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McCormick & Schmick's menu of bisque and risk

The five year price chart of McCormick & Schmick’s (NASDAQ:MSSR) is not very appetizing.  This upscale chain-restaurant has been unable to convince investors that it will stabilize operations or grow.  A quick peruse of their financials will tell you that they’ve had a tough year at the cash register, and there seems to be plenty of news on the company to suggest that the future is just as grim.  But distressed companies are not always poor investments.  Given that shares of MSSR are currently trading within two dollars of its 52 week low, is it possible that there is growth potential here that is not yet priced in?

The income statement is certainly not an effective marketing tool for this business.  It has been 2 years since a P/E ratio could even be calculated for McCormick & Schmick’s as a result of its negative LTM (last twelve months) earnings performance.  The trouble begins at the very top of the earnings statement, as the company has reported negative revenue growth in 9 out of the last 10 quarters.  Since December of 2008, their LTM expenses have exceeded LTM revenues, as well.  Same Store Sales gives you the same story, so the problem is certainly not just one-off impairments from store closings.  

At a high level the balance sheet also looks sound.  Compared to some industry leaders they show far less reliance on leverage to fund their operations, and have even trimmed an already reasonable debt to equity ratio down over the last year or two.   After some digging, the number that really jumped off the page was the sizeable figure labeled as “Other non-current liabilities”.   While long-term debt appears to be well managed, “Other non-current liabilities” have grown to almost double the size of the company’s short term assets!  Furthermore, the notes in the company filings reveal that over two-thirds of the value of this line item is made up of deferred rent, which on its own has been growing at a year-over-year rate of 15%.   For a company that is not exactly swimming in cash, it looks to me like management is trying desperately to manage cash flow.  This feels like a sinking ship.

News articles over the last year share a similar sentiment.  Earlier this year the company announced that they were shopping around for a high growth seafood restaurant chain.  ( With the current state of their operations in mind, it seems quite presumptuous that management would be able to solve their existing operational issues by bringing on another restaurant chain.   

Additionally, a stock that formally traded steadily in the mid-twenties received an acquisition offer this year from the owner of Landry's Restaurants for just $9.25.  If Tilman Fertitta, a Texas hospitality mogul, doesn’t seem to think a premium (suggesting future growth prospects) is justified, why should we?  Until management makes drastic changes to improve the efficiency of this chain, the bears will be driving the market on this stock.

It sounds like MSSR could use a change in management, so perhaps an acquisition would be best for the future of this business.  Unfortunately for us, if the company is taken private we won’t be able to benefit as shareholders.  

Disclaimer:  I have no positions in MSSR and do not plan to buy or sell in the next 72 hours.
Stocks: MSSR