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More than a Steakhouse: Don’t Miss the Juicy Upside in The ONE Group’s Deal with Kona

John Jannarone

The ONE Group Hospitality, Inc. Purchased 25 Kona Grill Restaurants, Increased Guidance

  • STKS may be worth over $8 a share based on conservative industry multiples
  • STKS got the pick of 25 very best Kona locations following sushi chain’s bankruptcy
  • STKS has shown consistent, industry-leading same-store sales under CEO Hilario

By John Jannarone

By the time successful restaurants are hot, it’s often too late to invest in them at a decent price. In the case of The ONE Group Hospitality, Inc. (ticker: STKS), which reports quarterly results Thursday, investors may soon kick themselves for not booking reservations.

The owner of upscale steakhouse-and-lounge concept STK announced in early September it was acquiring select locations of polished sushi-and-American restaurant Kona Grill, which had sought bankruptcy protection earlier this year. The Kona addition is transformational, effectively doubling STKS’s restaurant base with a differentiated concept that has little overlap with existing locations. But while STKS said the deal would quickly be accretive and subsequently raised its 2019 and 2020 outlook, the stock has essentially drifted sideways in the last several weeks.

Here’s what investors may be missing. First, STKS essentially got its pick of the very best restaurants under the Kona umbrella. While under bankruptcy protection, it’s easy to walk away from long-term leases at poorly-performing locations and hang onto the winners.

It appears that’s just what happened: A year ago, Kona had 44 locations and STK is picking up just 25. The majority of the restaurants being acquired also have a long track record, having been opened several years ago.

That suggests STKS won’t be overwhelmed trying to fix a broken business. Rather, it can focus on low-hanging fruit such as cutting overhead and using scale to buy ingredients and services at better prices. Perhaps most importantly, STKS management can help make Kona’s most successful restaurants even better.

Consider the success of STKS CEO Manny Hilario, who took the role two years ago. He previously was CFO of Sizzling Platter and both COO and CFO of Einstein Noah Restaurant Group, Inc., which was acquired at a hefty premium to a private buyer in 2014.

After Mr. Hilario took the helm at STKS, sales growth immediately accelerated. Since the fourth quarter of 2017, domestic same-restaurant sales have ranged from 6% to 15%, far above the industry average.

One key to success has been STKS’s ability to draw customers far beyond the traditional steakhouse crowd. With STK locations in trendy, youthful spots such as Miami Beach, the company has been able to attract more women than a typical restaurant with a core steak offering. STK has excelled drawing a happy hour and late-night crowd, boosting sales of beverages by creating a lounge experience fit with DJ performances.

STKS has also struck some lucrative deals abroad. Earlier this year, the company opened a restaurant in a Ritz-Carlton hotel in Doha and in the last several weeks, two more locations in Florence, Italy and San Juan, Puerto Rico were announced. Those locations, which are managed or licensed, are asset light and high margin, with the company collecting a revenue stream with minimal cost.

But while STKS has improved the user experience to boost the top line, it has also kept an eye on costs. The company projects SG&A to expenses to be below 10% of sales as it keeps headcount down and sources low-cost vendors.

As for valuation, there are multiple reasons to see STKS shares several dollars higher. One comparable company is Ruth’s Chris Steak House operator Ruth Hospitality Group, Inc. (ticker: RUTH), which trades at an enterprise value of 10.7 times 2020 Ebitda, according to Sentieo. RUTH commands such a valuation while only posting low-single-digit same-store sales in recent quarters, far below STKS.

Meanwhile, other high-end steakhouses have fetched decent multiples in sales to private-equity firms. Most recently, Del Frisco’s Restaurant Group, Inc. was sold to L Catterton for $650 million. According to filings retrieved with Sentieo, Del Frisco’s was sold at 12 times 2019 Ebitda and and 9 times 2020 Ebitda. At the time, Del Frisco’s had been struggling and was shuttering underperforming locations.

What should STKS be worth? Assuming the midpoint or the company’s 2020 Ebitda forecast and a multiple of 11 times, the stock should conservatively be worth around $8 a share, according to IPO Edge calculations.

Some analysts have also applied a sum-of-the-parts analysis to arrive at a stock price, which should also result in a similar number. The key, however, is to realize that earnings from Kona will likely grow a steady pace, and therefore deserve a healthy multiple.

Of course, skeptics will worry about the risk of integrating STK and Kona without any stumbles. But so far, the progress looks smooth, with the company already forecasting a boost to sales and Ebitda in the fourth quarter. Those who wait too long may find themselves late to the party.

 

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