Potbelly - Be Cautious After Shares Tripled From The Guided Price Range

| About: Potbelly Corporation (PBPB)

Potbelly Corporation (NASDAQ:PBPB) made its public debut on Friday, October 4. Shares of the sandwich concept operator ended their first day with gains of 119.8% at $30.77 per share.

Shares have tripled compared to the initial guided price range, marking a hugely successful public offering in the "fast-casual" restaurant segment.

At these multiples, Potbelly is valued a bit rich to my opinion given the poor operating earnings and the low comparable same-store sales growth rates.

The Public Offering

Potbelly is a fast growing sandwich concept offering warm sandwiches, salads and other menu items. The company aims to be "The Best Place for Lunch".

The company's stores feature vintage design elements with locally-themed decors, eliminating the uniform looks off a large franchise operation. A key advantage of the company is "The Potbelly Advantage" sharing the vision, mission, passion and value for customers.

The company operates 286 shops across 18 states, of which 280 are owned by the company, while 6 are franchises. On top of that, Potbelly has 12 franchise shops in Middle East.

Potbelly sold 7.5 million shares for $14 apiece, thereby raising $105 million in gross proceeds. 7.35 million shares were sold by the company thereby raising $103 million for the firm, while the remainder of the shares were offered by selling shareholders.

Initially, bankers and the firm set an initial price range of $9-$11 per share, which later was upwards revised to $12-$13 per share. Shares were eventually sold above the high end of the revised price guidance.

Some 27% of the total shares were offered in the public offering. At Friday's closing price of $30.77 per share, the firm is valued at $855 million.

The major banks that brought the company public were Bank of America/Merrill Lynch (NYSE:BAC), Baird, Goldman Sachs (NYSE:GS), William Blair and Piper Jaffray.


Potbelly was founded back in 1977, when it started its first store in Chicago. When the original owner sold the store to Bryant Keil in 1996, it marked the start of massive growth. Keil had the vision to expand Potbelly, opening a second shop in 1997 to reach a store count of a 100 by 2005.

Potbelly operates in the Limited-service restaurant (LSRs) segment of the restaurant industry. This segment accounts for a total of $21.9 billion in sales in 2012, according to research firm Technomic, which can be found in Potbelly's S1-Filing.

For the year of 2012, Potbelly generated annual revenues of $274.9 million, up 15.5% on the year before. Net income rose from $7.2 million to $24.0 million.

For the first six months of 2013, Potbelly generated revenues of $146.9 million, up 11.7% on the year before. Earnings fell slightly from $3.0 million to $2.8 million.

The company operates with $21.7 million in cash and equivalents and $15.1 million in total debt. Some $50 million of the $102 million in gross proceeds from the offering will be used to pay a dividend on common and preferred stock, on the day before the public offering. As such, Potbelly operates with a net cash position of around $40 million.

With the equity in the business being valued around $855 million, operating assets are valued around $815 million. This values operating assets of the firm at 3.0 times annual revenues and 34 times annual earnings.

Investment Thesis

As noted above, the offering of Potbelly has been a great success. The company priced the offering at $14 per share, some 40% above the midpoint of the original preliminary offering range.

Shares have seen even more upside, rising to $30.77 per share, some 207.7% above the midpoint of the preliminary offering range.

Investors are really enthusiastic about the prospects for Potbelly which is named a "fast-casual" chain just like other operators like Noodles (NASDAQ:NDLS) and Chipotle Mexican Grill (NYSE:CMG). These firms offer good quality food at great speed and for good value. Other competitors include Subways and Jimmy John's.

The company has been growing rapidly, mainly through store openings. Yet the current profitability and timid same store sales growth results are a reason to be a bit cautious. Operating income in the first half of the year was just 3.3%, which compares to 3.1% for the full year of 2012. Comparable store sales growth declined from 3.4% in 2012 to 1.5% in the first half of 2013. Note that 2012's earnings were inflated by a $16.9 million tax benefit.

Growth should be driven by store openings, as Potbelly guides for 32-35 own store openings this year. Another 7-10 franchises are expected to open as well for the year. For the coming years, Potbelly aims to boost its store base by some 10% per annum.

Another promising sign is that Starbucks' (NASDAQ:SBUX) CEO Schultz owns 20% of Potbelly through his Maveron Equity Partners venture, which is a key strength for the company. His experience to roll-out a global franchise networks can be used to expand Potbelly's business going forwards.

For now I am cautious. After shares have tripled from their initial guided price range, they have become a bit too expensive to my taste. The valuation on sales multiples are reasonable, especially given the growth prospects. Yet it is key to show better comparable store growth and margin expansion going forwards to support the current valuation.

I remain on the sidelines after a great IPO.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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