Thesis: Major activist in restaurants actions are underway currently. Bill Ackman has been a frequent restaurant critic but has a mixed record. We do not expect much new news from Ackman’s initial volley with Chipotle.

Introduction: Wall Street activists are often attracted to restaurants. Restaurants are often composed of multiple brands, sometimes owned real estate, and typically the potential to refranchise, that is to sell company stores to franchisees, or to expand via franchising. These elements make restaurants susceptible to financial engineering as fostered by activists. This article outlines activism in the restaurant space since 2005, current actions underway and common denominators.

Restaurants are sensitive: The decline in the number of publicly traded restaurants from 2000 to 2016, and ascension of Chipotle’s stock price and valuations since its IPO in 2006, soaring to $750/share in 2015 were significant drivers to what makes restaurant investments attractive, sensitive and volatile. Many investors hope to “get on the train for the next Chipotle”, and see its success prior to November 2015 as proof that it can occur again. Of course, that wish may be fanciful as the Chipotle of September 2016 is not that of Chipotle of October 2015 or even Chipotle of 2008 or 2009.

• The number of publicly traded restaurants fell from 102 in 2000 to 57 in 2010, setting up constrained supply conditions.
• There was great interest in restaurants after the effects of the Great Recession waning, as they are thought to be ‘early consumer discretionary plays.’

The activist typically gets involved when restaurant same store sales falters, management spends funds that could be used for buybacks, and has lost momentum in some way. A key is if there are assets that are saleable or spinoff able in some way. McDonalds (MCD), Yum (YUM), Chipotle (CMG), Wendy’s (WEN), Burger King (QSR), Darden (DRI), Bob Evan’s (BOBE), Buffalo Wild Wings (BWLD) and Jack in the Box (JACK) are all examples. 

How to make money: for a client, we once counted 18 different ways to make and another 18 ways to lose money in restaurants. Among them are relatively easy ways to extract value, if only on a short term basis:

• Sell real estate: some legacy restaurant brands bought the underlying land when they developed decades ago. That land can be sold outright or via sales/leaseback. The restaurant then has to cover the rent it had not been paying, and typically cover future year rent increases (rent stepups) Example: Darden (DRI) real estate spinoff, 2015; Bob Evans (BOBE) real estate sales, 2016.
• Refranchise: this means selling company stores to franchisees. The transaction may or may not be earnings neutral, typically corporate G&A expenses must be cut or a rent income stream markup needs to be established. Sale proceeds are received that can then pay down debt, buyback shares or serve as a dividend, either to equity investors or to private equity firms as a dividend recapitalization, if the debt markets allow it and credit ratings agencies can swallow it.
• Sell existing brands or business entities:  to conserve management time and focus, and to preserve CAPEX, developing smaller brands that the restaurant holding company is developing can be sold, sometimes for a premium, sometimes to dodge a bullet. Examples:  Wendy’s/Time Horton’s/Baja Fresh 2005.    

Current activity: Bill Ackman’s name is most often associated with restaurant activist plays. He was involved with Wendy’s in 2005, McDonalds in 2006, Wendy’s again in 2008, Burger King in 2012 and now Chipotle in 2016. Ackman’s understudy that started his own hedge fund, Richard (Mick) Mcguire at Mercato opened an activist campaign against Buffalo Wild Wings (BWLD) recently.  A review of their presentations over the years shows the same themes: financial engineering and optimism. While this paper isn’t an Ackman critique, Bill found success with the Burger King 2013 investment but generally missed on Wendy’s and McDonald’s. After the very high profile and costly Borders and JC Penny’s failures, he was advised to stay out of retail.

But others, such as Starboard, Corvex, and Sandell have engaged in campaigns as well. Starboard was able to oust the entire Darden board in 2014, the restaurant battle royale. See Table One:

Table One: Major Chain Restaurant Activist Activity

What worked: Close industry watchers consider the Darden (DRI) and the Burger King actions to have worked. Darden was able to pay down debt from the Red Lobster spinoff before the 2014 board ouster, then able to spinoff real estate into a standalone REIT. I’ve examined the rent conditions and it seems to be a fair deal for the Darden restaurants that have to now pay rent. Darden is considered on solid ground currently. Burger King hasn’t sold real estate but was able to refranchise virtually all of its company stores worldwide, and has international master area and JV development underway.

To be determined: McDonald’s stock has drifted higher after a new CEO came into place and that a companywide transformation was announced. Both McDonald’s and YUM have their Asia operators either for sale (MCD) or to be spin-off (YUM, YUM China, soon). Buffalo Wild Wings (BWLD) and Chipotle (CMG) are to be determined. And, the YUM China spinoff is massive and will be closely watched over the next several years.

What didn’t work:  No activist’s actions regarding Wendy’s seem to have worked. The stock price today, $10, has hovered in that range for years and is still considerably lower than pre-recession levels. It’s hard to see that activist campaigns at McDonald’s have worked because of so many moving pieces.

Cautionary: There are only so many brands with easily separated non-core divisions, real estate or the ability to franchise. Burger King worked because the brand was in a very low ebb in 2010 pre 3G purchase, and the purchase of Tim Horton’s gave international brand expansion potential and a small box investment that might be attractive to master area franchisees, that can step up international franchising. As restaurants are franchised, some inevitable loss of control is logical.

Ackman: We predict Ackman’s basic Chipotle presentation won’t vary much from a decade ago. Ackman’s credentials are particularly odd since he favors heavy day to day involvement but has no personal direct retail or restaurant management. Mcguire worked for Ackman. Upon activist entry, most of the stocks got an initial run up, as seen at Buffalo Wild Wings, and Darden. But that might be it. When companies are denuded of real estate or company operated units, there is clear future year system or brand risk if the rent can’t be serviced or the franchising system becomes a hollow shell. That does not seem to be a risk with the Sandell action.