At first glance, one may overlook the tremendous value in Noble Roman’s (NROM). It has been around since the 1970’s, has a ~15 mm market cap, and trades for less than $1. However, for the few investors who are willing to take a closer look, an extremely compelling story is emerging. After falling from over $7 during its 2007 peak, NROM trades at ~$.70 despite an extremely favorable business transformation that is so far unnoticed by the market. In five years, I believe the company will be have 60%+ operating margins (~40% ttm) and generate over $9 mm in EBITDA (~$3 mm in 2012). Today, you can buy into this growth story at just above book value and 6X ttm EBITDA. I conservatively value shares at $2, greater than 200% upside, but if their new “Take N Bake” franchise concept is successful (as early signs indicate it will be), this could be a true homerun and conceivably be worth ~$6.

Since very few investors follow the stock, I will give a brief background on the company and describe their various business segments.

Company Background

• Began in 1972 as a small Indiana pizza operator
• In the 1980’s and 90’s phased out of the operating store business
• In the 1990’s and early 2000’s, the company morphed into a franchising and supply chain pizza business
• In 2008, the company was sued by many of their franchisees who accused Noble Roman’s of fraud as a result of the dramatic failure of most the of the franchises
  • The company spent a couple million in legal payments company and is currently trying to recoup up to $5 mm in counterclaim payments.
  • The judge has already ruled in NROM’s favor, completed dismissed the lawsuits as frivolous, and there is a hearing in mid-February with possible payments to NROM for legal fees.
• In 2009, the company began focusing its efforts on selling “take n bake” pizzas to grocery stores
• In 2012, the company started another new segment, focused on opening individual “take n bake” franchises, modeled after Papa Murphy’s success in this market

The Business Segments: The four major segments listed here are described in detail below. Revenue percentages below are based on estimated full year 2012 results.

• Non-Traditional Locations (58% of revenue)
• Take-N-Bake Grocery Stores (18% revenue)
• Traditional Locations (12% revenue%)
• Take-N-Bake Franchise (1% revenue)
• Other (11% of revenue). I won’t cover other as it is insignificant (consisting of a couple company owned stores for testing purposes) that have had very consistent operating results, but are not a major source of value (and will shrink as % of revenue going forward).

Non-Traditional Locations

• This is basically convenience stores/ gas stations. Noble Roman’s sells stores the equipment to make Noble Roman’s pizza (upfront fees) and NROM takes a % of sales as a royalty fee. This is a high margin segment for the locations and a great proposition for Noble Roman’s as well.
• This is a very sticky business with essentially no costs. Once a location has the equipment, they have little incentive to switch. This makes the segment very easy to value/model
• Below are the results from this segment (2012 full results estimated)

The company has done a good job growing relationships with large operators of non-traditional locations. For example, it now has a relationship with The Pantry, which has 1,650 locations (see investor presentation). This is a sticky business segment that should at least maintain revenue, and more likely, slightly grow over time as they continue to roll out new units with existing operators of these locations

Take and Bake Business (Grocery Stores): ~18% of Revenue, Growing

• This is the company’s current main growth segment. They started selling “take-n-bake” pizza to grocery store chains in September 2009. These are made that day (non frozen) pizzas that are refrigerated and are taken to a customer’s home to cook and eat that day.
• The Company has signed agreements for 1,350 grocery store locations to operate the take-n-bake pizza program and has consistently added ~400 stores per year.
• Each store generates ~$2000/year (ramping up slowly). ~$1.16 accrues to NROM/pizza
• Again, the company has essentially no costs associated with this segment as they are licensing their brand. The company develops distribution agreements with grocery store distributors, signs licensing agreements with Grocery distributor customers, and services them through foodservice distributors

Individual Take N Bake Franchises

• Papa Murphy’s is the leader in this fast growing take n bake market. With over 1,300 locations, they are the 5^th largest pizza chain in the U.S. and are expanding quickly
• These locations serve pizza that can be customized when ordered and are then be taken home to be baked. It is fast and cheap.
• One key competitive advantage is that their food is not considered a finished good, and is therefore eligible for food stamps. Papa Murphy’s has 22% of their sales from food stamps. This gives them a competitive advantage over other dining concepts.
• Papa Murphy’s is the only major player in the market. The biggest players (Pizza Hutt, Dominoes, etc.) are unlikely to enter the market given it would threaten and cannibalize their existing brand image.
• NROM believes it is well positioned to enter this market (again via franchising.. another growth vertical that does not risk company’s own capital). There are already two in existence and six more already in agreement. The company’s first store generated an operating profit of 26.5% in its first month of existence
• The company takes 11% of all sales, and units are estimated (based on Papa Murphy’s financials) to bring in ~$550K/year, leading to $50K+ in revenue to NROM per year

So How Much Is It Worth?

• The CEO has stated they can double the size of the business with almost no increase in costs. This is the real beauty of their business model—almost all incremental revenue will flow to the bottom line
• In 2012, the company should generate ~$3 mm in EBITDA based on $7.5 mm in revenue and $4.5 mm in OPEX.
• I think the company can generate $9 mm in EBITDA in 2017
  • Assumes non-traditional revenue growth is flat (conservative)
  • Assumes the company can continue to sign 400 grocery stores per year for five years. By the end of 2017, this would be 2,000 additional grocery stores. At ~$2,000/grocery store, this results in $4 million in incremental EBITDA
  • Assumes the company will be operating 40 individual take n bake stores by 2017, generating on average $50,000 to NROM/year. This results in an incremental $2 million in EBITDA.
  • Adding this growth to the existing $3 mm in EBITDA gets you to $9 mm in 2017 EBITDA, but how much is that worth?
  • On low end, I believe an asset-light, growing company with 60% EBIT margins would be worth an S&P 500 average multiple (currently 9.32X EBITDA).
  • On high end, I have used PZZI (closest comp) 20.68X EBITDA. Note that PZZI has less than 2% EBIT margins and less EBITDA than NROM despite 2X market cap.

Am I Crazy? Are These Assumptions Too Optimistic?

• If you are anything like me, and you are unfamiliar with the story, your inner value investor may be cringing at the above tables. After all, aren’t those growth estimates just pulled out of thin air? Isn’t the take n bake individual franchise concept barely starting for NROM, making a 20X increase in stores (to 40) by the end of 2017 ridiculous? Let me explain…
• First, under the above 2017 scenario, here is how revenue breaks down per operating segment:

• The most valuable business segment is the grocery store segment. This also happens to be the growth segment with the most visibility. The company has for three years now built an impressive business segment from scratch, and they have a long runway for growth.
  • Sanity Check: Can they average 400 stores/year for five years?
    • They have signed 1,350 stores in three years. They already have relationships with 14 grocery store distributors that represent over 5,000 stores.
    • The number of grocery store distributors is rapidly increasing as well—already to 14 after Q3 2012 after only 10 YE 2011. At their last industry trade show, the company said they had “leads for 6 new grocery distributors and 30 chains representing 3,134 units”
    • Growth has been accelerating, not decelerating. Through only three quarters of the year, NROM had signed 411 grocery stores this year.  That puts them on pace for 548 this year, well above my run-rate estimate going forward
    • Independent channel check: spoke with a grocery distributor who confirmed that NROM is doing very well with grocery store traction and he expects continued success.
      • Conclusion: 400 grocery stores per year should be manageable for the next five years

• Individual Take N Bake Franchises
  • Can they get to 40 stores by 2017?
    • Company already has two in existence and six more in agreements for 2012.
    • The take n bake concept has already been proven viable by Papa Murphy’s and NROM is in an ideal position to enter the market
      • NROM franchises are much cheaper to start (~80K) vs. Papa Murphy’s (250-275K) and early indications hint at similar economics
      • CEO has stated he thinks they can get 50 by 2013. This is probably too aggressive (but wow if he is right this would rerate fast), but they are in talks with larger franchise operators to open many units (20+)
      • Conclusion: The Take N Bake market is growing (Papa Murphy’s plans to open 100+ stores in 2013). NROM is the only other real player in the market now (and the large players don’t want to participate), and if their new stores show continued success, they should be able to quickly grow given Papa Murphy’s is 3X as expensive to open. This is admittedly the hardest segment to value, but at the current market price, it is more of a free call option than anything else. You can value this at zero and the stock is still a big winner.

Concluding Thoughts

You can certainly argue on the margins with some of my assumptions: perhaps NROM falls short of adding 400 grocery stores per year, the non-traditional location segment has a small decline, the take n bake franchise concept does not take off, and operating expenses slightly increase. However, at a price of $0.77, representing just above book value, these segments can underperform my expectations and I can still have a very profitable investment given the huge margin of safety. I think the market has ignored this stock and that early investors that jump on this story and have the patience to let it develop will end up with very satisfactory returns. I peg fair value from $2-$6, an admittedly wide range given the potential in the take n bake market. Even the low end of the range represents over 200% upside from the current price.

Why This Opportunity Might Exist

• $15 mm market cap—under the radar of almost all institutional investors
  • Also zero write-ups on SZ or VIC
  • Trades for less than $1
  • Many shareholders have “puked” this stock out after its precipitous decline from over $7 in 2007
  • Multiple business changes over time have confused and caused doubt to investors

Risks

• Management is paid handsomely for such a small company (but they also own lots of stock)
• CEO is on the older side and plays an important role in the company
• Capital allocation—this is always a risk in a business that does not need a lot of investment. I feel the risk is small here though (but still exists) because management has indicated they will use cash flow to pay down debt, and then initiate a dividend

Other Reading

• Latest investor presentation: http://www.nobleromans.com/pdfs/2012%20Presentation%20PDF.pdf
• Good SA article: http://seekingalpha.com/article/853531-noble-roman-s-inc-who-knew-pizza-could-be-so-profitable?source=yahoo