POPEYE’S AND PANERA “CHECK OUT” AT TOP DOLLAR, VALIDATION OF INDUSTRY PROSPECTS AND VALUATIONS, OR WHAT?
Credit Cheryl Bachelder and Ron Shaich, Cheryl for her ten year stint leading Popeye’s Louisiana Kitchen (“Popeye’s”) to prosperity, and Ron Shaich, who built Panera Bread Company (“Panera”) from 20 stores (originally called “St.Louis Bread”) to 2000 stores over 25 years. Each has now sold, (agreed to sell, at PNRA) at valuations at the very top of historic ranges, roughly 20 times trailing EBITDA.
Popeye’s was bought by Restaurant Brands International (publicly traded QSR), which also owns Burger King and Tim Horton’s. It must be acknowledged that QSR has produced admirable operating results since acquiring Burger King and Tim Horton’s. The largest shareholder (16.66% according to Bloomberg) in QSR is Pershing Square Capital, managed by William Ackman. Simply put, Popeye’s has become the third leg within their QSR platform.
Panera is about to be acquired by JAB Holding Co., a Luxembourg-based privately held investment fund that has also acquired (at top dollar) Einstein Noah Restaurant Group, Caribou Coffee, Krispy Kreme Doughnuts, Peet’s Coffee & Tea, Keurig Green Mountain, (all previously publicly held in the US). Also in their portfolio, unfamiliar to us, are Stumptown Coffee Roasters plus Intelligentsia Coffee. JAB Holdings, according to Wikipedia, is 95% owned by descendants of chemist Ludwig Reimann, who co-founded, in 1828, with Adam Benckiser, the Benckiser chemical company. JAB is obviously very substantial since they paid $13.9 billion for Keurig Green Mountain, $1.35 billion for Krispy Kreme, and now over $7 billion for Panera.
We don’t doubt there will be corporate synergies at both parent companies. Popeye’s, Burger King, and Tim Horton’s can learn from one another and administrative overhead can be shared. Panera and Einstein’s and others can sell the various coffee related products controlled by JAB, and some of Panera’s food skills (and technology expertise) can be installed elsewhere in the portfolio. Corporate overhead can be spread more efficiently, and the public expenses at Popeye’s and Panera can obviously be eliminated, reducing the apparent valuation modestly. The point of this discussion, however, is more general. While Restaurant Brands and JAB holdings have taken stakes that will be very long term in nature, the history of the restaurant industry does not provide comfort.
People have to eat and drink, and investors are invariably seduced by the apparent simplicity and attractive returns on capital for successful operators, but there is no consumer product line more demanding to produce and deliver than freshly prepared food and drink. The challenges have only become more intense over the years, with increased competition which leads to more choice for consumers, higher labor costs, and higher rents for prime locations. Lately, slowing mall traffic, financially stretched lower and middle class consumers, and deflating grocery store prices have exacerbated the situation. Problems such as experienced at Chipotle can happen almost anywhere, so even a company that’s “on a roll” can be undermined at any time.
One of the most predictable elements of long term success within the restaurant industry has been the intense involvement of the founder. Off the top of my head, examples include Ray Kroc at McDonald’s, Dave Thomas at Wendy’s, Alex Schoenbaum at Shoney’s, Norman Brinker at Chili’s, Robert Rosenberg at Dunkin’ Donuts, Jim Patterson at Long John Silver’s, Jim Collins at Collin’s Foods, Howard Schultz at Starbucks, Jack Fulk and Richard Thomas at Bojangles, to name just a few. Almost all of these companies, some of which are still prominent, do not enjoy the “first mover” leadership and prestige of their earlier days. The only one still clearly at the top of the heap is Starbucks. We attribute that to the fact that Howard Schultz, clearly a visionary and an exceptional leader, happened to be a young man when he started Starbucks, and of course the four wall economics (to this day) provide a powerful growth engine. Schultz has stayed healthy, enthusiastic and deeply involved over thirty years (still young in his early 60s). Interestingly, Starbucks stumbled noticeably when he stepped aside seven or eight years ago. He stepped back after a couple of years and the great performance resumed. We should note that he is currently taking a step back, if not aside, so hopefully the company won’t suffer noticeably from his reduced role.
It is ironic that 2016 was a banner year for bankruptcies within the chain restaurant industry. Nine restaurant companies, including 14 chains, filed for bankruptcy. For the purpose of this discussion, we need not concern ourselves with secondary or tertiary brands. However, among the bankruptcies were Logan’s Roadhouse, Hometown Buffet, and Ryan’s Family Steakhouse. We “knew” these chains, and even owned stock in each of them when they were publicly held. They were generating compelling store level economics, excellent corporate returns on capital and steady growth. They had long runways for future growth. In short, they were “best of breed” at the time (just like Popeye’s and Panera today) and the stocks were valued accordingly. Ted Moats at Logan’s, Roe Hatlan at Hometown, and Alvin McCall at Ryan’s were dedicated and effective leaders. The reasons for each corporate demise have varied, but we contend that if the original dedication to detail and operational excellence had been maintained, bankruptcy need not have been the result. Times change and people change but competitive pressures or general economic downturns have never put any well situated restaurant company out of business. The problems have invariably been self inflicted. Why should Logan’s be gone when Texas Roadhouse has done so well? Why should Hometown and Ryan’s be gone when Fogo de Chao (all you can eat) is doing well. The departed companies might not be as dominant today as they once were but they could have still be reasonably prosperous. At the very least they could have been survivors, even in an increasingly challenging environment.
This brings us back to the top dollar purchases of today’s “best of breed” Popeye’s and Panera. Forty years ago investors bought “conglomerates”. Twenty years ago, they called them “rollups”. Over the last couple of years “platform companies” have come into vogue. Unfortunately, especially for many institutional investors, Valeant Pharmaceuticals recently demonstrated that not all apparent synergies at platform companies pay off. Williiam Ackman’s Pershing Capital Management, 16.6% owner of QSR as noted above, took a $4B realized loss on the sale of Valeant.
QSR enjoys a high valuation (30x ’17 EPS estimates and 19.9x trailing EBITDA), and can borrow at still low rates, so could afford to pay about 20x trailing EBITDA for Popeye’s. QSR is obviously comfortable expanding their “platform” JAB Holdings has billions of equity and more billions of borrowing power. They have to own “something” with long term “value” no doubt in addition to other assets and currencies around the world in an effort to maintain the family wealth over future generations. (I suspect they own at least a little GOLD, as well.) People have to eat, after all, and the apparent leadership position and predictable growth at Panera will make the price seem reasonable over time. On the other hand, as discussed above, Logan’s Roadhouse, Hometown Buffet, and Ryan’s Family Steakhouse looked pretty good in their time.
In conclusion: QSR and JAB Holdings can’t buy them all so I wouldn’t be buying restaurant stocks with the prospect of being taken out by a possibly overenthusiastic purchaser. Cheryl Bachelder has already left Popeye’s, and we hear that franchisees are already a bit apprehensive. They will get over that, but a new CEO will have to prove himself or herself. Ron Shaich at Panera has said “we’re here, nothing changes”, but he is a dedicated family man, very philanthropic, no doubt has other interests as well, so time will tell. A couple of predictions we are prepared to make: (1) The valuations of Popeye’s and Panera will prove to be “outliers” on the high side over time, a reflection of the still very low interest rate environment which encourages unnecessary risk taking (2) Cheryl Bachelder’s absence and our prediction of Ron Shaich’s reduced commitment and involvement over time will be reflected in less impressive performance at the store level, for both customers and owners. We are not predicting disaster, just “underperformance” relative to expectations implied by the purchase price.
Lastly, we’d like to take this opportunity to wish both Cheryl and Ron all the best for their future. Both are extraordinary business people and admirable individuals. They did a great job for all their stakeholders, including a shareholder exit at “top dollar”. Most importantly, they invariably provided the best possible leadership by example to their respective organizations.