Morton's Restaurant Group IPO Analysis, Comparison to RUTH and MSSR (MRT, MSSR, RUTH)

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Includes: MRT-OLD, MSSR, RUTH
by: Bill Simpson

Morton's Restaurant Group, Inc. (MRT) plans on offering 9 million shares at a range of $14- $16. The offering size will be bumped to 10.35 million shares if the over-allotment is exercised. Insiders are selling 3 million shares on the deal. Wachovia is lead underwriting the deal, co manager is Piper Jaffray. Post- offering, assuming over- allotment is exercised, MRT will have 17.45 million shares for a market cap mid- range of $262 million. Approximately 90% of IPO proceeds will be utilized to pay down and restructure debt, with roughly 10% going to Castle Harlan for a management fee termination.

This is the 2nd go round for Morton's as a public company. Than publicly traded Morton's(with symbol MRG) struggled mightily in the 2001 economic downturn, and was bought out in the summer of 2002 by Castle Harlan for $94 million in cash and considerations. Castle Harlan outbid Carl Icahn for Morton's. At the time Morton's was reeling, being hit by double digit same store sale decreases in the midst of the 2001/ 2002 economic downturn. Morton's, much like RUTH was/ is dependent on heavy corporate spending, which dried up quickly during those years. Morton's at the time of the buyout had $10 per share in debt with dwindling cash flows, potentially headed for financial trouble. The buyout itself added to Morton's stock price as it was trading at a sub $50 million valuation before the Castle Harlan/ Carl Icahn bidding war. At the time of buyout Morton's owned and operated 66 restaurants.

Castle Harlan which is selling 2+ million shares in the offering, will own roughly 30% of MRT post IPO. Castle Harlan has also recently brought MSSR/ HRZ public.

MRT owns and operates upscale steakhouses. They cater primarily to business clientele although they state that they're making an effort to bring in more non-business related diners. Currently their private dining group meeting rooms geared towards business meetings and referred to as "The Boardroom" at each site account for nearly 20% of annual revenue.

They've a total of 69 Morton’s steakhouses, including 65 restaurants located in 60 cities across 28 states, along with two restaurants in Canada, one in Hong Kong and one in Singapore. They also own and operate 4 upscale Italian restaurants. All restaurants are company owned and operated, MRT has no franchises. The first Morton's was opened in Chicago in 1978 and their motto ever since has been to serve large portions of high quality food. Average restaurant size is 8,000+ square feet with space for 200 diners.

After not adding locations in 2003/ 2004, MRT added 4 new restaurants in 2005 with plans for 6 more in 2006. Each restaurant averages a little over $4 million in annual sales with the average check totaling $85.

Financials

MRT posted a 2.5% same store sales increase for 2005. This is a much smaller increase than recent IPO RUTH which has posted 10%+ same store sales increases for 7 quarters in a row.

There is a debt attached to the public MRT. Post- offering factoring in debt restructuring MRT will have roughly $78 million in existing debt.

Negative book value post- offering.

MRT will experience a number of one time charges when they report 1st quarter 2006 results. These charges are for the most part related to the debt restructuring concurrent with the IPO.

After stagnant revenue from 2000 to 2002 MRT has grown roughly 10% annually since. Top-line came in at $301 million for 2005 a 9% gain over 2004 revenues. Operating margins have been in the 6-7% range the past few years.

It has been reported in a few mainstream outlets that Morton's has lost money each of the past few years. While technically true, once debt restructuring is taken into account as well as non-recurring charges are removed, MRT is actually turning a profit. However even with debt paid off on offering and remainder restructured, debt servicing is still eating up almost 1/2 of the operating profits.

Plugging full taxes into the equation, after tax margins for 2005 appear to be 2 - 2 1/2%. With everything taken into account as MRT will look post- offering, MRT looks to have made roughly 40 cents a share in 2005. At mid- range MRT will be trading 37 X's trailing earnings.

Looking into 2006, if we assume similar same store sales numbers as well as new restaurants, MRT should be able to grow the top-line another 10-12%. MRT has many fixed expenses, I doubt net margins will appreciate substantially with the increased revenue. Assuming 3% net margins, I think it is reasonable to expect MRT to post 55-60 cents a share in 2006 earnings. Note that due to the numerous one time charges expected in Q1, MRT's actual results for 2006 will not show 55- 60 cents a share. Assuming those earnings, MRT would be trading mid-range at 26 X's '06 earnings.

A quick glance at two recent similar IPOs, RUTH and MSSR:

Ruth's Chris Steak House, Inc. (RUTH) - 29 X's 2005 earnings and 2 X's revenue; 26 X's 2006 earnings with 15% top-line growth rate, 7% net margins and 10% debt to equity

McCormick & Schmick's Seafood Restaurants, Inc. (MSSR) - 29 X's 2005 earnings and 1 X's revenue; 26 X's 2006 earnings with 10% top-line growth expected. Minimal debt

MRT - 37 X's 2005 earnings and 0.9 X's revenue; 26 X's 2006 earnings with a 10-12% top-line growth expected with 3% net margins. 30% debt to equity

Risks

The big risk here is a slowdown in business spending, specifically business expense account spending. Conversely of course, MRT would benefit from any large increase in corporate expense account spending. The 2001/ 2002 slowdown hurt Morton's quite a bit, dropping the market cap below $50 million. With MRT's current debt situation a similar period of same store sale decreases would halt cash flow and could potentially put them at risk of default. My take is that it would take a pretty significant multi- year economic slump for this to occur, but with MRT's debt situation it is possible.

The CEO recently retired, however the new CEO had been CFO and Executive VP for 8 years.

Conclusion:

Coming on the heels of the Chipotle IPO, I expect MRT to do pretty well out the gate. I've a few reservations here, notably the sluggish same store sales for 2005, the debt situation and no immediate valuation gap. They've [MRT]a highly respected name brand and they've recently resumed controlled growth. I think MRT is a decent deal, I would have liked this a great deal more if the debt was being wiped off on offering. As it stands I think it will do okay as long as pricing/open are muted. This is definitely not a deal I would pay up for at all.