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THE BAR & GRILL BATTLE – EAT, DIN, RRGB, BWLD, RT – “ROLLUP” OPPORTUNITY?

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LIFE IN THE WALL STREET (SHORT TERM) FISHBOWL – BEWARE THE “CONFLICTS OF INTEREST”

LIFE IN THE WALL STREET (SHORT TERM) FISHBOWL – BEWARE THE “CONFLICTS” OF INTEREST

There are all kinds of pressures on growing companies, some obvious and some not so obvious. In this piece I would like to discuss some of the conflicting “agendas” of operating principals (owners) versus  outside investors.

There are lots of good reasons to expand a successful multi-unit food service concept, if you are so fortunate as to be generating an attractive return on invested capital. Aside from the natural desire to be “bigger and better”, “beat out the competition”, “attain critical mass”, “play on a bigger stage”, and “change the world”, the need to attract the best possible employee/partners to serve your customer base is always urgent. The interaction between your serving crew and your customer base will make or break you, and it is a special challenge to attract and keep the best available talent if you don’t provide the natural career path afforded when growing units. I’ve often counseled that “you’re not in the food business, you’re in the “adolescent training” business. So it helps a lot if you are expanding. You get the picture.

I’ve noticed, over many years, that most troubled restaurant companies bring on their problems by themselves, and virtually every restaurant chain that has seriously suffered, and/or died, has done so by way of self inflicted problems. I can’t think of one successful restaurant company that ran into serious problems as a result of competitors or general economic factors. It is actually amazing that in the face of tremendous long term competitive pressure from companies such as McDonald’s or Starbucks, there are still regional hamburger chains (e.g.-In and Out, Whataburger, Jack’S) and coffee chains (e.g. -Peets, Caribou, Seattle) that are successful. The problems have often been the result of headlong expansion, too many units too quickly, spread too thin geographically, poorly selected franchisees for sometimes immature concepts, new products introduced without proper testing. The names of the departed are legion, from D’Lites to G.D.Ritzy’s to Flakey Jakes, to Po’Folks, and dozens of others.

Conflicts of Interest : Publicly Held

Public investors clamor for growth: unit growth, same store sales growth, traffic growth, and the presumably accompanying growth in earning per share. If you are growing units at 10% per year, they want 15%. If you give them 15%, they ask why you can’t grow faster. If you are growing company operated units at 20% (which has been proven to be the top end of controlled unit growth for company operated stores) public investors eager to see the stock go up “tomorrow” are not sympathetic (or sometimes knowledgeable) to the risks of faster expansion. Public shareholders (and stock valuations) are also sensitive to what is called “the second derivative”. The public investor loves it when all parameters are in gear including accelerating: unit growth, same store sales and traffic increases, with operating margins and earnings growth accelerating. If any of those measures are contracting, the stock valuation will contract. When the growth in units has been 20% (the “first derivative”), the “slowdown in the (growth) rate, the “second derivative” to “only” 15% is considered a negative, and the stock price will consolidate or decline. We’ve seen this lately in the stock valuations of Shake Shack, Zoe’s, and  others, who admittedly were very highly valued, “priced for perfection” with all units of measure in gear.

Capital has to be raised to finance expansion, not to mention the allure of huuuge compensation by way of stock options, so the pressure to live up to investor expectations can lead to lots of imprudent decisions. Management may not admit to themselves why they are rolling out a “Wood Fired” menu upgrade, at  Applebee’s, or the upscale menu that Ruby Tuesday’s tried several years ago, both seemingly without adequate testing (IMO). Got to keep the SSS and traffic moving upward. Can’t tell the dozen analysts that are taking their P&L apart line by line on a quarterly basis, that six months of testing will be necessary. Buffalo Wild Wings, with the need to improve their entire menu,(IMO) has installed a 15 Minute Lunch  Guarantee. It could help traffic (at lunch), but I am providing a guarantee to  management that it will not build profits. How much can the customer spend in 15 minutes? How many table turns could you get? And how does that translate to attracting those customers back for a completely different experience in the evening? But analysts don’t want to hear that you are in need of a general “re-invention” of the concept, and it will take time. So money and time is squandered in an unproductive effort. Store level employees are pressured, franchisees question the leadership, and sometimes “activist” investors, (as is the case with BWLD) get involved. As a more positive example, Panera management has done an admirable job describing long term initiatives (mobile pay, catering, 2.0 technology platform) which are costly in the short term but strategically desirable. Analysts have generally responded well to the detailed updates as Panera has led by example with installation into company operated locations. Panera also seems to be adjusting the initiatives with feedback from franchisees as well as from company store experience.

My conclusion: If you are publicly held, doing well and fortunate enough to have a reasonably valued stock: maintain a debt free balance sheet if possible, raise enough equity capital, if necessary to sustain a prudent rate of unit growth, and then go back to running your business as systematically and prudently as possible for the long run. Good examples in the current crop of restaurant companies would include Shake Shack, Habit, Zoe’s and Chuy’s. The stock will fluctuate, but will grow over the long term on a parallel path with your corporate growth. As described above, in terms of the current effort, Panera has done a great job over 20 years to grow from 50 units to over 2000 units, and the stock has risen proportionately to the corporate results.

The Conflicts of Interest – Privately Held

It should be no mystery that there is “a price” when a private equity investor opens their wallet on your behalf. They will want substantial equity,  Board of Director representation, and the ability to “influence” operations in a variety of ways. They will have a lot to say about management compensation, key executive selection and expansion strategy, among others. They will have all of the concerns that public shareholders will have, but will take a somewhat longer term view, and will be in a position to strongly influence the decision making process. On the positive side, professional private equity investors can be a huge asset, in terms of their financial and operational knowledge, so the result can be a great partnership.

However, never lose sight of the fact that private equity investors are in the business of buying and selling, sometimes with a shorter timeframe than founders or operating management. Everyone wants growth but the outside investors may be more motivated to grow fast enough to meet their own hurdle rates. Some private equity investors are more experienced than other, but sometimes a growth rate is encouraged that can be costly to all. Let’s say, for instance, that a casual dining chain with 20 units is planning to open 4-6 units in the next twelve months, which is at the top end of the 20% growth rate of units that has often been dangerous to exceed. (I’m speaking of company operated stores alone, and franchised growth, a separate subject, can add to this rough guideline.) Management then finds three really excellent sites, but it’s tough to find two or three more that are quite as predictable in terms of demographics, and /or ideally situated geographically. So management doesn’t want to disappoint their highly regarded P/E partners, in fact would like to meet and beat expectations. I suggest, however, that the guaranteed way to really disappoint the P/E partners would be to open one or two mediocre, let alone poor, locations. One  bad location can offset two or three good ones. Open three units instead of 4 or 5 or 6 and investors will be less than thrilled, but no long term damage has been done. You might have actually strengthened the operational team for the long run, with less stress from the extra openings.  Open a couple of underperformers and the whole team is, at the least, set back by several years.

So….once again….just as with publicly held companies, maintain financial flexibility, and run your business for the long term, resisting the siren song of short term strategies that can seriously undermine  long term prosperity. Compound 15% growth (considered “modest”) and you get a quadruple in 10 years, 16 times your starting level in 20 years. Not too bad.

Roger Lipton