Rainforest Cafe Bear's Rebuttal
Jim Surowiecki (TMF Cinder)

The price of a stock is a curious thing, because although it exists in the present, its only value is as a reflection of a company's future. That probably sounds a little obscure, but actually it helps explain why Rainforest Cafe's stock is overvalued, and why Rick's able defense of the company's performance until now ends up being somewhat beside the point. The question you have to ask yourself about Rainforest Cafe is not: What has this company done in the past? The real question is: What is this company going to do in the future? And the most likely answer to that question is: Not very well.

Now, obviously a company's past record often does provide important clues to where it's going in the future. And, as Rick and I have both pointed out, Rainforest Cafe has done a great job of expanding sensibly and profitably, and of ensuring that it didn't sink beneath huge loads of debt. Rainforest Cafe is also definitely not Planet Hollywood. It has not overbuilt, nor has it constructed its entire business on the flimsy edifice of celebrity hype.

On the other hand, Rainforest Cafe's past now looks considerably more impressive than both its present and its future. In the present, the sharp decline in the same-store sales in question (and an 11% drop at a time when you're trying to grow earnings by 50% has to be considered sharp) suggests that people are tiring of Rainforest Cafe's themed environment. At the same time, the company saw its receivables rise by 50% in the third quarter, while its inventories jumped by nearly two-thirds. Both numbers are troubling. And though I don't think the absence of a President is ipso facto a sign that the company is floundering, eight months is a long time for any corporation to go without a chief operating officer. Why Martin O'Dowd has not been replaced is something of a troubling mystery.

More importantly, the company's future is one of declining consumer interest, smaller margins, and an eventual exhaustion of what Rick rightly calls unit growth as the available markets for Rainforest's peculiar brand of automated fan get used up. To be sure, this is a harsh conclusion to draw from one slow quarter. But it's also a conclusion that you can draw from the entire history of the restaurant business, which is singularly devoid of sit-down restaurant chains that generate profits consistently over long periods of time. (McDonald's is not considered one -- it's fast food.) Yes, Hard Rock has been around for 26 years, but over those 26 years would you rather have invested in Gillette or Coca-Cola or any large consumer company or in The Hard Rock Cafe?

Rick asks the excellent question: "If fashion is fickle, why are we so sure that one soft quarter will spell the end when a strong quarter would be quickly dismissed?" But this is a question with an answer, which is that it's much easier to lose the public's attention than it is to get it back. In a sense, the business of branding -- which is essentially what Rainforest Cafe is in -- is much like juggling. As long as the juggler keeps the balls in the air, he can hope to keep the audience's eyes fixed upon him. But as soon as he drops the balls, the audience wanders away -- and even if he starts juggling again, there's no guarantee they'll return.

In part, the audience here consists of investors who lost faith in the company after the earnings pre-announcement. But the more important audience consists of its customers, and what those same-store sales numbers are saying is that customers are starting to wander away. And until we have some evidence that Rainforest Cafe is able to keep them, this is a jungle you're better off staying out of.

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