CONCLUSION

In December, 2023 we made Bloomin’ Brands (BLMN) our stock of the month. Since then, the stock price has declined about 35%. While acknowledging that the US restaurant industry is under pressure, it is doubtful that the BLMN fundamentals have deteriorated proportionately. We suspect that most of the decline has been related to the “conversion” of a convertible bond to common shares, as discussed below. Though there is $170M more debt, material to some observers,  in place than previously, it is not major in relation to the $2.5 billion Enterprise Value, and paying 5x TTM EBITDA should not be considered “paying up”, even in retrospect. Eyes wide open as to the risk of a potential “Value Trap”, BLMN is now changing hands at just above 4x trailing twelve month Adjusted EBITDA, with the possibility of a divestiture (their Brazilian stores) that could provide $500M of fresh liquidity. A strong activist (Starboard Value) is already “hooked”, fundamentals as reported by the Company less than two months ago, seem to be stable at the least, further stock repurchase is authorized, and  the balance sheet remains strong. Lastly, the 5.8% annual current dividend seems well covered.Overall, the potential reward seems to far outweigh the risk.

Earnings, and a fundamental update, are due to be released on August 6^th. A link to our December report is provided just below.

https://www.liptonfinancialservices.com/2023/12/stock-of-the-month-december-23-very-little-risk-and-a-lot-of-ways-to-win/

 

COMPANY HAS REDUCED CONVERTIBLE DILUTION – AT A COST

During the Covid Pandemic, Bloomin’ Brands issued $230M of a five-year convertible bond. The initial terms were as follows:

• Issued May 5^th, 2020.
• $230M Face Value.
• 0% coupon
• Convertible into 19.34M shares at a price of $11.89 per share.
• The conversion prices was 25% over the last reported sale price of $9.51.
• The company also entered into a warrant agreement to attempt to offset some of the dilution of the convertible. The strike price of the warrants will initially be $16.64per share, which represented a premium of approximately 75% over the last reported sale price of Bloomin’ Brands’ common stock on May 5, 2020.

MAY 2022 TRANSACTION

• In May of 2022, the company exchanged for $197M cash and 2.3M shares for $125M face value of the convertibles bond.
  • Leaving 9.402M
  • Price adjusted to $11.14 per share due to dividends

MARCH 2024 TRANSACTION

• In March 2024, the company exchanged 7.5M shares and $3.3M in cash for $83.6M face value of the convertible.
• Leaves $20.5M in face value of the bonds.
  • The bonds convert into 1.875M shares at $11.05 per share
• In anticipation of the exchange, in February the company authorized a $350M stock repurchase.
• In March, the company bought back 7.9M shares for $220M or approximately $27.85 per share.
• The net result to the capital structure was to retire 7.9M shares of potential dilution and increase debt by approximately $170M. ($220+$33-83)

Editor’s Comment: In retrospect, management could have (might have, or should have) waited to buy the converted shares from the open market at levels less than the $27.85 paid, but they considered the stock “cheap enough” at a little over 5x TTM EBITDA, and could just as easily ended up paying more or living with more shares outstanding.

Before going further, it is worth noting, that public investors are not alone in their recent negative mark to market (from the high 20s or low 30s). In August 2023, Starboard Value (represented on the Board) filed a 13D after acquiring 8.4M share (9.76%) at a cost of around $220M or $25-$26 per share.

THE INDUSTRY IS HURTING, CAN BLOOMIN’ BRANDS COPE?

It is no secret that the entire restaurant industry is hurting. Restaurants have raised prices faster than the food at home category, which has resulted in consumers spending more on meals at home. Chili’s highly successful Three for Me $10.99 deals and McDonald’s new $5.00 meal are just a couple of signs of the times.

A recent Zerohedge article entitled “End of Restaurants as We Know Them? highlighted many of the closings and other problems in the industry.

From the article:

“TGI Fridays has closed numerous locations across the US and sold eight corporate-owned locations to strengthen their franchise model and close underperforming stores. Denny’s shut down 57 restaurants in 2023 and announced additional closures for 2024 due to inflationary pressures. Boston Market drastically reduced its number of restaurants from around 300 to just 27 by March 2024, driven by landlord evictions, unpaid bills, and state shutdowns due to unpaid sales taxes. Mod Pizza abruptly closed 27 locations across the US, including five in California, just before the new minimum wage law took effect. Also suddenly, Coco’s Bakery and Carrows chains closed 75 locations, leading to a federal lawsuit by former employees due to the lack of notice provided for the layoffs. PDQ, a regional restaurant chain, closed eight restaurants across North and South Carolina in February 2024 due to market conditions.. Subway has been undergoing a massive drawdown, closing over 400 underperforming locations since last year alone. And Applebee’s has been selectively closing locations since the start of 2024, focusing on optimizing its restaurant portfolio by shutting down low-revenue stores.

“In 2024, Buffalo Wild Wing will eliminate sixty locations in the United States. IHOP (International House of Pancakes) will wind down 100 locations. Other firms eliminating locations include Pizza Hut, Red Lobster, Hooters, and Chili’s. A handful of others may close down entirely. “

In contrast, Bloomin’ Brands management was rather upbeat on the Q1 2024 conference call (on 5/7/24):

“We are very confident that our strategy at Outback is working. We are seeing it improve sales and traffic at Outback. Outback sales outperform the industry by 270 basis points in the first quarter and beat the industry in 20 of the last 22 weeks. Importantly, traffic has been the key driver of this sales momentum. Outback traffic beat the industry 240 basis points on average over the last 2 months of the quarter.”

 However, on their July 9^th earnings call, Kura Sushi USA (KRUS) management made this interesting observation:

“As context for the softness in California, in past earnings call, we had mentioned our expectations that the FAST Act will be a tailwind for us as wage pressures would prompt more aggressive pricing among competitors and highlight the value that Kura Sushi offers. What we have seen instead is a general perception that restaurants as a category have become expensive introducing industry-wide pressures regardless of a given restaurant’s relative value.”

 While Kura Sushi pinpointed a negative change in sales patterns, starting late April, especially in their heavily stored California market, and we have not heard from Bloomin’ Brands since their May 7^th conference call, BLMN management @ 5/7 was upbeat, had confidence in their planned traffic building initiatives, and are far less dependent on California. We are therefore inclined to believe that though BLMN may well be experiencing the typical industry wide traffic softness, it likely does not justify the recent stock decline from an already distressed level.

That said, traffic continues to be weak across the industry. While Bloomin Brands is outperforming the industry, the fact remains that traffic is negative. Addressing this issue is likely the key to a much higher valuation.

IS THE (SUBSTANTIAL) DIVIDEND SAFE?

Bloomin’ Brands is currently yielding 5.8%. Only Dine Brands (6.79%) and Wendy’s (6.33%) yield more. Bellwether Darden Inc. yields 4.13%. In May, Cracker Barrel reduced its quarterly dividend from $1.30 per share to only $0.25 per share. Investors may be nervous that Bloomin’ Brands will also reduce its dividend. During the Covid pandemic, BLMN eliminated its dividend in Q2 2020 and didn’t restore it until Q1 2022.  The current quarterly dividend of $0.24 per share is higher than the $0.20 per share dividend it was paying in 2020.

While it is impossible to know what the Board may do in the future, at this point, the dividend is extremely well covered by FCF. In 2023, BLMN generated about $200M in free cash flow, while the dividend only consumed $83M. For 2024, FCF could be between $150M-$200M, which would leave a substantial cushion for payment of the dividend.

LIQUIDITY IS NOT A PROBLEM

As of March 31^st, 2024, the company had $952M (less than 2x TTM EBITDA) worth of debt outstanding and $132M worth of cash on the balance sheet. Versus 12/31/23, there was $20M more cash and $171M more debt. The shares outstanding were about the same as at 12/31/23 since the Company bought back the shares issued as a result of the converted debt. In addition to the cash, the company has approximately $350M available on the senior credit facility. The facility expires in April of 2026. The convertible transaction increased the interest modestly (less than $10M) relative to 2023.

WHAT ABOUT SELLING THE BRAZILIAN RESTAURANTS?

The Company has admitted to consideration of the sale of the Brazilian Outback Steakhouse restaurants. While we have no insights as to if or when that would happen, we thought it would be interesting to see what these assets might bring in a sale.

From public disclosures, the Brazilian Outbacks generate total revenues in Brazil of $529M, with a store level EBITDA of 20.5%, or $108M annually. If we deduct a 5% G&A burden ($26M), that leaves 82M of annual EBITDA.

A conservative 6x valuation would provide, assuming no debt, an Enterprise Value close to $500M for Bloomin’ Brands. While BLMN would lose $83M of EBITDA, however BLMN management would choose to allocate the new liquidity, BLMN shareholders would enjoy a substantial benefit.

CONCLUSION: Provided at the beginning of this article

Roger Lipton