Game on: Dave & Buster’s readies IPO, Shake Shack on hold

September 15, 2014
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The publicly traded restaurant group is likely to have two more names for investors to ponder in the months ahead, one a returnee and another that will undoubtedly be met with — yes — talk of its “next Chipotle” potential.

As for the first, it’s Dallas-based Dave & Buster’s, partly a restaurant and bar, partly a game center, which Oak Hill Capital Partners is taking public after an eight-year removal from the market. It’s announced definite plans for an IPO after previously withdrawing an earlier filing to do the same.

However, the second — still in the expected, not formally filed, phase — will generate greater excitement by far. It’s New York-based Shake Shack, one of the “better burger” chains that, along with the likes of In-N-Out and Smashburger, is drawing burger fans who want something other than fast food.

Every stock is different, but whereas last year simply being a restaurant almost guaranteed bountiful returns, 2014 has seen the group at large flatten out. For the restaurants that have gone public recently, results have been unimpressively mixed. Potbelly (PBPB), public since last October, trades under its IPO price and is down 49% this year. Noodles & Co. (NDLS) had its IPO in June 2013, and it recently traded at an all-time low. Papa Murphy’s (FRSH) never flourished. On the positive side, Zoe’s Kitchen (ZOES) and El Pollo Loco (LOCO) remain well above their offering prices but are beneath peak levels.

Wall Street is what Wall Street is, and turning these names out to the public is all part of the system. But predicting winners and losers among them won’t ever be easy. Still, with the next (likely) two, one has more going for it than the other. Perhaps a great deal more.

Burger mania

Shake Shack hasn’t confirmed an IPO, although published reports from Reuters and Bloomberg indicate it’s happening. The frenzy that will attend this may not be reminiscent of, say, Facebook (FB), but it will almost certainly qualify as deafening for a restaurant.

Doesn’t it just sell hamburgers and such? True. But, as with Shake Shack, traders, bankers and financial journalists are all over New York. They know Shake Shack, and they know other restaurants that are part of its parent firm, Union Square Hospitality Group — venues such as Gramercy Tavern and Union Square Cafe. And a well-known restaurateur is behind it. If you don’t like hysteria, avert your eyes and plug your ears.

However, noise notwithstanding, Shake Shack does have interesting qualities that would serve it well as a stock. “Better burgers” have resonated with consumers across the land. The company already has a foothold overseas, with 20 of the 49 locations listed on its website outside the U.S. The lunch lines are real. The announcement of “no hormones and no antibiotics” in its beef is in line with the “better ingredients” trend. That said, Shake Shack isn’t making money on low-calorie offerings: A single ShackBurger and an order of fries is listed at a combined 1,000 calories. Visit the original Madison Square Park location, add a Coke to your order, and you’ll pay just under $10 for your meal. Add a chocolate shake, and that’s another $5.15 and 640 calories.

According to food industry research group Technomic, the better burger stores, part of the fast-casual group, had sales of $2.4 billion last year. Five Guys was almost half of that. Size and buzz have helped them outpace established chains, but the fast-food operators, including McDonald’s (MCD) and Burger King (BKW), are exponentially larger, with sales of nearly $70 billion last year. In comparison, Technomic puts Shake Shack’s revenue for last year at about $62 million.

Also worth considering is whether other better burger chains eventually decide to follow. Being first will surely help Shake Shack, but if it were to go public and trade at elevated levels, Wall Street would find a way to develop an appetite for similar names. Investors have favored, for a time anyway, new stocks that potentially have elements of Chipotle (CMG) – that is, combining the promise of better ingredients, buzz that separates them from the daily chains and profits for shareholders. The “next Chipotle” is still being sought.

But with Shake Shack, it’s got a small store count, with room to expand. It’s fast casual. It has a New York base. And it’s not McDonald’s. It could be loud.

Back in town

Meanwhile, Dave & Buster’s, in returning its beer, foods and games to investor scrutiny, probably won’t get quite the same build-up. Since it’s already been on the market before, a calmer reception may be in order, especially if traders figure its future is anything like its past.

Before it was taken private by Wellspring Capital in 2006 and then sold to private equity firm Oak Hill in 2010, it did have a mostly positive history. The down years were bad, however. According to FactSet data, the stock’s three negative calendar years had an average loss of 40%. In seven positive calendar years, the average gain was 44.9%. In all, the compound annual growth rate was 7.3%. The shares, FactSet calculates, generally traded at about 17 times earnings (D&B hasn’t yet estimated a price range for the stock) last time they traded.

A price-to-earnings ratio of that level would be below the average of a large set of restaurants Yahoo Finance tracks but in line with several operators, including McDonald’s, Red Robin (RRGB) and DineEquity (DIN), the owner of Applebee’s.

Of course, none of those are half arcade. D&B’s games component accounts for more than 50% of its overall $636 million in revenue, a fact that provides help during times of climbing commodity costs. The games side, as a percentage of revenue, costs about half as much as food and drink procurement.

Notable is that D&B has a rather aggressive expansion plan, so that won’t happen cheaply. It’s currently got 69 locations, and it believes it can have more than 200 in the U.S. and Canada. At its expected annual growth rate of 10%, it would accomplish that in 10 or 12 years, assuming no locations close and it can pay for this. That’s around double the pace of the past few years, considering that, when Oak Hill took over, it had 56 stores.

Lately, PE-backed IPOs haven’t starred in the new issue market. Whether D&B’s continues that trend or not, it’s difficult to see it keeping pace with Shake Shack, at least initially. Maybe that’s OK, though.

  • Consumer Discretionary
  • Finance
  • Shake Shack
  • Oak Hill Capital Partners

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