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Monday, January 12, 1998
Rainforest Cafe
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Phone: 612-945-5400
Website: http://www.rainforestcafe.com
Price (1/9/98): $17 7/8
HOW DID IT FIND TROUBLE?
The king of the jungle has tripped on a vine. After perpetually meeting or beating analysts' earnings estimates since its 1995 initial public offering, rainforest-themed restaurant chain Rainforest Cafe fell short for the fourth quarter of 1997.
The penance was steep to a jaded market. As eatertainment peers Planet Hollywood <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PHL)") else Response.Write("(NYSE: PHL)") end if %> and Dave & Buster's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DANB)") else Response.Write("(Nasdaq: DANB)") end if %> had recently tumbled after earning shortfalls, hope sprang eternal for a company that had manifested internal confidence by not only declaring a stock split and a convertible debt offering, but one in which the CFO had shown comfort in analyst estimates the month before.
When the company pre-announced fiscal fourth quarter results, stating that earnings per share would come in at $0.23 to $0.24 when the estimates called for $0.25, the market went wild and the shares were clawed for a savage loss. In the jungle, the once might jungle, the lion sleeps tonight.
BUSINESS DESCRIPTION
Rainforest Cafe owns and operates a chain of rainforest-themed restaurants and retail stores. With live and audioanimatronic animals living in a faux jungle setting, the company dishes out casual comfort foods like blackened swordfish, chicken pot pie, and seafood pasta.
Each individual restaurant costs between $3 to $12 million to open and generates annual revenues between $10 to $35 million. The restaurants have an attached retail area selling Rainforest Cafe merchandise and related wares that account for 22% of total revenues.
FINANCIAL FACTS
Income Statement
12-month sales: $93.6 million
12-month income: $10.9 million*
12-month EPS: $0.65*
Profit Margin: 11.6%
Market Cap: $318.2 million
(*Includes non-recurring charge)
Balance Sheet
Cash and Securities: $128.8 million*
Current Assets: $100.4 million
Current Liabilities: $17.4 million
Long-term Debt: None
(*Includes $45.5 million in long-term investments)
Ratios
Price-to-earnings: 27.5
Price-to-sales: 3.4
HOW COULD YOU HAVE SEEN THIS COMING?
The stock's fall came courtesy of several factors affecting the company. Fourth quarter sales at the three oldest units were off 11% over the previous year. While sales at the fourth and largest unit at Walt Disney World actually rose 15% and had raked in $35 million in annual sales alone, the decline at the old and even new stores was troubling.
Themed restaurants tend to find sluggish sales in their sophomore year. Coming off the honeymoon rookie season, where the novelty finds the locations at full capacity with long waits during peak hours, it is hard to go anywhere but down. For Rainforest Cafe this was common knowledge. The second oldest unit, at Chicago's Woodfield Mall, had shown negative same-store sales results every single quarter. The third oldest unit, at Gurnee Mills on the outskirts of Chicago, had a 15% decline in comps the quarter before.
Compounding this news was the continuing lack of a President or Chief Operating Officer. When Martin O'Dowd resigned in the spring, investors took it in stride. As a matter of fact, the shares went on to double after his departure. While the search process may have seemed painfully slowfooted, as long as the company was besting earnings estimates no one was complaining.
Lack of more than interim leadership was not news. Lack of sales growth at existing units was not news. Yet, a $250,000 earnings shortfall snowballed into a one-day loss of more than $200 million in market capitalization when the market decided to question the concept's staying power.
WHERE TO FROM HERE?
Who will save the Rainforest? From a valuation perspective, maybe the company will save itself. At the end of the third quarter the debt-free company had $128 million in cash and fixed income investments, or more than $7 a share in liquidity.
The eatery is comfortable earnings estimates of a $1.20 a share this year on revenues of $235 million and sees earnings growth of 40-50% next year. Despite the analyst markdowns it seems the king dethroned, the headless emperor, still has some clothes to fall back on with the stock trading at 10-12 times next year's earnings yet growing four times faster.
Despite the lower comps, operating margins have remained above 20% at the restaurants. While that will translate into lower profits per store if sales continue to slide, the company is still achieving a 50% annual cash-on-cash return on each unit's investment. That is significantly better than the 6% return the cash hoard is presently collecting.
With a two million share buyback announced the day after last week's debacle, the company sees value in the ruins -- a landscape that should beautify as Rainforest Cafe sets out to open between 16-20 new units this year, including a second Disney unit come April.
With the recent price action, investors may very well welcome the rides inside the Disney parks for a change. This epicurean Splash Mountain has not been pleasant. Mr. Toad, ease up on the wheel. After all, the valuation seems to have considerable pessimism priced in -- giving Rainforest ample room to shoot up to the second star on the right, clear through to morning, if and when new leadership takes the company to Neverland.
-Rick Aristotle Munarriz
([email protected])
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