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August 18, 2014

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El Pollo Loco: PE Bust-out, 20+ years of failed
domestic expansion and pre-IPO window dressing
make this blind leap of faith stock an ideal short



There should be ZERO bid for this stock anywhere north
of $20.

Price Target: $6.10/share
Timeframe: next 12 months

-More like a Pollos Hermanos
than the Chipotle media
comparison it is currently getting

-20+ Years of failed Domestic
Expansion Track record

-Two year comp momentum is
largely average check growth
driven, and thus should be heavily
discounted

-Existing equity holders will be very
motivated sellers at lockup expiry




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Contents
I. Background & Introduction ...................................................................... 3
II. The Next Chipotle? Not even Close! ....................................................... 5
III. A Long History of Failed Domestic Expansion ........................................ 7
IV. Dissecting El Pollo Locos Pre-IPO Comparable Same-Store Sales ......... 9
V. El Pollo Locos Ownership History......................................................... 17
VI. Valuation: Whats it worth?................................................................. 24
Summary ................................................................................................... 30






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I. Background & Introduction



Juan Francisco Ochoa started the restaurant in Guasave, Sinaloa, Mexico, in
1975. After expanding in Mexico the first US location opened in 1980 in Los
Angeles, California. Which is when the journey of the publicly listed El Pollo
Loco we see trading as LOCO today began. After achieving notable
success in the LA market, in 1983 the US restaurants in the chain were
acquired by Denny's. Juan Francisco Ochoa and family would continue to
operate the restaurants in Mexico (he went on to setup a taco chain in
Texas called Taco Palenque and the Palenque Grill both serving Mexican
cuisine with recipes similar to El Pollo Loco). American Securities Capital
Partners (ASCP) acquired El Pollo Loco in 1999 and sold it to current
majority owner Trimaran Capital Partners in 2005.



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Which brings us to the fanfare surrounding the July 25
th
2014 first trading
day for El Pollo Loco. On the first trading day the stock opened at $19
(from an IPO price of $15) and closed near the days high at $24. Which
prompted articles touting El Pollo Loco as the latest quick service/fast
casual chain to emulate Chipotles rapid growth Which as you will see later
couldnt be further from the truth. The next 5 days of trading in El Pollo
Loco were truly epic in what appeared to be a high frequency trading game
of hot potato, combined with mini short-squeezes combined with day
traders gone mad. We think the below charts and tables sufficiently convey
the Loco-ness of it all:




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II. The Next Chipotle? Not even Close!

When El Pollo Loco filed to go public, we took a look at the chain knowing
full well that any Mexican themed restaurant chain going public would
draw surface comparisons to Chipotle. We figured that with Chipotles
recent operating and share price momentum that this IPO might actually
attract the momentum fast money crowd that eventually creates a good
short regardless of the underlying business involved (much like Veeva
during the SAAS euphoria in Q4 2013). What we concluded after just one
days worth of research and analysis was that a deeper dive on the name
was not justified as there was NO WAY the market would buy this story,
and this is coming from individuals who are rarely surprised by just how
stupid the market can be at times. This is because even the most cursory
look at El Pollo Loco leads one to conclude this company has no business
being compared to any restaurant chain growth story, let alone Chipotle.
Yet here it is a few weeks after going public trading at a higher multiple
than Chipotle, and garnering the type of market media attention bestowed
on growth story darlings. So, lets take a closer look.
Date Open High Low CloseVolume Float Turnover
8/13/2014 34.51 34.6 33 33.3 1,700,700 24%
8/12/2014 34.76 34.9 29 34.1 3,261,600 46%
8/11/2014 38.4 38.5 35.8 35.8 2,458,700 35%
8/8/2014 38 38.2 36.1 37 3,057,200 43%
8/7/2014 39.43 40.3 38.3 38.9 6,133,900 86%
8/6/2014 34.44 37.8 34 37 6,222,500 88%
8/5/2014 36.27 36.9 33.6 34.3 7,881,500 111%
8/4/2014 41.35 41.5 37.6 38.4 9,067,000 128%
8/1/2014 39.05 41.7 38.4 41.2 14,425,400 203%
7/31/2014 35.83 39.9 35.2 38.8 18,345,300 258%
7/30/2014 31.78 38.3 31.6 34.6 15,520,100 219%
7/29/2014 31.84 32.5 29.1 29.9 12,108,400 171%
7/28/2014 26.88 34.7 26.3 34.5 26,901,000 379%
7/25/2014 19 24.4 18.5 24 23,673,600 333%
Total 150,756,900 2123%
Float 7,100,000
Shares Short 900,173 *as of July 31 NASDAQ short report


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El Pollo Loco vs. Chipotle:

Chipotle Store Count End of 1999: 37 Stores All in Colorado

El Pollo Loco Store Count End of 1999: 278 Stores in 4 States(CA, NV,
TX, AZ) with 85%+ Los Angeles.

Chipotle Store Count End of 2013: 1,572 Across 43 States and D.C.
as well as 16 International
Stores in Canada, England,
France, and Germany.

El Pollo Loco Store Count End of 2013: 401 Stores in 5 States with 88%
of Stores in California

Here is a detailed snapshot of key metrics at these two companies over the
last decade:


As you can see from a historical analysis standpoint, these two companies
couldnt be more different. The only thing they have in common is that they
both offer Mexican themed cuisine.

Metric El Pollo Loco Chipotle Mexican Grill
2003 Revenue($ Mil) $206 $315
2013 Revenue($ Mil) $314 $3,214
10-Yr Revenue CAGR 4.31% 26.10%
2003 ADJ EBITDA $33 $7
2013 ADJ EBITDA $55 $644
10-Yr ADJ EBITDA CAGR 5.20% 56.80%
2003 Store Count 315 298
2013 Store Count 401 1595
Past 5-Yr Same-Store Sales Avg 1% 7.10%
Past 10-Yr Same-Store Sales Avg 2.10% 10.90%


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Ahh, but this is the story of the past, this stock is trading on what the future
will bring. Surely this IPO opens the door to significant domestic and
subsequently international expansion.

We seriously doubt that.

III. A Long History of Failed Domestic Expansion

El Pollo Loco is not some new hot restaurant franchise on the verge of
massive domestic expansion. They have a long history of trying and failing
to meaningfully grow their brand outside of the Southwest United States or
for that matter, the core Los Angeles market.

Here are some of the most recent failed attempts to expand geographically
across the United States

Chicago: 4 stores starting in 2005, all closed by 2012
Colorado: 1 stores starting in 2006, closed by 2011
Connecticut: 1 store opened in 2006, closed in 2012
Georgia: 9 stores starting in 2007, all closed by 2011
Massachusetts: 2 stores starting in 2007, all closed by 2010
New Jersey: 1 store 2009, closed in 2010
Oregon: 2 stores starting in 2008, all closed by 2011
St. Louis: 1 store opened in 2009, closed by 2011
Virginia: 3 stores starting in 2008, all closed by 2011
Vancouver,WA: 1 store opened in 2008, closed in 2009

Thats ten states entered and exited between 2005 and 2012!

Here is what management has had to say about this:



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As of March 30, 2011, we had 14 system-wide restaurants open in markets east of the Rockies.
Additionally, three stores (two franchise locations and one company location) were closed in
2010 and four stores located east of the Rockies (all franchise locations) were closed in 2011 in
these areas due to low sales. Our restaurants open east of the Rockies are experiencing a wide
range of sales volumes, and a majority of them have sales volumes that are significantly less
than the chain average due to the lack of brand awareness in the new markets.

Now here is an excerpt from one of their east coast franchisees on his
experience:

"That style of Mexican grilled chicken is very, very regional," said Ed
Doherty, president and chief executive of Doherty Enterprises. It originally
secured the rights to open as many as 30 El Pollo Locos in New Jersey and
New York, but the company decided not to go further with the concept after
sales in North Bergen were less than what they had hoped. To expand the
concept, Doherty said, his company wanted to see sales of $40,000 to
$45,000 a week at the North Bergen El Pollo Loco. Instead, it was doing
about $25,000 a week. After a fire at the store two years ago, the company
sold the location to a Wendy's, which is doing more than double the sales
volume.
"It wasn't the location," Doherty said. "Wendy's is doing great."

And keep in mind this is not the first time El Pollo Loco has had a tough go
of it geographically expanding. In the late 80s and early 90s there were
failed forays into Florida, North Carolina, Hawaii, and even Japan.

Suffice to say, El Pollo Locos repeated struggles to expand geographically
are very difficult to ignore. While discounting some of the failure to
multiple instances of poor economic timing, it is still hard to fathom the
uniform nature of the failure. This is not a case of one or two markets
failing to absorb 20 to 30 units, but rather about every single market failing
to accept the brand at all. We have no doubt that if In-N-Out Burger (a
chain which literally has the same exact Southwest regional presence as El
Pollo Loco) opened in these same markets that there would be lines out the


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door, and that those first couple of stores in each new geography would
literally mint money.

Clearly, El Pollo Loco, despite its near ubiquitous presence in the second
largest American city, has not developed the commiserate brand identity.
Banking on that drastically changing after two decades worth of irrefutable
empirical evidence requires nothing short of a tremendous Blind Leap of
Faith.

Well, then what about those solid pre-IPO comps?


IV. Dissecting El Pollo Locos Pre-IPO Comparable Same-Store
Sales

Anyone who has ever invested in restaurant franchise stocks knows how
hyper-sensitive the names can be to short-term comp sales numbers. One
need only look at the recent collapses of Bloomin Brands and Potbelly for
fresh examples of what happens when you slightly disappoint in this area.
Mature brands trading at close to 2x EV/Sales can quickly turn into 1x or
less EV/Sales stocks, and for hyped younger growth stories the 20x+
EV/EBITDA is quickly replaced by something a lot closer to a 10x multiple.
Thus, with El Pollo Loco trading at north of 30x EV/EBITDA and 5x EV/Sales,
one has to be quite cognizant of their recent comps and whats driving
them.

This goes without saying for any restaurant stock trading at such levels, but
is even more relevant for one that just went public. This is because there is
a tendency to window dress a company before an IPO by pulling short-term
levers that are typically not sustainable and/or not in the long-term
interests of the business model. This window dressing is most common in


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businesses that have been around for a while, and especially common in
ones that have been passed around by PE firms. That being said, once you
get to our review of the ownership/financial history of this brand, you will
understand why we pulled out the microscope to look at their pre-IPO
numbers.

We imagine that when the JOBS Act was passed that the sponsors did not
envision it being used to limit disclosures by companies that have been in
business for over 30 years. Thats what you get with El Pollo Loco. A
company that has nearly two decades worth of accessible financial
information, only ends up needing to disclose the results from the last
three years. Luckily for us, a company that has incurred this level of
indebtedness often has registered securities that require regular filings with
the SEC, and that is precisely the case with the El Pollo Loco. Combine these
filings with a failed 2006 IPO prospectus and a recent note exchange offer
that you can go through, and you end up with all the data you need to paint
a complete picture. With that in mind, any discerning investor looking at
the last two years of pre-IPO comps within the context of the chains
broader comp trends over the last 15 years is going to raise a red flag and
ask some questions.

El Pollo Locos company owned same-store sales have averaged 7% growth
over the last two years. This is a huge deviation from the 1.4% average over
the preceding 11 years, and jumps off the page when you see that traffic
attribution in the comps has been trending closer to 2%.

Why does it jump off the page?

1) El Pollo Loco reported some of the worst comps in their peer group
in the recession. In 2009, they ranked 47 out 50 QSR chains for year-
over-year same-store sales. Their combined 2009/2010 performance
puts them at virtually the bottom of the entire QSR 50 list. When


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you are looking for comp sustainability, you are trained to be wary of
what might be unusually easy comparable periods or sudden swings
that look like one-off/macro rebound driven numbers.
2) El Pollo Locos store base shrunk throughout the reported pre-IPO
comp period (412 stores end of 2010 to 401 at the end of 2013);
store closures remove underperforming restaurants from the store
comp base. This is good news for short-term comps, but again not a
sustainable positive trend one expects to be leveraged going
forward. Furthermore, it is an explicitly bad sign for a chain whose
stock is being valued at the highest end of the future growth
expectation range.
3) Large average check count increases for a non-growing regionally
concentrated chain tend to imply price increases. This is notable as
price hikes are by definition not a sustainable comp driver and also
come with their own potential down the road trade-off as customers
may gradually look elsewhere for value. Furthermore, in El Pollo
Locos case, this phenomena is accentuated by the fact that 80% of
their revenue is derived from one state, and even within California
its largely weighted towards the city of Los Angles (we estimate in
the 65-70% range). If your core demographic is Hispanic-Americans in
Los Angeles, investors are even more likely to discount comp growth
that implies significant price driven average check growth.


Now, #1 and #2 above speak for themselves, it is #3 were investors in
El Pollo Loco have not surprisingly been left in the dark.


The below excerpt is from Chipotles recent Q2 Conference Call:

Overall sales for the quarter increased 28.6% to $1.05 billion, driven by the comp and
from new restaurant openings. Year to date sales were $1.95 billion, an increase of
26.6%, including a comp for the year so far of 15.5%. The quarter comp was primarily


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driven by an increase in customer traffic, along with an increase in our average check,
which includes a 2.5% benefit from our menu price increase rolled out during the
quarter. Average check in the quarter was up about 5% from last year with half of this
increase coming from the menu price increase and the rest of the check increase coming
from catering, an increase in the group size per transaction along with additional sides
such as Chips & Guac.


As you can see, Chipotle clearly deconstructs their comp numbers.
The 17.2% comp for the quarter only includes at 2.5% benefit from
price (note to Cramer, Chipotles 17.2% and El Pollo Locos disclosed
prelim 4.9%-5% Q2 comp are not similar comps as one chain is
experiencing 14% yr/yr traffic growth while the other is doing 1.4%!).
This is not something Chipotle just started doing because the market
has been focusing on their recent nationwide menu price hike; this is
something they have always disclosed to investors even when price
increases have been more targeted.

El Pollo Loco does not offer this level of transparency in their
prospectus even though EPL Intermediate has offered it in past 10-
ks.

Here is how they define Comparable Restaurant Sales:


Comparable restaurant sales growth can be generated by an increase in the number of meals
sold and/or by increases in the average check amount resulting from a shift in menu mix and/or
higher prices resulting from new products or price increases.


The problem here is that when it comes to disclosing average check,
they do not break out the impact of menu price increases. For
example, in their banner 2012 comp year, 6% of their 8.6% increase
in company owned same-store sales came from average check


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growth. A number like that for a non-organically growing chain
screams significant menu price increases. Now, if this was a chain
with a large national presence, deconstructing these menu price
increases would be a challenge, but you dont have that problem
here.

Here are two photos we took a few days ago of an El Pollo Loco
drive-thru menu in LA





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What you see above is El Pollo Locos new menu, which is largely a
reflection of where management has decided to take the brand over the
past couple of years. What should jump out at you, (if you are familiar with
the brand) is the fact that the value QSR element has gradually been
replaced by what looks more like a fast casual menu. Over the past few
years the Dollar Menu morphed into the Value Menu, which is now
being replaced by the more value indifferent Snack Menu.

Now we could show you plenty of photos illustrating this genesis, but
deciphering the price changes from multiple images from countless
locations spread across several years is not ideal. So we will try and keep it
simple for you by sharing what our extensive research dug up.

This link is from an El Pollo Loco menu circa summer of 2009. As you can
see, when compared to the prices from the drive-thru screen shots above,
things have changed quite a bit. Popular value items like the BRC Burrito
and Chicken Taco al Carbon have seen price increases of 65% and 69%


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respectively. The introductory 8-pc family meal has increased in price by
14%, and the 10 piece by 17%. A 3 piece chicken leg and thigh combo has
increased by 27%, and the price of a small side has gone up by 44%. Now to
be clear the above photographed menu is new and is not reflective of the
entire store base, and 2009 is a little too far back for what we were looking
for in terms of pre-IPO comp insight.

A more relevant visual comparison would be this bloggers Jan 2012 visit
and review (with menu price photos) of an El Pollo Loco. At this specific
restaurant, we verified that popular value items, the BRC Burrito and the
Chicken Taco al Carbon, increased in price by 29% and 39% over the past
two years. Meanwhile, the intro 8 piece leg and thigh family meal increased
by 13%.

Now setting aside these select comparisons, our more comprehensive
research indicates that the key takeaways here are that the low end (i.e.
the value items) of the menu has come up rather significantly over the past
2.5 years, and that the family meals, starting in mid-2011 have seen 9-15%
increases. Basically the intro 8 piece range has gone from $15.99-$16.49 to
$17.49-$18.99 with comparable hikes as you go up in family meal size. The
ability to track the changes on the family meals is actually quite helpful as
management does disclose that these meals accounted for a little less than
a third of company operated store sales. Thus, you can estimate that there
is a 2.5-5.0% price hike impact embedded in the last two years average
check growth just from the pricing taken on this part of the menu. As for
other items, we can say that bowls and burritos have been relatively stable
over the past 2 years with a trend of new higher intro price point menu
items entering the total mix.

Overall, we came away from this exercise with the simple conclusion that
pricing has been a very relevant and likely dominant part of an already
average check dominated comp stack. We also have concluded that


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managements decision to move towards a more upmarket brand identity,
as they seek to try and grow the brand again, risks alienating the brands
core demographic and putting them head-to-head with much established
healthy fast casual chains. Basically, becoming more like Chipotle 15 years
ago would have been a good idea, but at this juncture it actually opens the
door to that powerhouse making inroads against you in your bread and
butter market. When your bread and butter market is literally one city, that
is a pretty risky maneuver. Chipotle has never really faired too well in LA
because of all the Mexican options and the existence of the likes of El Pollo
Loco dominating the value/family element amongst the Hispanic
community, if that were to drastically change sometime in the near future,
El Pollo Loco would quickly become a candidate for liquidation or
restructuring.





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V. El Pollo Locos Ownership History

Think Los Pollos Hermanos or the Bamboo Lounge from
Goodfellas and not Chipotle!



Anyone who has seen Breaking Bad is quite familiar with the Los Pollos
Hermanos story. Gus sells tasty chicken out the front door while Walter
and Jesse cook Meth in the basement.




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Well, if there is ever a private equity version of the hit series Breaking Bad,
El Pollo Locos story should be at the top of the list.

Sell Tasty Chicken out the front door while financial engineers behind the
scenes cash-in by piling on debt to pay outrageous dividends, management
fees and transaction fees.

The Bamboo Lounge bust-out in Goodfellas is also a good analogy. Find a
solid cash flowing business, run up its credit to take supplies in the front
door that are sold at 100% profit out the back door, and then light a match
to the place. When PE goes awry in the restaurant business its very hard
not to think of the Goodfellas bust-out, as piles of cash in the form of debt
literally come in the front door and go out the back, with barely a cent
seemingly ever making its way into the operating business.

The History of the LBO Family Chicken Meal:

The 12 restaurant Los Angeles based El Pollo Loco that was acquired by
Dennys in 1983 had the makings of what might have one day be todays
Chipotle. The chain expanded rapidly over the following seven years
(almost exclusively in southern California) to 200 units, and developed very
strong brand equity. But thanks to the late 1980s Junk bond driven LBO
boom (Coniston Partners purchase of their parent TW Services for $1.7
billion with $1.5 billion in high yield debt was the last great junk bond deal
of the 1980s), it spent most of the early 1990s as a neglected asset within
the portfolio of a large and financially burdened holding company.
Consequently, over the first half of the decade, El Pollo Locos parent only
managed to add 16 new restaurants. There were also multiple non-focused
failed expansions during this time that saw the chain open and close in
Florida, Hawaii, and even as far away as Japan. Not exactly how you grow a
restaurant franchise, but when you are that leveraged you take what you


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can get. Yet, a remodeling program and a new strategy to target the lunch
crowd in the mid 1990s seemed to position El Pollo Loco for an era of
renewed expansion. In 1996, their parent company announced ambitious
plans to expand the chain to 600 units by the end of the decade. Of course
the parents bankruptcy filing the following year threw a wrench into those
plans. The huge expansion never materialized, and by the end of the
decade a decision was made to put El Pollo Loco up for sale.

Enter alleged savoir/value creator PE Firm American Securities Capital
Partners.

The El Pollo Loco that was acquired by ASCP for $128 million in cash at the
end of 1999 ($44 million in equity from ASCP and the rest in debt financing
in the form of a senior loan) had generated $21 million in EBITDA the
previous year.

Here is what they saw themselves bringing to the table in a joint
presentation by Steve Carley- El Pollo Loco CEO and Glenn Kaufman-
Managing Director of ASCP


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Admittedly over the next three years they did seem to be making some
progress putting the chain back on the right track. They remodeled stores,
upgraded IT systems and improved overall operating efficiency while
selectively expanding in the core market. And yes, they reduced some of
the leverage used to finance their acquisition.

Then at the end of 2003 it would appear they got bored or determined that
El Pollo Locos future was limited to being a solid LA Mexican Chicken chain
whose cash flows were better served being milked than reinvested in
domestic expansion; $70 million in additional debt was incurred. $50
million of that was paid out in the form of a dividend and $20 million was
used to buyback preferred stock. El Pollo Loco ended the year with $133
million in debt. In 2004, we got more of the same. ASCP borrowed to pay
themselves a $37 million dividend. Then in 2005 ASCP decided to sell El
Pollo Loco, but not before another $11 million distribution was tacked on in
the form of transaction fees. All in all, in just over 5 years, ASCP took a


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company with $15 million in capital lease debt and $21 EBITDA and turned
it into one with nearly $185 million in long-term debt and $33 million in
EBITDA. If you run the numbers on the deal financing for the acquisition,
fees, and leveraged dividends cashed out; nearly every last cent of the
indebtedness incurred by El Pollo Loco effectively never made it into the
business.

Now here is an excerpt from the PR ASCP put out after they agreed to sell El
Pollo Loco in 2005:

Through continued and long-term focus on operational investment and strategic growth
during its time with American Securities, El Pollo Loco has substantially improved restaurant
level operating performance while more than doubling the

more

companys profitability. The heritage of our firm is in building great enterprises. We are
completely committed to working as partners with managers to build businesses that are far
better operationally, financially and competitively when we exit than when we initially
invested, added Mr. Kaufman. Our El Pollo Loco experience is a perfect example of our
business philosophy.


Seriously? Now doesnt that post sale case study slide about reducing this
acquired Orphans leverage seem a bit ridiculous to you. If El Pollo Loco
was an Orphan when ASCP bought it from TW Services, it was an orphan
with a new pair of shoes and no legs by the time they sold them to
Trimaran Capital Partners. A better analogy here would be that ASCP
acquired an orphaned chain, dabbled with nursing them back to health,
only to turn around and thoroughly bust them out before they sold them
off to somebody else.

During these five years of financial ingenuity, while El Pollo Loco was being
used as a PE ATM machine, Chipotle opened nearly 500 restaurants across
the nation. One cant help but wonder what El Pollo Loco would like today


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if all that debt had been used to fund a gradual and laser focused expansion
of the brand.

So, El Pollo Loco, whose biggest problem had been that it was stuck in the
portfolio of a restaurant holding company mired in junk bond mania debt,
was now also buried in debt.

The Solution: Why of course, another LBO to tack on even more debt, and
hopefully a quick flip IPO to save the day.

Enter Trimaran Capital, the current majority shareholder, which clearly had
no intention of holding onto El Pollo Loco for very long. Going back through
SEC filings we found the 2006 S-1 for El Pollo Loco in which they were
looking to raise up to $135mln for a company with $260mln in debt and
$36mln in EBITDA (according to 2005 numbers in the S-1.) Note, this S-1
was initially filed just a few months after the closing of the acquisition by
Trimaran. So for them having this quick-flip turn into a 9 year investment
was definitely not part of their original game plan. Their timing was to put it
mildly not very good. Over their ownership period El Pollo Loco reported an
aggregate net loss of $191 million. Their last profitable year was 2006, and
for the last year the company earned more than $1 million you have to go
all the way back to 2003. And as if being the last PE buyer in the door
before the music stopped and a major recession appeared wasnt bad
enough, they got hit losing a trademark lawsuit to the original Mexican
founder of El Pollo Loco (they ended up settling for just under $11 million in
2008). Not exactly a pleasant journey. In fact, it is a sheer miracle that they
averted bankruptcy here. Just a look back at their filings and you can see
that as recently as August, 2011 they were marking El Pollo Loco at 30c on
the dollar ($30 million equity value for the whole company). Yet now they
are sitting on a majority stake in a company that the market is valuing at
$1.4 billion, and income tax receivable agreement that is worth some $40


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million in distributions (to both PE firms) going forward. This is a pretty
remarkable turn of events to say the least.

So, what was the point of this trip down memory lane?

Well, to be clear, we wanted to set the record straight as far as current
popular perception of this name being some sort of hot story stock. El
Pollo Locos last twenty years of operating history are an absolute tragedy.
This was a business with a lot of potential that always seemed to find the
wrong owners, and now after decades of missed opportunity it is being
dumped on the unsuspecting retail investor. Now, there is no doubt that
management has done an excellent job stabilizing the ship, especially
considering they have been operating with the financial equivalent of a
noose around their neck. But that does not obscure the fact that this is just
about the furthest thing from an exciting growth story, and that owning the
shares at these levels is the equivalent of simply burning the cash in your
wallet.






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VI. Valuation: Whats it worth?

El Pollo Loco shares currently trade in excess of 30x EV/ 2013 ADJ EBITDA
(Chipotle is at 29x trailing and 24x consensus estimate for 2014)

Consider that multiple within the context of how long the brand has been
around, the missed opportunities to expand while PE played LBO hot
potato with it, subsequent and very recent failed domestic expansion, the
concurrent domestic metamorphosis of Chipotle into a Mexican chain
national powerhouse, and overall intense competition in their very
crowded niche. How many Pollo [fill in the blank] are there in the USA? We
counted at least 10 other regional chains including El Pollo Rico, Gordo, de
Oro, Regio, Inka, Primo, Campero, Feliz, Norteno and just plain El Pollo. The
multiple is just plain LOCO! When you further factor in El Pollo Locos
concentrated exposure to one city, a menu that is pushing the outer limits
of value for a brand with core demographic that is highly value conscious,
and still somewhat limited balance sheet flexibility; a multiple north of 10x
EV/ ADJ EBITDA becomes completely indefensible.

At 10x EV/ADJ EBITDA the stock would be trading at $9.80 which implies
over 70% downside from current levels. This would put it on par with
where recent food and beverage IPO Potbelly is now trading. We think fair
value for this business is still lower, with a price close to $6/share in the
coming 12-18 months not being out of the question.

$6 that must be some crazy sensationalist short biased target, right?

To be clear that target is not even predicated on some sort of gloom and
doom scenario.

Mature niche restaurant chains are very sensitive to short-term comps, and
there is no shortage of them trading at trailing EV/Sales multiples of 1x or


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less (Potbelly, Bloomin Brands, and Red Robin Gourmet all trade at EV/Sales
multiples of less than one). Considering El Pollo Loco generated $315
million in revenue last year, a 1x EV/Sales multiple works out to
$3.50/share. Now Potbelly is interesting comp because its a more recent
expansion story, IPOd less than a year ago, operates 280+ company owned
shops across 18 states, had 20% shop level margins vs El Pollo Locos 21% in
2013, and is sitting on a much healthier balance sheet with net cash at 2x
EBITDA vs net debt of 3.4x ADJ EBITDA at El Pollo Loco. Yet Potbelly
doubled from its offering price, traded side ways for a few months, then
slowly trickled back down to the offering price, and later fell off a cliff after
its third quarterly report as a public company on weaker than expected
comps. It currently trades at an EV/ADJ 2013 EBITDA OF 8x and EV/2013
Sales multiple of 0.96x. These multiple should give any El Pollo Loco
investors pause, especially when you factor in that Potbelly has been
steadily growing their brand since 1995, and has not experienced the type
of significant geographic retrenchments El Pollo Loco has faced over the
years. However Potbelly has been weak of late, so lets look at a more
mature restaurant chain with better recent operating momentum.

Jack in the Box, which owns the 600+ unit Mexican themed Qdoba chain,
(as well as 2,200+ Jack in the Boxes) has been on a tear of late with shares
up 60% over the last 12 months. The driver has been significant comp
momentum at the Qdoba chain recently, which as of the most recent
quarter were up 7.5% year over year, and year to date are up 500bps over
2013. Despite this recent run-up, the stock is trading at EV/TTM EBITDA of
roughly 10x. In fact, most of the successful established national restaurant
chains trade in this neighborhood. Panera, Bloomin Brands, Wendys,
McDonalds, Red Robin Gourmet, Buffalo Wild Wings, and Yum Brands all
trade at roughly 11x EV/EBITDA or less.

The next step up comp wise is Popeyes Louisiana Kitchen which has 20%+
mkt share in the domestic chicken QSR segment, and thus makes for a solid


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comparable. Popeyes trades at 14.5x EV/ TTM EBITDA. The chain sports
EBITDA margins that are nearly double El Pollo Loco at 31.7%, and grew
revenue by 35%(only 2% of the chains 2,225 are company owned) over the
past two years. Their Net Debt to EBITDA clocks in at 0.9x, and over the
past three years they have on average returned 36% of EBITDA to
shareholders via buybacks. Furthermore, the Popeyes brand continues to
grow both domestically and internationally despite it large unit base. The
global brand equity is hard to ignore considering the brand was founded
only two years before El Pollo Loco.

After Popeyes, the next chain worth looking at in the comp ladder is the
very relevant Fiesta Restaurant Group. FRGI, which operates two
Mexican/Caribbean themed chains in Taco Cabana and Pollo Tropical, is
about as close as you are going to get to El Pollo Loco. The chains have a
similar regional focus with Pollo Tropicals base concentrated in Florida and
Taco Cabanas in Texas. FRGI trades at an EV/EBITDA multiple of 18x or 40%
lower than El Pollo Loco. We believe the name is also an attractive Chipotle
inflated Mexican chain stock short, but will concede that for now it
provides a more marketable surface level growth story. Pollo Tropicals 7%
average same-store sales growth over the past two years is 66% weighted
to traffic vs El Pollo Locos 37% traffic weighting for a virtually identical
company owned same-store sales two year average. Pollo Tropicals stores
are also averaging 53% more in avg sales per unit, and exhibit 350 bps
higher restaurant level margins. Wed also note at that FRGIs largely
company owned model has resulted in a much more controlled domestic
brand expansion with no significant failed retrenchments in recent years
damaging brand equity, and thus remains more open to future domestic
franchising margin expanding opportunities.


The last non-Chiptole chain in El Pollo Locos valuation neighborhood is the
50x+ EV/ADJ EBITDA multiple sporting and seemingly unique


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Mediterranean concept story of Zoes Kitchen, ticker ZOES. Zoes, which
has gone from 20 units to 100+ in the past five years, is still growing its top
line at close to 50%. But a fresh concept chain and a small store base with
exceptional and consistent unit growth trends over five years is again the
very antithesis of El Polo Loco.

We even fished around for private chicken chain comps during our research
and came across QSR behemoth Churchs Chicken which was sold four
years ago for an estimated 6x EBITDA.

There is another way to think about how to value this business other than
looking at public company comps. If youve had any experience valuing
small regionally focused private service industry businesses or large
franchisees of a healthy restaurant brand, El Pollo Loco should be right up
your alley. When you come across a regionally strong business that has the
characteristics of a finite/limited geographic expansion story, you dont
want pay more than 5x EBITDA. Ideally, you come across such a business
and conclude you can clean it up and significantly improve profitability and
find a seller who is willing to part from it for less than 3.5x. However, youd
be willing to pay up to 5x knowing there is plenty of room to grow your
value and effectively reduce your cost base. The exact opposite is true if the
business is being well run or has in fact made some recent changes which
significantly improved operating profitability.

In such a scenario, you are more likely to discount the recently improved
operating metrics as what you are trying to buy is a cash cow and not a
growth story. Essentially, if the current owner has recently significantly
improved operating profitability, you are going to be much more stubborn
with respect to your valuation ceiling. We like to think of El Pollo Loco in
the same way, but on a somewhat grander scale. This is not a hot growth
story brand or national/global scale play. At best, there might be room
for some selective further southwest regional expansion, but for the most


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part the view here is that this is a more mature regionally specific strong
service brand. This puts the 10x+ EBITDA range out of the question for it.
Our acceptable range is going to be more like 5x-10x. The more confident
we are that they can significantly improve operating profitability, the more
comfortable we are with the higher end of the range. This is where the pre-
IPO metrics come into play. The 340 bps in restaurant contribution margin
improvement, sizeable average check growth, huge comp deviation from
historical averages, new menu changes, near 50% completed store base
remodelings, 2013 debt refinancing, Second Lien Term Loan paydown in
conjunction with the IPO, and recent wave of underperforming store
closures are ironically all the things WE DONT WANT TO SEE as buyers of a
strong cash flowing Southern California restaurant chain. Because what is
there left for us to do but try and turn it into a growth story, which as
buyers looking at this regionally mature brand we already have assumed it
is not. If both parties are sharp, what you end up with here is a stalemate.
The buyer doesnt want to pay top dollar for a cash cow business that has
just gone through a thorough once a decade refurbishing, and the last thing
the seller wants is a prospective buyer who does nothing but remind him
that he has put all this work in and is selling here because he has accepted
that meaningful expansion is not feasible.

This is the key issue with El Pollo Loco, and probably goes a long way to
explaining how the underwriters were able to price the IPO at $15. If you
pro forma the hell out the name, the stock priced at a seemingly
reasonable P/E of 22x 2013 net income. That is a pretty big leap from $16.8
million reported loss, and the close to $200 million in reported losses
incurred by the company since Trimaran bought it. Bankers love these
types of IPOs because they are essentially deleveraging turnaround stories
that are partially contingent on the IPO happening, and the huge
deleveraging impact on reported results quickly becomes the only thing
investors want to talk about. The El Pollo Loco business couldnt have been
more ideally suited for this type of pitch. Between 2011 and 2013 revenues


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are up 15%, operating income is up 56%, restaurant contribution margin
improved by 230 bps, ADJ EBITDA margins improved by 300 bps, and
company operated store average unit volumes went from $1.6 million to
$1.75 million.

These are impressive metrics to say the least, and that is the problem here.
They are literally so good that you are immediately forced to red-flag them.
How are you growing operating income 56% with 2.5% yr/yr growth in
traffic? 230bps in restaurant margin expansion is no joke for a mature chain
with 67% of their stores in one city, are you not testing the upper limits of
pricing on your core Hispanic base in Los Angeles? What happens to
Average Store Sales Volume when stores doing 30-50% less than the core
LA base close down? What kind of restaurant chain goes from 6% D&A avg
expense of total revenue to 3%? When you answer all these questions, you
should have no problem figuring out that El Pollo Locos impressive growth
in metrics are not due to organic growth. Instead, they reflect a cash-cow
business pulling short-term levers in anticipation of a sale. The fixed cost
leverage that has been extracted here doesnt comport with a growing
franchise. El Pollo Loco has the labor, occupancy, depreciation, food cost,
and marketing spend cost structure of a very mature one region focused
chain that is simply milking its base. Start to expand, which btw they have
failed to do when there was much less powerful competition for their
brand, and these savings being squeezed out all go in the other direction.
Start growing and lower average store volumes as you enter markets
further away from your core base or cannibalize your existing mature base
with new stores, more complex and costly distribution, expanding
overhead, much higher marketing spend to build brand awareness are what
you have to look forward to. There are also regulatory issues to worry
about like the July 1, 2014 12.5% California minimum wage increase, and a
further 11% increase coming at the end of 2015. Considering that 88% of
the store base is located in California, a 25% increase in payroll over the
next 18 months is going to be a very meaningful EBITDA headwind (again


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nice IPO timing). Put all this together and you start to appreciate why a
discounted multiple is warranted here. In our case we settled on 7.5x ADJ
2013 EBITDA or a fair value of $6.10 a share for now.



Note there is nothing wrong with running this business the way it has been
run. Management has done what they needed to do over the past three
years, and the economic rebound obviously helped them out as well. Our
concern with El Pollo Loco is that between its LBO ownership history
nightmare and its recent refurbishing a whole lot of time has passed, and
the competitive landscape is not what it used to be. Their core
demographic in Los Angeles has absorbed the pricing shifts thus far, but the
risks have gone up with respect to economic sensitivity of the chain and
vulnerability to competition from more upmarket brands as well as from
the better positioned value players. We have not accounted for these risks
in our fair value, but we are fairly confident that if a whiff of evidence
were to materialize indicating tiring of the brand in Los Angeles, 5x and not
10x ADJ EBITDA will quickly become the ceiling.

Summary

1) El Pollo Loco was a hot franchise chain with amazing growth
prospects 30 years ago. Today its still just an LA staple that is
probably going to have to work very hard just to maintain its grip on
what it already has. Comparing it to Chipotle is like comparing a
highly touted draft pick from 20 years ago whose early career was
marred by injuries and poor coaching, and thus ended up being
relegated to role player status, to Lebron James today.
2) Chipotles success which has buoyed the share price out the gate
actually works against them as far as future growth prospects go.


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3) El Pollo Locos pre-IPO comp numbers and margin expansion are
somewhat misleading. Significant price increases/menu mix shift into
a rebounding economy have been the driver, and thus should be
heavily discounted by investors.
4) Setting aside what repeated failed domestic expansions implies
about the brands future long-term growth prospects; the very
recent nature of franchise expansion failures across multiple states
does not bode well for any future franchising in an already
competitive franchise marketplace.
5) The largest shareholder is a legacy PE fund in runoff mode that filed
to take them public no more than six months after initially acquiring
them. At lock-up expiration their holding period will have been just
shy of ten years! The sheer fact that they avoided bankruptcy and a
complete wipeout of their investment is a miracle in and of itself. As
of a couple years ago, they were marking this investment at $0.30 on
the dollar. We imagine anything greater than $5/share feels like a
victory to them at this point. With all this in mind, we have no doubt
they will be highly motivated sellers anywhere over $10.
6) The income tax receivable agreement with the current shareholders
is like pouring salt on an open wound. Its just another way of
structuring a $40 million IPO contingent distribution kicker for the
pre-existing shareholders at the expense of new investors. The $10
million in cash interest expense savings from retiring the 2
nd
lien
facility ends up getting funneled back to the current PE owners in the
form of cash tax savings over the for the next four years. Further
evidence that this is a financially engineered and abused orphan of a
restaurant business, and not the next potential shining growth star
its being portrayed as in the financial media.
7) Finally, the restaurant stock euphoria of the last 18 months is no
longer a tail wind. Red Robin, Bloomin Brands, Potbelly, and Noodles
and Co have all recently demonstrated just how quickly the market
will punish the slightest dip in operating momentum. Those looking


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for long exposure in this sector are better served nibbling away at a
solid growing brand like Panera that has spent the last year or two
dealing with its own operational hiccups and is trading at an
attractive 8x EBITIDA multiple. We think betting on them ahead of a
potential rebound beats giving your money way in this dressed up
Chipotle piggy-back PE exit.




DISCLAIMER

Suhail Capital Limited is an exempted company registered in the Cayman
Islands (Suhail Capital) is an investment advisor to funds that actively
participate in the buying and selling securities and other financial
instruments.

You should assume that as of the publication date of this report, Suhail
Capital (possibly along with or through our partners, affiliates, employees,
and/or consultants) along with our clients and/or investors and/or their
clients and/or investors has a short position in El Pollo Loco LOCO
(and/or options, swaps, and other derivatives related to the stock), and
therefore stands to realize significant gains in the event that the stock
price of LOCO should decline. You should also assume that as of the
publication date of this report, Suhail Capital (possibly along with or
through our partners, affiliates, employees, and/or consultants) along
with our clients and/or investors and/or their clients and/or investors has
a long or short position in Chipotle Mexican Grill, Potbelly and any other
publicly listed company in this report (and/or options, swaps, and other
derivatives related to these stocks) , and therefore stands to realize
significant gains in the event that the price of Chipotle Mexican Grill,
Potbelly or any other company listed should increase or decrease.


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Suhail Capital strongly recommends that you do your own due diligence
before buying or selling any of the securities mentioned in this report.

We intend to continue transacting in the securities of issuers covered in
this report for an indefinite period after its publication, and we may be
long, short, or neutral at any time hereafter regardless of our initial
recommendation.

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available information, field research, inferences and deductions through
our due diligence and analytical process. To the best of our ability and
belief, all information contained herein is accurate and reliable, and has
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