The Best and Worst
Stocks of 1997
Loser -- Manhatten Bagel
(Nasdaq: BGLSQ) Price -- $3/4
The Company's Biz. Manhattan Bagel owns, operates, and franchises bagel restaurants, with about 360 stores in 19 states, Washington, D.C., and Canada as of September 30. About 9% of the stores are company-owned. It is number three in the bagel biz behind also troubled Einstein-Noah Bagels (Nasdaq: ENBX) and Bruegger's, formerly part of Quality Dining (Nasdaq: QDIN).
Manhattan Bagel derives most of its revenue (87%) from the sale of boil-and-bake "New York style" bagels and cream cheese spreads at company-owned stores or by franchisees and licensees. Like most franchisors, it also makes money from royalties and franchise and area developer fees, though these fees have declined recently due to a slowdown in expansion. Earlier in the year, the firm was busy working on expanding through co-branding arrangements with regional chain stores and in-store kiosks at third-party retail outlets, such as the Subway sandwich chain.
The Story. Before investors went gaga over Einstein, they had already cooked up a frenzy over Manhattan Bagel. The stock rose from $5 a share in early 1994 to a June 1996 high of $29 1/2 as bagels seemed like the greatest idea since sliced bread. Usually, these hot concepts crumble when companies start believing their PR, expand too rapidly, pay too much for leases, and find new competitors driving down profit margins. Franchisees start to fail, and then the franchisor has to make good on loan guarantees or otherwise ends up owning a bunch of stores that are barely profitable. Asset writedowns follow.
While Manhattan Bagel would face all of these problems, its first troubles resulted from sloppy due diligence on a couple of West Coast acquisitions, both of which had to be written off or sold. The company had missed bookkeeping discrepancies in one case. Even before Einstein started wooing investors in the late summer of 1996, Manhattan had already lost half its value through simple mismanagement, and had opened itself up to class-action lawsuits. Special charges in the third and fourth quarter of 1996 plus high operating costs kept the stock heading south.
The company squeezed out a penny per share in earnings in the first and second quarters, but suffered from legal expenses and the added costs of transporting bagel dough from New Jersey to the West Coast as the company experienced further troubles with its California operations. Though sales were rising, the company obviously needed cash. On August 5 it announced a deal with the Doctors' Associates franchisor of Subway to pay $14.7 million for a 6.25% note convertible into stock at $5 7/8 per share. Though that would have diluted current shareholders by 33%, it would have broadened bagel distribution to Subway's 12,800 store chain.
The deal was never finalized. On November 11, Manhattan announced a $1.89 per share loss and a $12.6 million asset writedown. That was followed by a November 19 filing for Chapter 11 bankruptcy, since the company was in default on loans and had negative working capital of $3.7 million. The asset adjustments included $4 million in written off receivables, area developer fees, and company-guaranteed loans. Two plants were closed and the value of company-owned stores and other assets was reduced by $8.1 million. The stock plummeted.
How Could You Have Avoided This Loser. Restaurant concepts have a faddish quality to them as well as their own boom/bust development cycles. Long-term investors should either stick to the dominant players or enter an ownership position with a healthy and alert sense of skepticism.
At the June 1996 highs, Manhattan shares were trading at something like six times sales, a pricey multiple. The West Coast debacles indicated managerial incompetence, an absolute red flag. Then there was growing competition within the bagel industry from Daily Troubles Quality Dining and Einstein/Noah, both of which were having their own difficulties, which suggested that the business simply couldn't live up to the hype. If that wasn't enough, Manhattan's amended credit agreement in April, which boosted its interest rate, should have offered another good reason for investors to worry.
The Future. The company has declared bankruptcy and angered many of its franchisees as a result. It hopes to sell its company-owned stores to franchisees or to close them down. It has downsized its corporate staff, closed two production plants, and will likely make additional efforts to cut costs. Although the company is currently trading at a discount to its book value of $21.8 million, it's really not clear what its liquidation value is. About $11.6 million worth of assets are notes receivable and $17.4 million is chalked up to property, equipment, or store investments. All of this is a bit suspect. Arguably, Manhattan's brand and recipes are worth something if you assume there's someone who knows how to run a profitable bagel chain -- which may be a risky assumption. A work-out will require a significant cash infusion. That seems iffy, given the current state of the bagel franchising business.
-Louis Corrigan (TMF Seymor)
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