Looks like I got one thing right in La Cucaracha-the next catalyst for BJRI was activist noise. The stock was up 21.6% to $33.62 on March 6 after PW Partners (Patrick Walsh) and Christian Leone (Luxor Capital) teamed up to nominate five representatives to the board. Including a recent increase in Luxor’s stake from 6.1% to 9.7%, they control 12.4% of the stock. Investors were short 4.1MM or 14% of the outstanding shares on 2/14. No doubt, unwinding a chunk of the short position fueled the big jump in BJRI. Another activist, Clinton Group, has 0.48% of the stock and Citadel, not necessarily an activist and not teamed up with PW and Luxor, has 4.2%. All together it is a safe bet that at least 20% of shareholders will be in favor of new board members.
Walsh creates urgency at poor performing restaurants
Patrick Walsh has been an activist agitator at three public restaurant companies—Denny’s (DENN), Red Robin Gourmet Burgers (RRGB), and Famous Dave’s (DAVE). Each of these worked out very well for their shareholders.
DENN rose 76% from $2.16 at the time of the 11/27/10 disclosure of Oak Street’s 6% stake (Walsh was a partner at Oak Street) to $3.85 at 3/30/11 after Oak Street had begun a proxy fight to get three representatives on the board (see amusing letter here). When Oak Street’s board nominees were defeated and Denny’s results remained poor, the stock dropped 40%; a roundtrip back to $2.32. The re-elected board members surprised investors when they promptly dumped the longtime CEO and initiated a share buyback. Same store sales at Denny’s have remained sluggish but the company has steadily repurchased stock and kept its growth focused on franchising. The shares are up 176% since Oak Street’s 13D was filed.
DAVE has been smokin’ in a good way since Ed Rensi, a well-regarded former McDonald’s executive, became a board member in January 2014 then interim CEO in February. PW Partners announced a 10.3% stake in November 2013 when the stock was $20. It promptly rolled over to $16 as the market pulled back in January before exploding to $27 after Rensi was appointed CEO. Blue Clay Capital Management was a pre-existing agitator at DAVE. Rensi overlapped with Walsh at Great Wolf Resorts (WOLF).
Red Robin may be the best template
At RRGB, Oak Street followed Clinton Group into what had been a long floundering casual diner. The stock is up 245% since the Oak Street 13D was filed though Oak Street missed the biggest part of the gain.
In December 2009 management at Red Robin Gourmet Burgers detailed a strategic plan to reverse the company’s long faltering performance. Those plans included increased television advertising and a continued commitment to unit expansion although traffic was declining at existing units. Clinton Group and Spotlight Advisors took a 5.7% position in Red Robin Gourmet Burgers and met with management to suggest a different strategy and greater urgency in correcting operational shortcomings. The stock closed at $17.90 on 12/31/09.
On March 4, 2010 the company appointed three independent directors to the board and agreed not to re-price management options or cash tender for underwater options. On August 5, 2010 the company appointed a Clinton/Spotlight board member. On August 11, 2010 the board appointed a new CEO and adopted a poison pill. A new initiative Project RED was rolled out in October 2010. This was designed to increase traffic, cut costs, improve capital deployment, and ensure an appropriate capital structure. Unit expansion would continue at a moderately slower pace. The stock closed at $21.47 on 12/31/10.
In January 2011 Patrick Walsh’s then firm Oak Street Capital, which had a 13% position, sent a letter to the board (here) in which he suggested removing the poison pill, declassifying the board, cutting overhead, halting new unit expansion, buying back stock, and appointing Oak Street representatives to the board. Walsh and his partner further asserted that the board lacked urgency in cutting costs or fixing capital allocation and that Project RED was a cookie cutter list that inspired little confidence. The board said that Project RED needed more time. In February management amended its poison pill threshold from 15% to 16.5% and announced a $50MM share repurchase. In April, the company added an Oak Street partner, David Makula, to the Board. In May the company terminated its poison pill and reported better than expected first quarter margins and announced that it had repurchased 2.5% of its outstanding shares. In August, Makula resigned from the board after Oak Street sold its position. The stock was then $29.88 and had traded in the mid-30s during most of June and July.
And that was basically the end of the activist portion of the story at Red Robin. Management slowed then held unit expansion to 11-12 units per year from 15 earlier. They succeeded in improving restaurant level operating margins from 17.8% in 2010 to 20.7% in 2012. Aided by increased alcohol sales and new burgers, traffic finally turned up solidly in 2013 and margins jumped further to 21.7%. The traffic and margin gains caused the stock to leap from $35 at the start of the year to $83 in November (kudos to Joe Buckley at BofA for calling it). The company also continued to repurchase $50MM of stock per year. Management re-accelerated unit expansion in the fourth quarter of 2013 and plans to continue at a pace of 20ish per year going forward. The company has also begun growing a fast casual concept called Burger Works.
Next up—The "you need to allocate capital smarter" letter
Based on the above, BJ’s board is likely to receive a letter from PW Partners and Luxor prior to the annual meeting. No date has been set but last year it was on June 4, 2013. The letter may detail BJ’s weak performance and lousy return on invested capital then suggest that the company use its balance sheet to improve return on equity (borrow to buy back stock) and that BJ’s slow or halt unit expansion to create free cash flow and continue buying back stock. Until the company figures out how to improve traffic and margins, it is really hard to argue against slowing expansion especially since management’s preference for locating new units in malls, near malls, and on restaurant row may be part of the problem.
Valuation is an issue
DENN was trading at a TEV/EBITDA multiple of just 6.5x when the Oak Street 13D was filed. Today after repurchasing 10% of its outstanding stock and enjoying a 176% jump in its share price, DENN trades at 10.1 times. RRGB was trading at 6.5x at the end of 2010 and now, with the stock 244% higher, it trades at 10.6x. With yesterday’s big pop, BJRI now trades at a TEV/EBITDA multiple of 13.0x. Investors are, in effect, paying for a rebound in margins that has not happened.
More to Dave's story?
Famous Dave’s is a different story than BJRI, RRGB, or DENN. DAVE was trading at an already optimistic TEV/EBITDA multiple of 12x in November when the PW Partners 13D was filed and now trades at a euphoric 15 times. Investors are clearly betting that DAVE’s restaurant level cash flow margins can improve a lot from just 11.7% in 2013. It is worth noting that Famous Dave’s management was rolling back marketing spend as part of its effort to improve margins. BJ's has been increasing it marketing spend as sales slowed. If the latest "One For All" effort fails, marketing expense would be an obvious opportunity for improving margins.
Ed Rensi, the former head of McDonald’s US operations, as the interim CEO of DAVE is a bit of a head-scratcher or at least would be if he became the non-interim CEO. Famous Dave’s has just 194 locations (54 company-owned and 140 franchised) and revenues of $155MM. Bringing in Rensi to run DAVE is kind of like replacing a high school quarterback with Brett Favre—past his prime but still insanely overqualified. If Rensi becomes the full-time CEO, investors may wonder if Famous Dave’s is just a platform for something bigger such as rolling up and restructuring other weak performing chains. Stay tuned.