Dear Sally,
You’re probably unaware, but your company, BWLD, is on the Hedgeye Restaurant Best Ideas list as a LONG…for all the wrong reasons.
That’s right, it’s not because I think you are going to manage the company through these turbulent times. Many of your peers would agree that your twenty-year tenure as CEO can be characterized as a success, as you have built BWLD into a national brand, and the 4th largest casual dining brand based on system-wide sales. Yes, the stock has significantly outperformed the S&P 500 by 600% over the past 10 years, but your stock has gone sideways for the past three years, underperforming the S&P 500 by 7.8%.
The past is the past, and Wall Street has a very short memory. All of your success can be eroded in an instant if you don’t recognize when the time has come to change.
With the emergence of an activist shareholder, the time has come for you to pivot and take the company in a new direction. If you look carefully at your past performance, the strategy you have employed for the last ten years has a limited long-term sustainability, can’t be replicated, and has generated mediocre returns. In fact, by most measures, you have the lowest store level returns of anyone in your casual dining peer group. As I said, it’s time for a change!
It’s also important to recognize some of the strategic missteps you have made that are now coming home to roost. If these issues are not addressed now it could potentially cost you your job and your credibility. You are a well-respected CEO, so the question many are asking is, will you fight the winds of change, or recognize the shifting market place and pivot the company in a new direction?
Here are a few reasons why you should consider altering the company from the current path:
- As the company has grown to a national chain you have failed to upgrade the management team or the Board of Directors, until recently (10/11/16). The scale, size and complexity of the organization has increased significantly and your managerial process is stuck in the past.
- You have not invested in the much needed infrastructure to run a significant multi-unit chain.
- Your long-term incentive compensation was over indexed to revenue growth, leading to poor capital allocation decisions. I suspect this is why you have repurchased a number of franchises over the years. In the end, this was a poor use of capital and added significant volatility risk to the overall business model.
- In the past 20 years there has been no menu innovation. Early in the concept’s life, mediocre food was acceptable when it was inexpensive. Now it’s just mediocre food where the price/value equation is out of whack.
- Getting distracted by multiple smaller brands is a lesson you should have learned not to do. What gives your management team the confidence that they are able to identify/develop incubator brands when they can’t even manage the core business properly?
- Your capital allocation strategy is just silly. Can you justify the analytics behind your strategy and its connection to shareholder value creation?
Given the recent events, the biggest mistake you are currently making is not taking Marcato (or your investor day) seriously. I did not attend the meeting, but I listened closely and have heard lots of feedback from those in attendance. From all indications, the investor day was a joke! Prior to the investor day, you knew for months about the Marcato’s investment and what they wanted to see. Two things come to mind about how you handled this situation: First, prior to the investor day, you had a chance to make an official statement and you chose to say nothing. Second, the investor day came and went and there was very little thought about the issues, and it was clear that there was minimal preparation for the meeting. Overall, your management team came across as nervous, clueless and weak. Lastly, did I see that you actually sold stock the day before the analyst meeting?
It’s no wonder Marcato came out firing after the meeting. Your inability to manage this company is becoming clearer every day. You had a chance to diffuse this situation and all you accomplished was to make Marcato mad! Given the latest Marcato 13D on 10/14/16, you are still provoking them and looking very immature in the process!
Marcato has put forth compelling arguments and substantial evidence that you have ignored the basic principles of corporate finance. As with other Restaurant activist situations we have witnessed, the likelihood of the activist winning is very high. You will be able to see this being played out in real time in your stock price. As the market perceives you are maintaining control of the company the stock will trade down. As the market perceives the activist gaining control, the stock will trade higher…
- The Marcato investment sent the stock up ~23%
- For the 4 weeks following the analyst day the stock down ~4%
- Your push back on Marcato has sent the stock down another ~10% over the past month.
- Marcato threat of litigation sent the stock up 2%
Can you see the pattern developing? The sooner you realize where this is heading the better it will be for all shareholders.
More importantly, settling your feud with Marcato will also help in the CFO search. I’m assume that identifying the new CFO and then having him back out at the last minute was a real stinger, and I don’t have to tell you how bad this looks for your reputation. Given the current setup of the company, finding a high-quality CFO is going to be a difficult. Needless to say, the longer this search continues, the more your credibility as a CEO will be called into question. The biggest challenge you have is the mounting evidence chronicling how poor your capital allocation track record has been. With Marcato calling for new management, who is going to risk taking a new job that may only be temporary?
On another subject, how is the morale at BWLD? There have also been some recent high profile departures from BWLD. You announced that Kathleen Benning (EVP Business Development and Chief Strategy Officer) left, but we have also heard that Michael Sullivan, head of Emerging Brands at BWLD, left to go to Rock & Brews. I suspect that you’re finding it’s going to be more difficult keeping morale up at the company. The longer you fight the process of change, the worse it gets for your employees.
I assume it’s only going to get harder to pay bonuses if sales remain on the current trajectory, which means turnover can only go higher from here. Of course as turnover heads higher we know what that means; the downward spiral has begun. As you go down this slippery slope, I hope you realize that the status quo will not work anymore. If you can’t come up with an appropriate response to the Marcato deck and embrace change, I suspect your days as CEO of BWLD are numbered. I’m guessing you don’t want your career to end like Clarence Otis’ did.
There are also some other issues you may want to seriously consider:
- Relative to how your peers present to the investment community, your investor day presentation was lacking in details, sophistication, and displayed no analytical capabilities needed to manage a company of this size.
- The “stadia” conversion looks like a major blunder. Clearly, BWLD is a restaurant not a sports stadium. Your first priority is to serve good food that is supported by sports programming, not vice versa. More importantly, why would you do a conversion that removes 10 seats from the restaurant?
- You continue to ignore the competitive threat from copycat concepts — smaller stores that add more value (i.e. Delivery services). In fact, a major competitor is thriving on delivery and you are just beginning to explore that option. This is crazy and yet another example of the lack of creative thinking you have displayed over the years.
- You never stated clear reasoning for the last minute exercise of the first right of refusal to buy a big block of franchise stores in 2015 and the reason for not accounting for the acquisition correctly. This is a perfect example of how misguided your incentive compensation structure is and how poor strategic planning can lead to poor capital allocation decisions.
- Your focus on events and trying to mimic the atmosphere of a sports stadium has led to bad marketing decisions. Firing the marketing spokesperson over a “controversy” is appropriate, but it seems like marketing is invisible and pivoting to sporting events with very limited viewership will not work.
- Why do you blame the sports calendar for your last two years of same-store sales misses? What is really going on? Do you know what your competition is even doing?
- Why are you now just leaning into a loyalty program? Essentially, your loyalty program is a earn & burn program with very few “loyalty" attributes.
- Lastly, the Guest Experience Captain initiative was trivial and a waste of labor dollars.
- Adding three new members to the Board and not reaching out to your activist shareholder could be seen as an act of war! Marcato’s entrance should be viewed as a crucial partnership and you should recognize the significant influence they can have at the next annual meeting.
Lastly, here are some good next steps that could make life easier for everyone involved and could preserve your job as CEO:
- Invite Marcato to HQ and have a heart to heart (you have already begun doing some of the things they have requested!)
- Sell the non-core brands, or announce your intention to sell them. From the beginning, the strategy of diversification was never coherent or actionable and was never going to create shareholder value. (On that note, we have been hearing rumblings that the founders of PizzaRev want to cash out.) Also, why have you stopped building new PizzaRev units in Minneapolis? Too expensive?
- Announce you are going to cut growth capital spending in 2017-2018 and use the incremental free cash flow to start paying a dividend.
- Announce you are going to refranchise the bottom 10% of the store base
- Announce you will focus on cutting corporate G&A
I will be following up this letter with a more detailed look at the company and what the future may hold on 10/25/16 at 11:00am EST. If you would like to listen in please let me know. While I could be wrong in my assessment of the current situation, I suspect I am close to having it right.
Warm Regards,
Howard Penney
Managing Director
Shayne Laidlaw
Analyst
