I guess it's clear by now that the management at Ruth's Chris Steak House, Inc. (NASDAQ:RUTH) really coughed it up with the recent Mitchell's Seafood acquisition. The deal was pricey even in the best of times, but as market conditions worsened, it became increasingly apparent that this deal was on the upper end of expensive when you factor in the depressing effects of a consumer driven bear market.
It's true that the terms of the deal were hammered out in what seems like a distant time and place and it was easier for management to rationalize its attributes. It's also true that Mitchell's was a high quality, nicely profitable, PRIVATE company and wasn't subject to the mercurial day by day judgment of a public market in a bad mood. Mitchell's didn't need to sell and could afford to stand by their price. Something they call "Private Enterprise Value."
What's interesting to me about this deal was that it done for cool clean cash and not any stock. From an acquisitor's point of view, perhaps management felt that the Private Enterprise Value of Ruth's Chris stock was much higher than its public market value (at the time, it was around $12 per share) and therefore an unsuitable currency for the transaction. With the price of the stock now somewhere between 7 and 8, we are starting to see deep value in its shares. Management is hard-headed and their philosophy on how to allocate capital is flawed because it is too rigid. They are reticent to initiate a meaningful stock buyback, stating that they prefer to use capital for expansion, upgrading the business, and for financial flexibility.
However, this is where the value really is. If they are willing to get behind Mitchell's at an average price of around 4.1 million dollars per restaurant unit, then why not get behind their own stock where the market values each restaurant unit at around 1.5 million dollars? What further widens the valuation gap is that the traditional Ruth's Chris unit generates more revenue and profit than the new Mitchell's unit. RUTH is a quality company with good profitability, real growth opportunities, and no credit problems. They will survive and they will thrive, but they are wide open to a hostile bid. As I understand it, RUTH's bankers have already approved a 50 million dollar stock buyback line. As a fan of the deep value style, I would get busy with it now before private equity does it for them. As public companies go, we could soon be RUTH-less.
Disclosure: Author has a long position in RUTH