Activism Finally Comes To Restaurants

| About: Buffalo Wild (BWLD)


Activism might finally be ready to ramp up in the restaurant space.

The recent targeting of Buffalo Wild Wings could be the start.

Here's the key thesis for activists in the space and other potential targets.

Shareholder activism is finally coming to big name restaurants. Marcato Capital, ran by Mick McGuire, has started the ball rolling with a 5% stake in Buffalo Wild Wings (NASDAQ:BWLD). McGuire worked at Pershing Square Capital under Bill Ackman before starting Marcato in 2010. One of Marcato's key theses has been in the real estate, whether it be spinning off or monetizing real estate.

Now, Marcato's targeting of BWLD comes as the company had a mild setback with health scares related to norovirus. Shares of BWLD are flat in 2016, and now down more than 20% since topping out at $200 late last year. The activist investor has said it's held talks with BWLD management and expects discussions to continue.

The franchising thesis

Other potential targets in the restaurant space include Panera (NASDAQ:PNRA) and Chipotle (NYSE:CMG), both of which could accelerate revenues with more franchising. Now, Panera already had a pseudo activist, Luxor Capital. Luxor has pushed for more buybacks and franchising - something we will likely see from Marcato. Things have been working out fairly well for PNRA, with shares up 50% in the last two years, besting the 12% return for the S&P 500. Thus, the key thesis is that BWLD could really juice revenues and earnings by focusing more on franchising.

Here's what Marcato had to say about its discussion with BWLD management: they could include topics such as "improving returns on invested capital, determining appropriate capital structure and capital allocation methodology, optimizing mix of franchised versus company-operated units, aligning incentive compensation with disciplined capital allocation practices, and general corporate strategies to enhance unit-level and franchisee profitability."

However, unlike what PNRA and CMG might be facing, BWLD is seeing bigger issues with getting customers into its stores. Beyond that, BWLD could hit capital allocation issues, which would move counter to Marcato's thesis. More capital allocation geared toward buybacks and re-franchising can be a double-edged sword, where the company can make missteps with overpaying for franchisees and wasting money on buybacks, if ill-timed.

In fact, BWLD has already been aggressively re-franchising stores, having gone from nearly 60% of its stores being franchised in 2012 to just 50% currently. However, the company was quick to allude to the fact that it might be more than willing to cave to Marcato. BWLD recently said it has the ability to take on more debt, which would inherently be used for franchise buying or buybacks.

Big issues I see with BWLD

BWLD is having major issues when it comes to drops in same-store sales, reporting yet another fall last quarter - down 2.1% (the second quarterly decline in a row). This came in well below the expected 0.5% fall. The company also guided for another drop in same-store sales for the third quarter. Already, the two straight quarterly same-store sales decline has been the first since 2010.

So do we have a core customer issue? We're seeing strong employment numbers and wages, so the customer is doing well. Yet, is it that we're seeing just an overall decline in watching big sports events? It seems more like the issue is that BWLD just isn't attracting the level of everyday restaurants goers that it needs to.

Meanwhile, CMG and PNRA has the opportunity to keep attracting new customers with the "clean food, clean ingredients" pitch.

Then, there's costs and pricing. BWLD has been consistent in upping prices, which could be a drag on getting customers into the stores on a consistent basis. However, the company has also been battling the rising costs of chicken that it's having issues with keeping pace with - it's really been a catch-22 with price hikes.

The real underrated thesis

At the end of the day, I think we could see a bigger thesis at play - a management overhaul. Management hasn't been able to juice same-store sales with the money it's already spent on re-franchising, and the CFO is retiring just as the company enters a period of financial instability - being on the cusp of posting a full year of negative same-store sales for the first time in nearly a decade. The board will likely see an overhaul as well, with three members having been there for over 15 years, plus the average age of board members is north of 60 years old.

Management has simply been spreading itself too thin and poorly managing price hikes while navigating cost increases. It hasn't helped that BWLD has been trying to expand into other areas of the market with a Mexican (R Taco) and a pizza (PizzaRev) brand, further limiting management focus. Meanwhile, the door has been left open for other competitors like TGI Friday's to take market share. So, BWLD's biggest battle will be actually winning over new customers, which takes time. There's no easy fix here, despite the belief that more buybacks or re-franchising can boost the stock price in the short term.

Disclosure: I/we 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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