I’m still stunned by the sheer arrogance of Darden management. It’s been rumored that, shortly following the emergence of activist shareholders, Matt Stroud (VP: Investor Relations) said shareholders had no say in the running of the company. I laughed when I heard that comment, but the truth is he’s right.
The message from Darden management and the Board is fairly straightforward: “As long as we are in office, we get to run the show.” All the activists can do now is turn up the heat and try to replace directors at the upcoming annual meeting. To that end, the deadline for nominating board candidates for this meeting is today. The ultimate outcome, however, will likely not be known until sometime later this year. Until then, we are confident that management will continue to destroy shareholder value under its current operating plan.
Moving forward, management has introduced two or three initiatives that could appease shareholders, but we believe the core value destructive initiatives remain in place:
- The current management team has proven they are incapable of fixing broken brands.
- Carrying on with excessive unit growth – growing the Specialty Restaurant Group is not a value creating strategy.
To be clear, increasing market share in an industry in secular decline by growing new units is a value destructive strategy. According to NPD, visits to casual dining restaurants were at a six year low in the twelve months ending February 2014. Since 2009, casual dining traffic has declined nearly 2% each year, totaling a loss of 7.1 million visits. Meanwhile, Darden's CEO Clarence Otis has been excessively compensated to open 417 net new stores since the end of FY09.
As we see it, the investment case for the new Darden is centered on fixing Olive Garden. According to management, they plan to “continue to execute our comprehensive Brand Renaissance Plan at Olive Garden, building on progress simplifying operations to enhance food quality and taste to improve the guest experience.”
We have major concerns with the lack of visibility around this plan and believe management is in “trust us” mode – a truly scary thought. Given their track record, we have little reason to believe this plan will be successful and won’t see any evidence of this, supportive or not, for at least another 12-18 months.
All told, the sale of Red Lobster does very little to change our view of the company. We firmly believe that the only legitimate way to create shareholder value will come from a shakeup of senior management. At this point in time, significant changes (e.g. Starboard gets controls of the board) are not likely to have any significant impact until late in FY15, if at all. Absent this, the earnings power of the company will continue to deteriorate.
On a pro-forma basis, we are currently projecting FY15 EPS of $2.20 versus street estimates of $2.72. This puts the fair value of DRI, under the current management team, in the low $40s.
Absent any significant changes to the Board, this stock is headed lower!
Here's the question-and-answer portion from our daily institutional Morning Call hosted by Hedgeye CEO Keith McCullough and Senior Macro Analyst Darius Dale. Keith answers questions on markets, hedge fund performance and even youth hockey.
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Takeaway: We had a good conversation with YELP’s CFO…We are reiterating the Short
- INCREMENTAL COMPANY DETAILS: We have included some notes below to assist you with your models.
- ATTRITION ISSUES?: We are now more confident that the attrition issues we have been highlighting are occurring.
- TOTAL ADDRESSABLE MARKET: We suspect that the company sincerely believes its TAM is as large as it has publicly stated. We have previously detailed why this isn't the case, and we'll have follow-up note on this topic shortly.
We spoke with Rob Krolik of YELP yesterday. We believe he was very honest and forthcoming with us. He answered pretty much all of our questions with the exception of one very important one, which we will get to below.
INCREMENTAL COMPANY DETAILS
- Salesforce: YELP’s salesforce has been rising 50% y/y for about the past 8 quarters. They now represent a little less than 60% of its total employee count of 2,156 (as of 1Q14). Most of those reps focus on the Local Advertising Segment (Brand Advertising salesforce is fairly small). The breakeven on those Local Ad reps is roughly 6-9 months (on a cash basis).
- Customers: Most customers sign 12 month contracts. There is 2-3 month penalty for cancellation, but YELP doesn’t always enforce (e.g. client has financial problems or goes under). The Active Local Business accounts reported by the company are essentially all of its customers excluding Brand Advertising; specifically all Local Advertising customers (which includes SeatMe as of 2014) and Other Services customers (Gift Certificates and Deals)
Where we didn’t get a tremendous amount of detail was when we delved into its customer repeat rate, which is how we are backing into its attrition rate. We did spend some time discussing this topic, and while he wouldn’t explicitly verify or refute our attrition thesis, he did say that YELP has never said that they are not losing customers after we delved into its reported numbers.
The question he wouldn’t answer, which is a spin off of its customer repeat rate metric: “How many of your current customers have been generating revenue for YELP for over a year?”
This is the most important question because it drives at the heart of the retention issue we have been highlighting. We estimate that in any given period that the overwhelming majority of YELP’s reported Local Business Accounts are accounts the company has signed within the LTM (meaning YELP is losing the majority of its accounts after the first year).
He did point out that total accounts continue to grow on a quarterly basis at a strong rate (there’s no denying that), and he reiterated YELP’s strategy of focusing on acquisition vs. retention given its large addressable market; highlighting YP.com as a reasonable opportunity (575K customers).
To be explicitly clear on this front, we believe Rob (and the company) sincerely believes that YELP’s TAM is as large as they have publicly stated. We do not; we have gone into detail on why this isn’t the case in our original YELP Short Best Ideas note (with much greater detail in the deck).
We will be publishing another note shortly with incremental detail on YELP’s TAM to emphasize this point.
If you have any questions, or would like to discuss in more detail, let us know.
Hesham Shaaban, CFA
Client Talking Points
Consensus bullishness on the Nikkei and bearishness on the Yen continues to be one of the worst macro positions of the year. The Bank of Japan didn’t deliver the drugs overnight (60-70 TRILLION Yens still not enough!) so the Yen is breaking out to fresh year-to-date highs versus the US Dollar and the Nikkei was down for the fifth day in the last six to -13.1% YTD (Fed mins should be dovish next).
Got #StrongCurrency = Strong People (Consumption)? With the #StrongPound testing year-to-date highs in Q2 versus the US Dollar, UK Retail Sales for April were a barn burner of +6.9% year-over-year – that’s a 10 year high, reminding the Keynesians that they have the whole FX burning for 1920’s “export demand” completely wrong. It’s 2014.
Our breakout signals for both Brent and WTIC have been confirmed in the last two weeks as WTIC inflates another +0.8% this morning to $103.21 – one more #InflationAccelerating tax on American Consumers for Memorial Day weekend (unless, of course, you roll with Bernanke using car service for non-inflationary $400,000 Fed whispering sessions).
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Top Long Ideas
Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration. The first survey tool measures 3-D Mammography placements every month. Recently we have detected acceleration in month over month placements. When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner. With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.
Construction activity remains cyclically depressed, but has likely begun the long process of recovery. A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating. Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms. As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.
Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.
Three for the Road
TWEET OF THE DAY
COMMODITIES: US growth stocks -1.7% yesterday vs Commodities up #InflationAccelerating @KeithMcCullough
QUOTE OF THE DAY
"It's how you deal with failure that determines how you achieve success." - David Feherty
STAT OF THE DAY
During his eight years as steward of the world’s largest economy, Ben Bernanke’s salary was about $200,000 a year. Now he makes that in just a few hours speaking to bankers, hedge fund billionaires and leaders of industry. This year alone, he is poised to make millions of dollars from speaking engagements. (New York Times)
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