Buy Recommendation

1

• Buy Recommendation

2
Business Model
Business Model
Royalty Trusts

• Receives royalties based on top-line revenues of
  Pizza Pizza stores in royalty pool
• 6 on Pizza Pizza
• 9 on Pizza 73
• Receives partial royalties from new stores added
  to royalty pool
• Extremely simple business
• No capex, few expenses, transparent growth

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
3
Business Model
Just a little complicated
Royalty Trusts
Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
4
Business Model
A bit simpler
Pizza Pizza RoyCo
Royalty Trusts
Risks to Royalties
OpCo
Brand Strength
Franchisee Profitability
Strength of OpCo
Franchisees
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
5
Royalty Trusts
Business Model
Royalty Trusts

• The royalty trust receives royalties from the
  OpCo
• OpCo usually has a 20 stake in RoyCo
• OpCo receives royalties from franchisees (flows
  through)
• Protection against store closures/sales declines
• When new stores are added to the pool, OpCo
  recieves units in RoyCo equivalent to 92.5 of
  value based on current yield of RoyCo
• New stores are only 7.5 accretive to RoyCo

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
6
Risks
Business Model
Royalty Trusts

• What happens if franchisee profitability
  declines?
• OpCo will make up for small variations
• However, this will eventually decrease royalty
  payments to RoyCo
• Therefore, strength of brand and profitability
  of franchisees is a key determinant of risk of
  RoyCo

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
7
Strength of Brand
Business Model
Royalty Trusts

• The dominant player in a fragmented industry
• 30 market share in Ontario
• Pizza Hut is 2nd at 12
• Share has consistently grown in sales and stores
• Extremely strong brand recognition
• 967-1111
• Will Pizza Pizza still be around in twenty
  years?
• The Tim Hortons of Ontario pizza

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
8
Strength of Brand
Business Model
Royalty Trusts

• Leading marketing program
• Spends more per dollar of sales than any other
  pizza franchise
• Positioned as the premium/healthy pizza brand
• 1 choice for families
• Aggressive store renovation program
• Big differentiator from competitors
• Dominates walk-in orders
• Renovations/expansions are free for RoyCo

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
9
Strength of Brand
Business Model
Royalty Trusts

• Innovator in the pizza industry
• First to introduce reduced fat cheese
• First to introduce reduced fat meats
• Leader in dipping sauces
• Consistently introduces new products
• Home of whole wheat
• Does everything possible to encourage customers
  to spend more per visit
• One of the few places to offer 40 minutes or
  free
• Central purchasing of supplies

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
10
Profitability of Franchisees
Business Model
Royalty Trusts

• Franchises are exceptionally profitable after
  royalties
• Average ROIC of 17
• Very few closures
• Even with heavy renovation program and marketing
  costs, Pizza Pizza restaurants are known as one
  of the best franchises to own

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
11
Strength of OpCo
Business Model
Royalty Trusts

• OpCo has a coverage ratio of 1.2x
• As more stores open, OpCo coverage ratio
  improves due to feedback from new units in RoyCo
• Coverage ratio projected to grow to 1.3x by 2009
• Only The Keg has a better coverage ratio
• The Keg and Pizza Pizza are the strongest trusts

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
12
Strength of OpCo
Business Model
Royalty Trusts

• Very well managed company
• Management team averages 20 years of tenure
• Has consistently improved market share and
  competitive position
• Current Pres/Chairman opened the original Pizza
  Pizza in 1967 and his top VP was his first
  delivery boy
• This team loves pizza more than we can imagine
• Nearly all executives have been with Pizza Pizza
  since the 80s and early 90s
• Their track record is incredible ? no
  complacency

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
13
Back of the envelope valuation
Business Model
Royalty Trusts

• Pre-trust tax yield of 9.7
• After-trust tax yield of 7.6
• Long term growth of 3-4
• Discount rate of 8
• Expected return 7.6 3.5 11.1
• Annualized distribution adjusted for tax 0.7
• 0.7/(8-3.5) 15.5 per unit
• Not factoring in tax advantages, store growth,
  more rapid SSSG

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
14
DCF Valuation
Presentation by Dave Gregory 03/26/2008
15
Sensitivity
Business Model
Royalty Trusts
Risks to Royalties
Brand Strength

• Pizza Pizza is dirt cheap at 9.4!
• We do not pay tax on their distributions

Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008
16
Conclusion
Business Model
Royalty Trusts

• The market does not understand royalty trusts
• One of the least risky equity stakes out there
• Incredible business model with strong
  OpCo/franchisees
• Equity research analysts are discounting at 10
• This makes NO intuitive sense as a Ke!
• Buy 10,000 of Pizza Pizza at 9.4 per unit

Risks to Royalties
Brand Strength
Franchisee Profitability
Strength of OpCo
Valuation Analysis
Investment Conclusion
Presentation by Dave Gregory 03/26/2008