There's a battle a brewing -- one that will come to a head on Friday at Buffalo Wild Wings' (BWLD) annual shareholder meeting. The combatants are company management and activist Marcato Capital Management, with the latter holding a 9.9% beneficial ownership interest in BWLD. At stake are board seats- Marcato, which is waging a proxy fight, has proposed four board candidates -- and the future direction of the company.
Marcato's main issue with the company, beyond the typical earnings and profitability, is regarding the capital structure, and more specifically the fact that BWLD has a 50/50 mix between company-owned and franchised locations. The activist does not believe that BWLD's strategy of owning locations has been a wise use of capital, and believes that a transition to 90% franchised stores should be the path of the future.
"Refranchising", or selling company-owned stores to franchisees, has been gaining acceptance in the industry over the years. Success stories that have adopted this approach, given lower capital costs, and better margins, include Denny's (DENN) -- which has very quietly been one of the great turnaround stories over the past several years -- and Jack In The Box (JACK) . In both of these cases, refranchising helped to create value for shareholders.
Marcato has highlighted declines in BWLD's operating performance, including margins and same-store sales, which were in negative territory in all four quarters of 2016. It has also been a critic of the company's repurchase of 113 stores between 2011 and 2015, at a cost that Marcato believes was 50% above replacement cost.
Of course, to move forward with such a radical change means changes in leadership, and the results of Friday's vote will tell the tale. Interestingly, two proxy advisory services -- Institutional Shareholder Services (ISS) and Egan Jones -- appear to be on Marcato's side, with ISS recommending three out of the four activist-proposed board candidates, and Egan Jones recommending all four. Meanwhile, proxy advisor Glass Lewis is backing BWLD's slate of directors. If Marcato is successful, a CEO change will likely be in the "wings" (pun intended).
As is usually the case in proxy fights, management has not been silent, highlighting company successes since it's 2003 IPO, including revenue growth from $126 million to nearly $2 billion, strong returns versus peers, and actions the company took in 2015 as the company was facing headwinds. Management does not believe that refranchising will create shareholder value, and has been citing its own plans to cut costs and improve margins. It has held out DineEquity's (DIN) , poor performance since refranchising Applebees stores as an example of what can go wrong with Marcato's plan. It has held the activist's feet to the fire for supporting DIN's plan, then selling the stock shortly thereafter.
Enough he-said, she-said. No matter which side you land on, BWLD has had its share of stumbles in an industry that is already facing headwinds -- and already overvalued, in my view. BWLD shares currently trade at the same level they did in October 2013, and the company has badly missed consensus estimates for the past two quarters, and outpaced consensus just once in the past ten quarters.
Shares currently trade at 26x 2017 and 21x 2018 consensus estimates, which, if accurate, are not exactly cheap given the uncertainties with the company and industry as a whole. Furthermore, net margins have fallen from 6.2% in 2014 to 4.8% last year, and rising labor and commodity costs don't bode well for anyone in the industry.
In BWLD's case, chicken wings, which years ago were often discarded as waste, are not cheap, pushing $2 a pound. A huge fan and consumer of wings, I have not been compelled to return to our local BWLD. It ain't exactly cheap, and I can make better wings at home.
While I don't have a dog in this fight, it would not be all that surprising to see some major change coming out of tomorrow's vote. Either way, the victor will have its share of challenges. For now, just sit back and enjoy the show.