Is $300M too little for Zoes Kitchen?

A large shareholder says that $12.75 per share “undervalues” the fast-casual chain, says RB’s The Bottom Line.
Photograph: Shutterstock

The Bottom Line

Zoes Kitchen last week said that it was being sold to Cava for $12.75 a share in a deal valued at $300 million.

It was a surprising deal, and the price was a 33% premium over its price the day before.

But to some, it’s not enough. One of the chain’s shareholders, PW Partners Atlas Fund, a hedge fund and frequent activist in the restaurant space, said in a filing with the Securities and Exchange Commission this week that the $12.75 for Zoes “undervalued” the company.

Investors in reaction bid up the price of the chain, which went well over $13 per share on Tuesday. Investors don’t pay a price higher than the proposed per-share sale price unless they think someone else will step in and pay more for those shares.

How much Zoes should be valued in a sale process depends on how you view Zoes. The chain is either a struggling concept in need of some revitalization, or it is a growth chain in the booming fast-casual sector that has just been through a down cycle but still has enormous potential.

Just two years ago, Zoes was one of the hottest restaurant stocks on Wall Street, trading above $35 per share as investors bet on the company’s future growth.

But Zoes stock has declined steadily since then, largely because of weak same-store sales. That includes a 2% full-year decline last year and a 2.3% decline in the first quarter—when Zoes CEO Kevin Miles said the company would not only slow development but take a look at underperforming restaurants, potentially setting the stage for closures.

As such, Zoes could be considered a chain in need of some revitalization, and investors have treated the stock that way. It was below $10 per share when the deal was announced and had been below $9 for much of the summer.

In that sense, the valuation that Zoes is receiving could be considered good for a chain in need of some work. Cava is paying 14 times earnings before interest, taxes, depreciation and amortization, or EBITDA.

That’s a decent multiple, if not quite of the level that more experienced chains such as Panera Bread and Popeyes have received. But it might be what you’d expect of a potential growth chain in need of some work.

Still, the $12.75 is still well below the $15 that shareholders paid at the company’s initial public offering three years ago. It’s well below the more than $17 per share, 52-week high.

And keep in mind that Zoes is still a growth chain and has just more than 250 locations. Theoretically, investors in the company should be patient, willing to ride out periods of weak sales on its way to growth. Zoes was remarkably small when it went public, generating annual EBITDA of just $10 million. It was bound to have some challenges.

Investors could therefore demand a larger premium if they’re going to sell their shares in a fast-casual growth concept.

And the past couple of years have not necessarily been kind to fast-casual chains, as consumers armed with numerous choices spread their money around. Several companies have had same-store sales challenges, though Zoes first quarter results were clearly not good.

Companies can overcome those issues, however. Last year, for instance, Noodles & Co.’s stock was trading in the low single digits and needed some major financial assistance from a pair of private-equity firms a year ago.

It fixed operations, simplified its menu, slowed growth, closed units, developed zucchini noodles and has been one of the stronger performing stocks of late—to the point that those private-equity firms, L Catterton and Mill Road Capital, were able to sell stock and make a bundle off of their investment.

Zoes will probably be better off as a privately held company where its investors can operate with patience and out of the glare of quarterly earnings reports and analyst expectations. But its buyers will probably have to pay a bit more of a premium if investors are going to let that happen.

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