Frothy Stocks Yield More IPOs


Wellspring Capital might soon find out if the public investors really are more willing than private investors to pay high prices for restaurants.

Wellspring's Checkers is reportedly preparing an IPO, according to Reuters. It would join several restaurant companies standing in line to sell stock to the public. Some offering efforts are official, like Potbelly's $75 million filing. Others are not, or at least not publicly so, like Focus Brands and Papa Murphy's. All of them are hoping to benefit from the same market that doubled the price of Noodles & Company stock on its first day of trading earlier this year.

That market has been giving restaurants some outsized valuations, in part due to a decline in the number of publicly traded restaurants over the years. "I really think there is a shortage of supply," said Adam Birnbaum, managing director at Grandwood Capital.

We'll admit, our initial reaction to the Checkers deal was one of surprise. It was not among the companies we'd heard as likely candidates for an initial public offering. And it doesn't quite fit the profile of companies that would benefit from a Noodles-like first-day return.

Wellspring has been looking for an exit for some time. The private equity group, which bought Checkers in 2006, tried to find a buyer for the chain last year, according to PEHub, but couldn't find one willing to pay higher than 6x EBITDA. The investor wanted 9x.

Instead, Wellspring recapitalized Checkers in November, borrowing $160 million at 11 percent, and used some of the proceeds to pay the chain's investors a dividend.

The big question is whether public investors will look more favorably on Checkers than did the private buyers. Perhaps, but don't expect anything close to a Noodles-like return on this one.

Checkers has yet to file publicly, and thus its filing isn't available. But according to its FDD, its burger restaurants, mostly drive-thrus, have average sales of about $940,000 a year. Its newer prototypes are performing better than that—the chain's new freestanding design with a drive-thru boasts a sales-to-investment ratio of 2.4-to-1, better than the 1.5-2 ratios of its other formats. That's also better than the ratio at other fast-food burger chains.

(Interestingly, the FDD says that the sales-to-investment ratio for operators that reopen closed locations, at an average cost of $95,200-$322,480, is more than 5-to-1, suggesting that a combination of fanfare and better operations can make such moves highly profitable.)

Checkers is also one of the few companies that report potential franchisee profits on its FDD. Operators' margins after the 4-percent royalty, but before occupancy costs, was 14.2 percent last year.

One number investors might like: the chain's same-store sales. According to the FDD, Checkers' comp sales grew 5.46 percent last year, on top of 5.22 percent the year before. Both numbers outperformed other fast-food burger chains like McDonald's, Burger King, Jack in the Box, Sonic and Hardee's.

But here's the number investors won't like: 489. That's the number of units the chain had at the end of last year, down from 504 locations. While in theory Checkers has plenty of room to grow, a company has to be actually growing.

None of this is to say Checkers shouldn't go public. The IPO market tends to go through cycles. In some periods, private investors pay higher prices and thus companies get sold instead of going public—which is why the restaurant industry went nearly more than four years from 2006-2010 between IPOs. These days, public investors are paying higher prices, thanks to the frothy stock market. So more companies are jumping in to see what they can get.

Indeed, Birnbaum said to expect more filings in the coming months, so long as Obama doesn't get into a cage match with Congress that causes stock markets to collapse and the economy to stumble even more. Lots of strong private equity groups are hanging onto growth companies that could benefit from an IPO, and which could get high returns. "You should have a lot of these popping out," he said.

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