Shake Shack Could Signal a Top for Restaurant IPOs

 | Aug 18, 2014 | 2:30 PM EDT  | Comments
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If Reuters is right and Shake Shack takes advantage of the seemingly unstoppable appetite among consumers and investors for new burger joints, I have a prediction: It will mark the top of the burger bubble, and if not burgers, certainly the market for restaurant IPOs.

Unless, of course, it doesn't, and instead it will open the floodgate for the last wave of restaurant IPO wannabes.

If and when it files, Shake Shack will be the latest in a string of restaurant IPOs, most of which have come out of the gate like a rocket, only to fade after the first turn.

Shake Shack, is without question, good. Its quality is good. Its concept, which is employee-centric, is very good. Management is considered really good. And most of all, its majority owner, Union Square Hospitality, run by legendary New York restaurant maven Danny Meyer, is considered exceptional.

We don't know, of course, what the numbers will be. But on the basis of steady lines in the few Shake Shacks I've either eaten in or passed, it's fair to say they're probably better than most. (I'd love to know the annual revenue of the unit in New York's Times Square, for example. Sure, it's Times Square, but that unit must be hitting some kind of record.)

Trouble is, in the land of burgers, the space has exploded in recent years, and not just Five Guys and Smashburger (always in the IPO rumor mill), but a lot of local chains that are sparking big followings, such as SoCal's Burger Lounge and The Habit (the latter of which is rumored to be eyeing an IPO). And they're going up against the likes of cult fave In-N-Out Burger on the West Coast (amid rumblings that quality has taken a spill) and the granddaddy of them all, McDonald's (MCD), which has not entered old age gracefully.

Lost in all of this is this, when it comes to burgers, is that they're all going up against local burger shops, which as a group are growing faster than the burger chains and all quick-serve restaurants.

According to the blog Burger Business, independent burger shops last year showed unit growth of 6% this year, compared with just 0.3% for the chains and 0.8% for all restaurants.

And that may explain why Five Guys, Smashburger and other burger chains, as hot as they may appear based on hype, aren't going public.

There may be something else: They just aren't doing that well.

According to public franchisee documents, same-store sales for both, as measured by gross sales of mature units, have slipped. (They had slipped year over year at Noodles (NDLS), too, by the time it IPO'd -- and its stock has become downright soggy.)

Adding to the intrigue: Five Guys and to some extent Smashburger have been ambitiously buying back franchisees -- not usually a good sign. As one longtime restaurant industry analyst put it to me, "Franchisees don't sell because they are tired of making money. They want out since they are losing money, or, new construction doesn't cover cost of capital (or barely, on a risk adjusted basis)."

Adds San Diego restaurant consultant John Gordon, "It is typically speculated that is done to keep the lights on in that market."

By contrast, Gordon says, Shake Shack doesn't franchise "and is in the dense, higher-income Northeast and high visibility international gateway markets. Danny is smart that way."

And because there are no public franchisee agreements, there are "no numbers known other than rough press clips."

If Shake Shack goes public, the problem it will face, Gordon says, is "the quick national growth expectation, etc."

On the other hand, he adds, "Shake Shack has a more urban, hip feel, and with liquor and a smaller U.S. base and more international, could do better."

Reality: If Shake Shack comes out, it may spark a new wave of restaurant deals, perhaps even burger deals, as private equity, looking for an exit on current restaurant concepts, uses interest sparked by Shake Shack as the window to get out. And investment bankers will be busy trying to convince CEOs of under-the-radar concepts and local burger chains that this may be their last chance to get cash so they, too, can be the next Shake Shack. Of course, most likely won't be. And quite a few may never even cross the finish line.

Want more from Herb Greenberg? Sign up for Reality Check, his institutional research product, and get the watch list of all the companies on his radar with detailed analysis.

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