Ark Restaurants (ARKR, Financial) is in the business of running non-formula restaurants at high traffic locations. Ark does enjoy some minor economies of scale by sharing a backend infrastructure across its operations. Although, this advantage is by no means comparable to the advantages held by large franchises, it does grant the company a small edge over small competitors. At the company level there are a few very major developments going on:
1) The company recently invested in a restaurant called the Rustic Inn. As it turns out this successful local seafood restaurant has the potential to be franchised. A second location has been opened and if that one works out, it will not be long before the company will be adding a third and fourth restaurant under the same brand. Within a couple of years this can transform Ark restaurants from a operator of non-branded restaurants into a franchise chain, that usually command higher multiples. I am keeping an eye on this development.
2) Ark Restaurants has a 10% stake in the New Meadowlands Racetrack. The NMR is trying to get the approval necessary to build a casino at this location. Ark Restaurants will manage the restaurants at the site but also has a stake in the casino operations. With luck the company could install slots as soon as approval is granted, but ultimately the plan is to build a casino, which will require additional investments.
Source: Google maps
Note that the New Meadowlands are less than a 30 minute drive from Manhattan and close to the Giants & Jets stadium. The potential of the Meadowlands stake and the fair price at which it is available is one of the main reason why I hold a small stake in Ark Restaurant.
Financial position
Financially, the company is in a sound position. Actually, its financial position is a little bit too good to be optimal. It has $6 million of cash on its balance sheet and $6 million in long term debt. Market cap of this micro cap is only $82 million. The return profile would improve if the company levered up a little bit. Management has a clear reason not to draw on any loan facilities or issue more debt, yet. The company has a 10% stake in a possible casino development site. If and when a license to run a casino here is granted, the company will likely need to make an additional investment in order not to get diluted. In conclusion, for now the balance sheet is very strong but do not be surprised if management increases leverage to make a few large investments in the future.
Management
Michael Weinstein has been Chief Executive Officer and director since the company’s start in January 1983. Weinstein was elected Chairman in 2004. Weinstein has a lot of experience in the restaurant business and in addition to his partial ownership of Ark Restaurants has stakes in multiple other restaurant companies in New York. Weinstein has usually sold off shares over the past 10 years but last year began buying instead. Other insiders have bought some shares as well:
Risk
The balance sheet being what it is right now, the premier risk with Ark Restaurants is that its ongoing operations disappoint and shareholders are rewarded with subpar returns. Later on the risk profile will change once the company starts investing more into the Rustic Inn franchise roll out or in the casino development. Although this changes the risk profile of the investment, it is also the way to unlock the value that lies within the company’s current assets.
Valuation
Because of all the moving parts, valuing this tiny company is not as straightforward as you think. In essence there are three main pillars of value within Ark Restaurants:
Restaurant operations
Value of the New Meadowlands Racetrack stake
Potential Rustic Inn franchise
The easiest part to value is that of ongoing operations. In this instance, I have come up with an estimate of what a “normalized” Free Cash Flow figure looks like, given the current revenue level at about $3 per share. I think it is not unreasonable to attach a 8x multiple to that. Branded chains usually trade at higher multiples but these come with a more powerful business model and greater competitive advantages. Still 8 x $3 represents a fair value of $24 just for the restaurant operations.
Since I have been looking at this company, the New Meadowlands Racetrack stake has given me the most trouble. It is difficult to value. The downside is limited to just $4.7 million, which is what has been invested so far. It still looks like with some luck a thousand slots can be put on the track site before the end of the year (more about that in the paragraph called Outlook). The end game is a complete casino at the site which can result in an increase of Ark Restaurant EBITDA by as much as $11 million per year, just from its 10% stake. To understand how big that is, it could double or triple the stock price without multiples getting re-rated. In my opinion this optionality adds a couple of dollars of value to this stock. My estimate it is worth between $5-$10.
The third potential value driver is the possibility the company rolls out a large number of crab houses. It recently bought the Rustic Inn and subsequently opened up another shop nearby carrying the same name to capitalize on the strong brand of the original. If this turns out to work, this could become a statewide chain of crab restaurants. At this time I ascribe $0 to this but will dial this up when it turns out to work. A branded chain is worth a higher Free Cash Flow multiple and it would quickly add a few dollars to Ark Restaurants share price if this operation became significant.
In summary, I estimate current value of Ark Restaurants is between $29 and $34 per share, which is a significant premium to the price it is trading for.
Outlook
Management is confident legislation will be written to allow gaming in the Meadowlands. Weinstein commented on the issue on the last earnings call:
We think, and we are comfortable with being able to say that we are pretty much certain that a license will be -- legislation will be written for a license at the Meadowlands for casino gaming. Whether it's this year or next year, I can't predict, but I'm fairly confident that it could be this year.
How significant this development could be becomes clear when the CEO explains how many slots could be placed at the casino site:
We have a building that was built not only as a grandstand for a racetrack but that can service about 1,000 slot machines right now and some table games and we could be in business -- once legislation is written and a referendum passes, we can be in business in literally 30 days in the grandstands. That is not the whole of the casino development. Eventually, this thing will have 4,000 to 5,000 slots and substantially more table games.
So, when legislation is written there could be a huge uptick in free cash flow within 30 days. Once this happens, I expect the stock will appreciate meaningfully and perhaps it will also draw more attention to the potential of the expansion to 4k - 5k slots and table games. Expect the company to start investing heavily once opportunity arises. In the meantime, expect it to continue trucking along; operating its restaurants and paying out a small dividend, like it always has.
