Why a Buyout Is the Worst Outcome for Chipotle Investors
Chipotle Mexican Grill (NYSE: CMG) could be a case study in reputational risk. After its Initial Public Offering (IPO) price of $22 per share, shares were on a tear for the greater part of a decade, cresting at approximately $760 per share in 2015. Soon thereafter, the stock came crashing down to earth as the company faced a series of foodborne illnesses, with the first outbreak infecting 55 people in 11 states. Later outbreaks fed into the greater narrative that the company's management was unable to fix the issue.
The company has taken a series of steps to remedy the situation, and parted ways with then co-CEOs Monty Moran and founder Steve Ells. Still, diners are not willing to give Chipotle Mexican Grill the benefit of the doubt. Last quarter, the company produced an anemic 1% comparable-restaurant sales increase, lower than meager expectations of 1.2%.
A recent report from Wall Street analyst firm Bernstein noted Chipotle could be a takeout candidate. For many investors, this is one of the worst possible outcomes.
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A ripe environment for restaurant acquisition
If Chipotle decides to shop itself around, it joins a growing list of restaurants that have exited the public markets. There have been a handful of restaurant sales this year, notably from private equity.
Earlier this year, JAB Holdings took Panera Bread private in a $7.5 billion deal. Recently, Arby's Restaurant Group, formed when private equity firm Roark Capital purchased the majority stake from Wendy's in 2011, recently expanded its portfolio by buying Buffalo Wild Wings (NASDAQ: BWLD) in a $2.9 billion all-cash deal (debt inclusive).
This may be good for Chipotle as a company
When Panera was acquired, then-CEO Ron Shaich called being private "a competitive advantage," noting that investors too often think on a short-term basis. Impatient shareholders force management to maximize earnings each quarter or face depressed stock valuations and calls for their ouster. I think even those bearish on Chipotle feel that the company's issues are fixable with time and improved operations.
What going private -- or being acquired by another restaurant -- gives Chipotle is time to return to basics without the hot glare of Wall Street every quarter. Chipotle will be able to address its issues without worrying about shareholder fallout. In the last conference call, the company noted it would be slowing the rollout of new stores to return to a training culture, and the stock sold off as investors understood the bulk of Chipotle's top-line growth has been due to increased restaurants.
This won't be great for many shareholders
Unfortunately, an acquisition may not be the best for Chipotle shareholders -- at least those who purchased the company in the last few years. After peaking at $760 per share in mid-2015, the company's shares now sit at less than half that figure.
It's unlikely that any offer to buy Chipotle will drive the stock back to that price. As a rule of thumb, acquisition premiums decrease as the acquisition price increases. Buffalo Wild Wings received an acquisition premium of 38%, while Panera's acquisition premium was 20%.
Even assuming the higher 38% premium, many long-term shareholders will be forced out of their positions at a loss. Most likely, the premium will be closer to, or less than, Panera's 20% premium as its enterprise value (market capitalization plus debt minus cash) of $8.3 billion is higher than Panera's takeout price.
However, even if shareholders are rewarded with a one-time gain due to the buyout, that ends the transaction. Chipotle is a well-known brand with a strong value proposition that's suffering from reputational risk. Current shareholders are betting new management is able to fix these issues and reclaim its former glory. They may, however, not get that chance.
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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Buffalo Wild Wings and Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
