Another Horrible IPO

Investors have had the distinct pleasure this year of welcoming a handful of downright horrible stocks to the public markets -- and I'm not even talking about Facebook's (Nasdaq: FB  ) sorry excuse for an IPO.

Two weeks ago, Motley Fool managing editor Brian Richards warned investors about the impending IPO of Manchester United (Nasdaq: MANU  ) , the hyper-inflated and heavily indebted professional soccer club based in the U.K. And over the past weekend, Fool contributing writer Sean Williams implored our investing community to resist the siren song of Bloomin' Brands (Nasdaq: BLMN  ) , the debt-laden proprietor of Outback Steakhouse, Carrabba's Italian Grill, and Bonefish Grill.

Today, I want to add one more to the list: Chuy's (Nasdaq: CHUY  ) , the casual-dining Tex-Mex restaurant based out of Texas. Although Chuy's shares are the only ones that are up considerably since going public at the end of last month, don't let this deceive you. To be blunt, Chuy's is a debt-ridden, speculative venture that's doomed to fail.

Chuy's is unoriginal
Originality isn't everything. Cornelius Vanderbilt's New York Central didn't invent the railroad. Henry Ford didn't dream up the automobile. The hamburger preceded McDonald's. And Chipotle Mexican Grill's (NYSE: CMG  ) founder only discovered the mission-style burrito upon eating one.

But what successful operations like these have in common is that they took established concepts to another level. Vanderbilt exploited size. Ford increased efficiency. McDonald's leveraged convenience. And Chipotle united process and quality. In other words, they all brought something to the table.

Unfortunately, the same cannot be said for Chuy's.

While I'm no culinary expert, I've eaten at various Chuy's locations, and I can't distinguish it from any other middle-tier Tex-Mex establishment by its food, service, or ambiance. Sure, I can appreciate its motto: "If you've seen one Chuy's, you've seen one Chuy's!" But displaying different "hand-painted wooden fish, vintage hubcaps hanging from the ceiling," and "palm trees crafted from scrap metal" simply won't bring home the proverbial bacon in the ultra-competitive restaurant industry.

Indeed, while this may be hard to believe, even the chain's complimentary self-service "Nacho Car" -- a mock automobile trunk filled with tortilla chips -- won't get this done. These are window dressings, lipstick on a pig -- or, to borrow a culinary term, garnishes not meant for consumption.

What's lacking is a competitive advantage, such as a moat or something -- anything -- to distinguish and protect the company from its near-identical yet better-established competitor, Chevy's. For God's sake, even their names are alike!

Even the founders have jumped ship.
The company's founders saw the writing on the wall five years ago when they effectively abandoned ship. I say "effectively" because both remain shareholders and directors, but they collectively own only 6% of the post-IPO entity and control a mere two out of seven seats in the boardroom. The decision-making authority falls instead to Goode Partners, a New York-based private-equity firm that purchased Chuy's in 2006.

Here at The Motley Fool, we believe strongly in founder-led companies like Starbucks, Amazon.com, and, until recently, Costco. John Mackey of Whole Foods put it best: "The founder is like the father or mother of the business … and the business is like their kids. No one's ever going to love that business like the founder."

Yet in Chuy's case, the two founders have as much say in their company's affairs as does Michael Stanley, a 29-year-old Goode vice president who was elected to the Mexican eatery's board in May of last year. According to Stanley's bio:

Michael was promoted from associate to Vice President of Goode in January 2011. Prior to working at Goode, Michael worked as an analyst at Wachovia Securities. Michael currently sits on the board of directors of Rosa Mexicano and is a board observer of Bowlmor Lanes. We have concluded that Michael should serve on our board based upon his experience as an investor and his intimate knowledge of our operations.

That the Chuy's founders allowed a travesty like this to happen speaks volumes about their confidence in the future of the company. Not to mention -- nothing against youth or Mr. Stanley in particular -- there are better places than the boardroom for aspiring financiers to learn how to run a publicly traded company with thousands of shareholders.

Chuy's has a suffocating debt load.
Up to this point, my argument has consisted largely of subjective opinion, but the objective numbers paint a picture that's just as bad, if not worse.

With respect to its balance sheet -- and not unlike other restaurants victimized by private equity -- Chuy's is encumbered by backbreaking debt. At the end of its most recent quarter, the company reported $82 million in total debt versus assets of $135 million. Of the latter, moreover, a full $46 million are intangibles associated with goodwill and the company's trade name. Once you strike these, as prospective investors should always do, Chuy's is underwater to the tune of $20 million.

And what, pray tell, was this debt incurred for? Financing the construction of new locations? Hiring top-notch executives? Enticing the Chuck E. Cheese mouse to jump ship and take a ride in the Nacho Car? Nope. It was used to "recapitalize" the business, a Wall Street euphemism for paying Goode a $19 million "special dividend" in May of last year, repurchasing $22.4 million of stock eight months later -- most of which was Goode's, mind you -- and making a one-time $2 million payment to the same to terminate an advisory agreement.

Oh, and in case you're wondering how Chuy's will use the proceeds from its IPO (emphasis mine): "Since the dividend payment paid on May 25, 2011 was paid in the most recent 12-month period presented prior to the initial public offering and the dividend was in excess of current period earnings, such dividend [as well as the $2 million termination payment] is deemed to be paid out of proceeds of the offering."

Its growth history is pathetic.
Even though Chuy's has styled itself an "emerging growth company" to take advantage of relaxed disclosure requirements under the JOBS Act, its record of growth is as limp as a leftover taco salad.

At this stage in its growth trajectory, it should be recording same-store sales figures, or "comps," in the high-single-digit range at the very least. Yet over the last three years, its average same-store sales were a paltry 0.6% -- though this figure conveniently improved to 2.6% on the eve of the company's listing.

To offer you a comparison, in the recently concluded second quarter, Panera Bread and Chipotle recorded comps of 7% and 8%, respectively. And in the latter's case, analysts were flabbergasted; Jim Cramer even called Chipotle's results "apocalyptic."

But enough about the past already. What about the future?

According to Chuy's registration statement: "Certain of our restaurants operate at or near capacity. As a result, we may be unable to grow or maintain same-store sales at those restaurants." In all my years of investing and reading financial statements, I've never come across such patently self-defeating verbiage in a registration statement. I seriously doubt, for instance, that those words have ever come out of a McDonald's executive's mouth -- certainly not one that's still employed there. If nothing else, it demonstrates clearly that even the people running Chuy's don't believe it can meet the market's expectation of growth.

Foolish bottom line
There are literally thousands of public companies to invest in. There are even other Tex-Mex restaurants, like Yum! Brands' Taco Bell, if that's your particular fancy. But do yourself a favor and steer clear of Chuy's. Go eat its food. Enjoy the Nacho Car. Feast your eyes upon its mosaic of hand-painted wooden fish and vintage hubcaps. But by all means, unless you're a speculator looking for short-term volatility, do not buy its stock. You will regret it.

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Fool contributing writer John Maxfield does not own shares in any of the companies mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill, Facebook, Starbucks, McDonald's, Costco Wholesale, Whole Foods Market, and Amazon.com. Motley Fool newsletter services have recommended buying shares of McDonald's, Whole Foods Market, Costco Wholesale, Facebook, Starbucks, Chipotle Mexican Grill, and Amazon.com. Motley Fool newsletter services have recommended writing covered calls on Starbucks. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (8) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 13, 2012, at 4:27 PM, Frank2007 wrote:

    Your objective numbers may be correct (other than $135M minus $46M is not $20M less than $82M - it leaves them $7M to the positive).

    Your subjective opinion is not so great. Living in Texas, I've eaten many very good Tex-Mex meals (and quite a few not so good). Chuy's uses fresh ingredients and it shows. Their food is clearly better than Chevy's. Chuy's (and Maudie's) is the best Tex-Mex by far.

  • Report this Comment On August 13, 2012, at 4:34 PM, JohnMaxfield37 wrote:

    Frank2007 -

    The $82 million figure refers to total debt not total liabilities.

    You can take or leave my subjective opinion about its food. Like I said, I'm not a culinary expert.

    - John

  • Report this Comment On August 13, 2012, at 7:00 PM, Jesus4al wrote:

    I like to eat Mexican food. In Calif. it's not uncommon to get a chance to do so often. But the restaurants that have been there for years and built up clientele are the favorites of mine. But a couple of months ago I decided to gamble on an IPO (LUXR). The first day I recorded was 5/12/12 and it was in the green; and the next day it was in the red and has been red ever since. Down 91% now. Thank God I'm teachable.- - -

  • Report this Comment On August 13, 2012, at 8:55 PM, sfwarriors wrote:

    Love Chuy's. Purpose of the IPO is to raise cash to pay short term notes and to expand so I won't be surprise if they have debts. Future expansion is on the way so consider this a growth stock.

    Chuy's restaurants are always full so people likes them. That's the number one criteria for me to buy this stock. Are they profitable? Yes.

    Chuy's is like the "IN & OUT" burgers of Tex-Mex fast food + drinks. Love it!!!

  • Report this Comment On August 13, 2012, at 10:09 PM, JohnMaxfield37 wrote:

    sfwarriors -

    I agree with you about the typical purpose of an IPO.

    But this is a private equity backed deal. It's different. The IPO proceeds in this case are simply going to backfill the gaping hole left in Chuy's balance sheet by its majority shareholder Goode Partners after it pillaged the company for $40 million by means of a "dividend recapitalization."

    Also, with respect to it being a growth stock. Take another look at Chuy's comps over the last three years. Those are unequivocally not worthy of the growth stock label.

    Again, nothing against Texas or Chuy's or Mexican food -- I lived in Texas for four years and enjoyed all three -- but once you strip away the sentimental value, there's little remaining for investors to like about Chuy's.

    John

  • Report this Comment On August 15, 2012, at 2:50 PM, jclimber99 wrote:

    Didn't know about all the Chuy's debt, thought the IPO funds were mainly to be used for expansion.

    I live in Austin and all the Chuy's here are virtually jam-packed all the time, unless you go at off hours. Not too surprised about the growth in same-store sales because I'm not too sure how they could make more money unless they drastically increased prices. On originality - there is nothing quite like it in Austin, if you like Tex-Mex anyway.

  • Report this Comment On August 15, 2012, at 3:50 PM, atxfool wrote:

    It's one of the best, if not the best, mexican restaurants in Austin, a city with hundreds of mexican restaurants. With that kind of quality, it can easily dominate in other cities that lack much of a mexican cuisine. You call its growth statement "self-defeating verbiage", yet from what I've seen every lunch, dinner, and weekend, it is true that it is at capacity. Every time I'm in Panera Bread I see 80% of the tables open, so they have plenty of room for growth.

    From a selfish standpoint I was sad to see Chuy's expand since it won't be as special to take guests to anymore now that it is more readily available, but from an investment standpoint their growth through the nation has only begun and if it maintains its great food and character, it could be huge.

  • Report this Comment On August 17, 2012, at 4:34 PM, thesloth2 wrote:

    The prospectus seems to indicate that the $69M in net proceeds from the offering went directly to decrease this debt load - which on a pro-forma basis would instead have come to $13M in the March quarter.

    This excludes the additional $6M in proceeds from the greenshoe which was exercised in full, though it's unclear whether this went to further decrease debt.

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