acquisitions and the buzz in the better burger space. The Shake Shack IPO will ultimately be helpful in directing attention towards Chanticleer.

Why I established my position now

I began a series of conference calls with Chanticleer CEO Mike Pruitt last year, and although I was impressed with his ability and track record, I didn’t believe the timing was right for a large investment. However, the combination of last quarter’s phenomenal revenue growth and positive EBITDA took my interest to a higher level. And then when the acquisitions in the better burger space appeared to be feasible, I began building a long position because I realize profitability could be reached in the near term.

But a primary driving factor for my investment is the extreme level of undervaluation in such a rapidly growing company. A .2 forward-looking price to sales ratio is about as low as I’ve seen.

I expect Chanticleer’s shareprice to move significantly higher prior to Q2 as Wall Street becomes aware of this company and pushes the shareprice towards fair valuation.

Chanticleer’s investor presentation is enlightening

If you want to expand your due diligence, Chanticleer has a great investor presentation that will clarify areas that I did not cover.

MarketWatch article provides validation of Chanticleer’s strength

There was also a good MarketWatch article released yesterday that provides a very compelling chart presented at the beginning of the article. If you’re considering investing in Chanticleer, I highly recommend studying the chart because it clarifies how much Chanticleer stands out when compared to peers.

What’s the risk?

The biggest risk is that Chanticleer does not become profitable this year as anticipated. It would then be in the same boat as Zoe’s or Shake Shack, with projected future profitability. That wouldn’t necessarily be a bad place to be, but it would be a disappointment with regards to what I am expecting.

The other risk is that Hooters of America does not sell as quickly as expected, which would delay additional expansion based on the cash infusion from that sale.

And finally, even though I feel confident the rights offering will raise significant capital, I could be wrong, and the capital raised could be less than expected.

In general risk is minimized by the ridiculously low valuation, so I do see downside protection.

Conclusion

At the very least I expect the shareprice to double, and longer-term investors could realize 6X to 8X returns. If Q2 is profitable, and Chanticleer receives $5 million from the Hooters of America sale, the company could report blockbuster numbers which should generate attention from Wall Street and significant share price appreciation.

The rights offering is a huge catalyst for Chanticleer, because if substantial capital is raised, not only does that validate demand for the company’s stock, but more importantly it could push Chanticleer into profitability. Equally important, the company would be able to generate levels of revenue that will force Wall Street to pay attention.

Chanticleer is an ideal asymmetrical trade, tremendous upside potential, and with a $16 million valuation, downside is limited.