Activist Investing Won't Save This Company

If you've been following the BJ's Restaurants (NASDAQ: BJRI  ) story for the last two years, you've seen the stock surrender half of its value as the company repeatedly failed to impress Wall Street. However, the stock recently jolted to life by climbing 20% after SEC filings revealed that activist investors have entered the picture. 

What's an activist investor?
Investopedia.com gives this definition for an activist investor: 

An individual or group that purchases large numbers of a public company's shares and/or tries to obtain seats on the company's board with the goal of effecting a major change in the company.

Activist investors PW Partners Atlas Fund II and Luxor Capital Partners L.P. have taken an interest in BJ's. PW Partners's Patrick Walsh heads up the combined effort, and since 2010 he has had his hands in Denny's, Red Robin, and most recently Famous Dave's of America. Initially, he plans to nominate five new members to the board of BJ's who will better create shareholder value.

What this likely means for BJ's 
A clash over how to best create shareholder value will likely come as a result. BJ plans to invest its available cash in new units. With $23 million in cash, no debt, and revenue that has nearly doubled in just five years, it's certainly in a fine financial position to do so. 

The plan for 2014 involves opening 15 new locations -- for an increase of 10%. BJ's opened 17 restaurants in 2013 at a cost of $80 million, so this year -- with all things equal -- it should spend around $70 million. Considering that the company had $95.5 million in cash flow and $21 million in net income in 2013, it should hit its current goals with no problems.

However, it's unlikely that Patrick Walsh will agree on BJ's value-creating method. Activist investors typically propose share buybacks, massive dividends, and company restructuring. These moves often focus on short-term returns, rather than strengthening a company for the long haul. 

Cracker Barrel (NASDAQ: CBRL  ) has fought a long battle with activist investor Biglari Holdings. The popular Southern restaurant wants to use its money to pay down debt, open new restaurants, and keep cash on hand in an emergency -- moves that Biglari calls "asinine." Biglari's (assumedly) non-asinine plan has included a $20 special dividend (about 20% of Cracker Barrel's market cap), leveraging Cracker Barrel's position for a large share buyback, and even offering to sell Cracker Barrel to the highest bidder. Notice that these proposals offer nice one-time paydays for existing shareholders, yet they do nothing to grow Cracker Barrel into a bigger and better business.

Shareholder pressure also factored into the Darden (NYSE: DRI  )  decision of hatching an ill-conceived plan to spin off Red Lobster. Originally concocted by activist Barington Capital Group, the idea allows the company to shed dead weight since Red Lobster has been the company's weakest-performing brand. Once free from the mental pressure of fixing the floundering restaurant, management can turn its focus to growing its Specialty Brands portfolio, which includes the promising Yard House and Capital Grille chains. The spin-off begins May 26th.

While The Red Lobster spin-off served as the talk of the conference call, the call also highlighted four other moves: Red Lobster's spin-off, slowed unit expansion, improved operations, and tweaked incentive plans. This satisfied some. However, noticeable absences included healthy business goals like identifying new revenue streams, better discovering what customers want, and expanding upon successes.

Cracker Barrel resisted activist proposals because it wants to invest cash to make its business stronger. Darden folded under pressure, and it has turned from business building to asset managing.

So what now?
If Walsh decides to make Darden-esque decisions or Cracker Barrel-style proposals, I would expect BJ's to strike those ideas down. On the conference call BJ's management did concede the possibility of slowing down growth for a bit, but this company still remains very much set on expansion and possibly tripling from its current size.

Yet one can't ignore that BJ's is struggling right now. In addition to a poor casual-dining climate in general, new restaurants are cannibalizing the old ones, comp-sales went negative last quarter, traffic was down 2.3%, and the company has been forced to sacrifice earnings by offering more competitively priced menu items.

However, remember that BJ's -- thanks to its solid financial position -- doesn't need to do anything rash. It still has plans in place for expanding into new markets like Palm Beach, FL and Baltimore, MD this year which should cut down on restaurant cannibalization. New products like Brewhouse Burgers have resonated with customers. Most impressively, BJ's average unit volume tops $5.7 million per year. There's too much good going on with this story to shift the business focus.

Even though issues are present, activist investing won't save BJ's because that implies that it needs saving. Businesses frequently go through ups and downs, and management needs more time to right the ship before taking drastic measures that will hurt the business over the long term.

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