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Friday, October 30, 1998
Avado Brands Inc.
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Phone: 706-342-4552
Website: http://www.avado.com
Price (10/29/98): $8 1/8
HOW DID IT FIND TROUBLE?
With a float like a bloated fly and a sting like an Applebee, few would have considered Avado Brands <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AVDO)") else Response.Write("(Nasdaq: AVDO)") end if %> to be the greatest. For years, the company -- under the Apple South moniker -- was known simply for being the largest franchisee of the successful casual dining chain, Applebee's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APPB)") else Response.Write("(Nasdaq: APPB)") end if %>.
As Applebee's went, Apple South was sure to follow. With leveraged expansion going at full speed, the company at one time had a higher market capitalization than Applebee's itself. Yet the operations were beginning to suffer. While revenues shot up 84% between 1995 and 1997, the earnings per share reported during those three years were $0.73, $0.75, and $0.73, respectively.
At the mercy of Applebee's to revitalize the chain, the company that would eventually be renamed Avado began to diversify. It purchased the Don Pablo's and Harrigans restaurant chains and found that owning its own concepts was a welcome challenge over growing a proven entity and mailing out royalty payments.
After three more acquisitions, Avado wanted more than diversification -- it wanted complete freedom from the chains of the Applebee's chain. It announced it was selling off all of its franchised units. The expected bounty of $400 million net of taxes would go to reducing debt and growing the freshly bought chains. As worthy as the approach sounded, investors who had grown comfortable with the Applebee's franchise play asked for the check and bolted. The feast was over. The famine was getting under way.
BUSINESS DESCRIPTION
On October 14, Apple South was renamed Avado Brands. The company's properties include 120 Don Pablo's Mexican Kitchens, 44 Hops brewery restaurants, 18 Canyon Cafe Southwestern Grills, and 21 McCormick & Schmick's seafood restaurants. The company also owns a 25% stake in the 11-unit chain of Harrigans and has 20% ownership of Belgo Group, a United Kingdom-based operator.
FINANCIAL FACTS
Income Statement
12-month sales: $904.2 million
12-month income: $68.1 million*
12-month EPS: $1.59*
Profit Margin: 7.5%
Market Cap: $359.9 million
(*Includes one-time gains and charges)
Balance Sheet
Cash: $3.7 million
Current Assets: $358.5 million
Current Liabilities: $95.6 million
Long-term Debt: $385.5 million
Ratios
Price-to-earnings: 5.1
Price-to-sales: 0.4
HOW COULD YOU HAVE SEEN IT COMING?
Images of Quality Dining <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QDIN)") else Response.Write("(Nasdaq: QDIN)") end if %> may have been running fresh through the minds of Avado shareholders. For years that company was putting out a cozy living as a franchisee for Burger King and Chili's. Yet the company overpaid for both Grady's American Grill and Bruegger's Bagels and soon realized that it took more finesse to run a restaurant as a proprietor.
It has suffered through Grady's and had to sell Bruegger's back to its founders. Over the past 30 months, Quality Dining has shed more than 90% of its stock value. Similar fears that maybe Avado's management was better suited to living life as a franchisee than an owner weighed heavy with investors. The fact that the restaurant sector has been an unloved sector for the last four years now -- and down more than 20% so far this year alone, according the Investor's Business Daily Retail-Restaurants Index -- certainly didn't help soften the blow.
WHERE TO FROM HERE?
The outlook for Avado is not as bleak as Quality Dining's was when its flair for individuality emerged. For starters, Quality Dining was not making savvy purchases. When it bought Grady's from Brinker International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EAT)") else Response.Write("(NYSE: EAT)") end if %>, it was a troubled chain that Brinker was hoping to unload. Bruegger's was quality, but it was quality in a sector that was overexpanding a faddish commodity.
Avado has gone a different route. It is buying strong performers in their infancy. The four fully owned decentralized concepts were all acquired when they were just a few units young. They were successful high volume ventures. As a matter of fact, all but Don Pablo's were winners of Nation's Restaurant News annual Hot Concepts awards. However, expansion would have been difficult in a market that has soured on restaurant stocks with the recent debacles of the once high-flying casual steakhouse, themed restaurant, and rotisserie chicken chains. Avado made a tempting offer -- ownership without taking the reins of control. The restaurateurs would continue to run their chains but with easy access to funds for expansion and enjoying the economies of scale of a network of "Hot Concepts."
Avado has not been perfect, but at least it has had the vision to realize imperfections and act quickly. When it saw limited growth potential in Harrigans, it sold off all but a 25% stake in the chain. When its stock price slipped, it entered into an aggressive stock repurchase program that bought back 8.3 million shares and has recently been authorized to buy back 2.5 million more.
Industry analysts were expecting the worst from the December announcement of the Applebee's divestiture. They were expecting morale to run low at the units in transition. Yet Avado is just about finished selling off the last of its Applebee's in a much quicker timeframe than initially projected -- and at $50 million more in net proceeds than the original expectations of just $350 million.
The infusion of capital from the piecemeal sale of its Applebee's franchised units has been put to good use in paying down Avado's considerable debt, buying back shares (yes, you knew that the "float like a bloated fly" part would have to be remedied) and, of course, helping build more of these new exciting concepts.
Wall Street is now expecting the company to earn $0.82 a share next year, which is pretty impressive considering it will be without any of the Applebee's units that for years had made up the bulk of the company's fiscal performance. As a matter of fact, the June quarter marked the first time ever that Applebee's didn't account for at least half of the total reported revenues.
The low valuation relative to earnings, along with a balance sheet that gets prettier with every handshake, makes Avado an attractive consideration from a value standpoint. Also, looking at the four strong chains ready to dot the landscape with most of that incoming cash both here and abroad, as the partnership with British-based Belgo suggests, gives Avado inspiring growth prospects. Can getting rid of the South in Apple South be the key to getting the stock to head back up north?
-Rick Aristotle Munarriz
([email protected])
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