IPO Insanity

Just when you thought it was safe to go back into the market...

Along comes Cava (CAVA), with its first-day 99% pop to around $40. And it's a Mediterranean fast-casual restaurant chain, no less, which is another way of saying it has nothing to do with artificial intelligence ("AI") or tech, for that matter.

I'm pretty sure most people didn't have restaurants on their bingo cards to become the hottest IPO of the year so far.

Yet here we are...

"It's been 20 months since a sizable deal raised the range," as Renaissance Capital's Bill Smith put it in a weekly IPO note he writes. "CAVA's 99% pop was the biggest for a U.S. company since 2021, and the biggest for a restaurant IPO since Shake Shack in 2015."

One reason, he says, is that "IPO investors have been starved of quality growth names," and Cava has plenty of fans in the investment community.

Or as veteran restaurant analyst Roger Lipton of Lipton Financial Services puts it in his blog...

The appeal, not necessarily in this order revolves around (1) the stores seem busy and well run and the menu is in tune with more healthful eating trends (2) store level economics, as described, are attractive, with a stated 35% cash on cash return in year two (3) Chairman, Ron Shaich, who built Panera, is very well respected by the investment community.

But there's a catch: This is the restaurant business, which in the best of times can prove challenging...

And Wall Street is littered with the remains of more than a few promising concepts, including some from well-known operators.

Like retail in general, with restaurants there's always the need to balance growth for the sake of growth (i.e., building units fast enough to meet investor expectations) with the reality of finding good locations, solid staffing, and the normal vagaries that make the restaurant business so difficult.

Making matters worse, some concepts that do well in one region simply might not do well in another. (On that point, now that Cava has led what is likely to be a parade of restaurant IPOs, keep an eye on this week's deal du jour, Gen Restaurant Group (GENK). It's a Korean barbeque restaurant chain that currently has 34 units, mostly in California, but thinks it can grow to 250.)

For Cava, with its IPO complete, now comes the hard part. Or as restaurant consultant John Gordon of Pacific Management Consulting Group explains...

Now that CAVA has been through an absolutely stunning IPO cycle, management must think about earnings, to power the price to earnings ratio that Wall Street will be endlessly thinking about.

He adds...

This is the downside of going public. Management has logical ideas. With just 263 units, certain companywide fixed expenses, such as G&A [general & administrative) are naturally high, at 12.4% in 2022.

That number must come down with more units and higher AUVs (average unit volume]. Improved company store margins, as already noted in Q1, plus more profitable units, and fixed cost leverage is the path to more enterprise earnings.

“This is the downside of going public”...

You don't hear it often, but Gordon has been around long enough to know that the IPO is the easy part.

With plans for 1,000 units by 2032, Cava is awfully ambitious. But nine years is a long time. It got a jump start on its expansion in 2018 by acquiring competitor Zoe’s, and converting its 145 stores to Cava. That represents 55% of its store base. "Unfortunately for Cava," says David Trainer of the research firm New Constructs, "and its path to profitability, this cheap source of store expansion, is coming to an end."

The company says as much in its IPO filing, he notes, disclosing that its operating expenses "will increase substantially in the foreseeable future."

That's why, as good as the concept may appear to be, Lipton cautioned...

You will not be surprised to learn that we will take our time to learn more about the sustaining economics of the CAVA growth plan. Even Panera provided its share of volatility over the years and provided alert investors with better timing opportunities than about to be presented by CAVA.

He's not the only seasoned restaurant analyst I've heard say the same thing.

And therein lies the moral of this story: If the pros are waiting to "learn more about the sustaining economics of the Cava growth plans," maybe you should be, too.

Speaking of IPOs, there's always the question of why companies go public in the first place...

The key reason, of course, is to raise cash, but it goes beyond that...

For many companies, it's a way for early backers and venture capitalists to cash out regardless of whether that's what management wants to do.

For others, it's management's ego gone wild. That's why, when I see them celebrating their IPOs on the floor of the exchanges, I often wonder: Do they really know what they've gotten themselves into and that going public is not the equivalent of the Good Housekeeping Seal of Approval?

As my friend Lise Buyer recently wrote, in an essay last March geared to private companies yearning for the high valuations of a few years ago...

The thoughtful, well-prepared teams will likely recognize that going public isn't just about the price on deal day. It's about a fully liquid market, a message of on-going stability, an enhanced treasury account and the opportunity to earn, not hope, the way back to a more fulsome market cap. 

Lise, whose Class V Group advises companies on going public, is a former analyst who was deeply involved in Google's (GOOGL) IPO... so she knows something about this.

Her advice to companies that have seen their values plummet...

Complete a smaller-than-originally-dreamed-of IPO, hit your forecasts, prove that yours is really a company, not a just a product or worse, a feature. 

Demonstrate to the throngs of institutional investors with too much cash on the sidelines today that the management team understands the responsibilities and frankly challenges of being public, and remind your employees that the stock goes up only if the business delivers. 

That's the point... long after the investment bankers have taken their fees and moved on, and the confetti stops falling at the stock exchanges, management is left to fend for itself... public filings and all.

As more than few learn the hard way: Those who fake it rarely make it.

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DISCLAIMER: This is solely my opinion based on my observations and interpretations of events, based on published facts, and should not be construed as investment advice.

(I write two investment newsletters for Empire Financial Research, Empire Real Wealth and Herb Greenberg’s Quant-X System. For more information, click here and here.)

Feel free to contact me at herbgreenberg@substack.com. You can follow me on Twitter @herbgreenberg.