To Profit From A Bubble, You Need To Find The Needle

| About: Wingstop, Inc. (WING)

Summary

Wingstop appears overvalued by almost any reasonable standard.

This overvaluation is as much a result of Wingstop's current ownership profile and recent IPO as the bulls getting too excited.

This should change within the coming weeks as the one year anniversary of the IPO nears; I recommend shorting Wingstop right now.

I'm not the first writer to point out that Wingstop (NASDAQ:WING) appears grossly overvalued. WING is trading at over 9x sales, and over 60x trailing earnings. While these types of valuations can sometimes make sense for technology companies growing at 30%+, Wingstop is a chicken wing restaurant. They have little differentiation in terms of their product, and basically no protection from competitors entering their space. You can bet that Buffalo Wild Wings (NASDAQ:BWLD) will become increasingly competitive after two quarters of disappointing comps, and the privately held Wing's Over (Insert City) franchise is growing and expanding outside of college towns almost to the point of relevance.

WING's growth rates also leave much to be desired. Over the next three years, revenue is expected to grow at just over 12% annually and earnings around 20% (FactSet Average Analyst Estimates). Ignore the fact that these growth percentages are coming off a small beginning base ($0.05 EPS to $0.06 EPS is 20% growth too!) and are sell-side estimates, which tend to be overly optimistic. These numbers are solid but absolutely do not warrant a valuation of 9x sales. Put another way, even if WING can grow its EPS by 15% continuously over the next 7 years without any hiccups or slowdowns, you are still paying over 20x for year 2022 EPS.

Source: Company Reports Click to enlarge

Note this table uses the adjusted, Non-GAAP "recurring EPS" of $0.47 for 2015 instead of the reported, fully diluted EPS of $0.36 to avoid one-time costs of the IPO.

Comparable company analysis - Domino's (NYSE:DPZ), Zoe's Kitchen (NYSE:ZOES), and Sonic (NASDAQ:SONC) to name a few - and DCF models also reveal that WING has to grow at extraordinary levels for almost a decade for its valuation to make sense.

So WING is overvalued... now what? Should you short it? Shorting is tricky because due to borrowing costs and margin calls, the timing of shorting is very important. If you're early on shorts, you can be forced to cover at huge losses before ultimately being proven right. It is key, therefore, when you find a company you're interested in shorting that you answer the following questions:

1. Why is this company overvalued?

2. What is going to change in the next few weeks/months to change that?

The answer to these two questions is why I believe WING is an excellent short right now.

First to address why WING is overvalued. The easiest and most obvious answer to this question is that the market tends to get too excited about new companies and IPOs in general. Everyone wants to find the next Chipotle (NYSE:CMG). Some even believe that it makes sense to buy every IPO and hold them forever. That is due to the fact that some of the IPOs you would buy would turn out to be superstars, i.e. Chipotle, and those massive gains would offset the losers where your losses are capped at your initial investment.

While excitement over new companies may certainly explain some of the reason why IPOs are overvalued, it is only half of the story. The other reason involves the simple market dynamic that when a company issues an IPO, much of the float is held by insiders who are legally restricted from selling their shares until later dates. You end up with the whole market ready and able to buy the stock, and very few people who are actually able to sell.

This bids up the price rapidly, and the phenomena is often called the IPO "Pop and Drop"; you can see it in any number of recent IPOs including GoPro (NASDAQ:GPRO), Shake Shack (NYSE:SHAK), Potbelly (NASDAQ:PBPB), GrubHub (NYSE:GRUB), and more. In fact, many professional investors run screens to identify IPOs from 18-24 months prior that have been beaten down due to insiders dumping their shares after lockups expire.

In WING's case, the big insider that has yet to dump their shares is Roark Capital Group. They are a private equity firm that specializes in restaurants and made their initial investment in WING in 2010. And while the official lockup period on insider shares for WING ended in December, Roark still owns over 44.7% of WING. It is not uncommon for major holders like Roark to have special lockup requirements, lasting up to a year or more.

click to enlarge)Source: SEC Filings Click to enlarge

To put Roark's ownership in perspective, as of the last regulatory filing, they owned 12,765,858 shares of WING. WING's 10-day average daily volume is ~200,000 shares. If Roark decides to liquidate their holdings, it is tough for anyone to sell more than 25% of a stock's average daily volume yourself without bidding the price down too much. So Roark probably wouldn't sell more than 50,000 shares per day.

It would take Roark 255 consecutive days of selling 25% of WING's daily average volume to exit their position! That is basically an entire calendar year of trading days. Maybe Roark, who invested in WING at a fraction of the IPO price, is fine with selling more than 25% of WING's daily volume to exit the position more quickly... even better for the shorts!

Roark's ownership is akin to a giant boulder hanging over WING's stock, ready to crush its share price whenever it is released.

That brings me to the second question: Why now?

Because we are approaching the 1-year anniversary of WING's IPO, June 12th. Lockup's generally last for 3, 6, 9, or 12 months and it just makes sense for part of Roark's lockup to expire a year after the IPO. And while I certainly don't have access to the specifics of Roark's lockup clauses, do you think it is a coincidence they sold several million shares of WING during the weeks leading up to March 15th (See Above Image), exactly 9 months after the IPO? Not likely. Also note that the share price of WING fell well over 10% during that time frame while the market as a whole rose.

Second, Roark is a Private Equity firm, not a long-term focused mutual fund. Private Equity firms generally look to exit their investments in 5 years. Roark's initial investment in WING? April of 2010... 5 years prior to the IPO. Roark is already approaching 6 years on their WING investment. They would rather start the whole process over to find another WING than wait an extra year to exit at maybe a few dollars per share more. Sell WING before Roark beats you to it.

Disclosure: I am/we are short WING.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.